Real estate, like every other markets, goes through up and down cycles. We’ve been in a strong market for several years now, and, as a result, many investors have gotten wealthy. While there is by no means consensus, some pundits are predicting that the U.S. will be entering a recession some time before the next election. We can’t see the future, but we know how commercial real estate investors should prepare for it.
Commercial Real Estate Differs from Residential
The 2008 economic meltdown was a huge event, not at all like a typical down cycle. The biggest losers were folks who could no longer pay the mortgages on their homes. Millions lost their homes through foreclosure and were forced into rentals.
This is an important distinction. While an economic downturn puts downward pressure on residential real estate, it simultaneously creates new demand for rental units. This is an unfortunate fact of life. It should guide the behavior of investors who own rental homes and apartment buildings. The extra demand caused by foreclosures might not be enough to drive up rents, but it should cushion any softness in rental rates.
Buying Real Estate While It’s on Sale
The best time to buy stocks is when they are selling at a discount, which often happens during a recession. Real estate is no different. Whether you are a flipper or a long-term investor, smart investors use recessions to snap up highly desirable properties at discount. For example, suppose a small apartment building was valued at $2 million at the top of the market and generated an NOI of $200,000. That’s a cap rate of 10%. If the property goes on sale for $1.6 million during a recession, the cap rate rises to 12.5%. That’s a healthy increase in expected return.
The tax benefits of commercial real estate continue through up and down markets. We recently wrote about the tax advantages of long-term investing in Opportunity Zones. Then there is the 20% qualified business deduction that favors the real estate industry. Of course, the long-term capital gains rates for properties held for at least one year continues to cut a huge chunk of tax stemming from property sales.
Also remember that carrying costs on CRE is tax-deductible. This makes it much easier to hold CRE compared to one’s own residence. Another factor that takes some sting out of a real estate downturn is that mortgage interest rates drop. This is a vast incentive to purchase commercial properties at a discount, financed at a low rate, which will allow you to collect rents as you ride out the recession. You can then sell at a profit after the market recovers.
Specialty Lending Group provides hard money loans in the Greater Washington DC region. We know first-hand how all phases of the real estate cycle present unique opportunities. If you’d like to learn more, contact us today.