Buying ‘Recession Proof’

January 15, 2019

Following on from the more general article above – no matter what the current economic outlook, take the following into account when you buy and you’ll see through the next downturn without flinching – 

Buy primarily for Cashflow. Do not ‘Buy for capital growth’

Right now I’m in Cebu, Philippines (much of our back office work is done here). The city is the middle of condo boom, the like of which I’ve seen before, and it didn’t end well. Gross yields are 4%. ‘Investors’ are buying for capital growth. Thousands of new units are being built right now, lending for locals has been loosened to USA 2006 levels, and everyone suddenly thinks that buying a condo to Airbnb is the way to riches. I remember witness a very similar scenario in 2006 in Las Vegas, when the salesgirl tried to convince me that the 4% gross yield that wouldn’t cover the mortgage didn’t matter because you were ‘buying for capital growth’ Anyway we all know what happened next. 

Buying this way amounts to pure speculation, rather like buying tech stocks where no one really knows what they even do, if anything. The certainties are there though – easy lending, leads to speculation and overbuilding, leads to oversupply of rental property, leads to falling rents and empty condos, leads to investors losing money and selling for a loss. 

I avoid this kind of market. In Buffalo the houses we are buying are still cheaper than build cost, so there’s no competition from new builds. However I do notice that now the market has tightened up, the quality of rehabs have improved tremendously and competition for good quality tenants has increased. However, good quality long term tenants are prepared to pay premium rents for a house in good condition that is managed well. And the owner of that house, with strong steady cashflow (sure, plus the bonus of capital growth) is where you want to be long term. 

Buy in a location with strong Tenant Demand

Another mirage of the young and hungry condo salesmen is the idea that there is a never-ending rental demand. If you build 500 condos and sell them all to ‘investors’, then the market has just jumped off a cliff in terms of oversupply. Perhaps wiser to check out a market where tenant demand vastly outstrips supply. There are numerous reasons and situations for that. One I mentioned above is a place like Buffalo (and this is common in a few cities across USA) where the new-build cost is higher than the cost to buy an existing house so new houses in that segment of the market simply are not being built (why would you build a house and sell at a loss when you can simply rehab an existing house?) A few cities saw giant influx of tenants (North Dakota Oil boom towns, for example) but this isn’t a sustainable business model. Best to stick to places where you still have that built in equity, and therefor a build in over-demand for the houses. 

It is also worth being sensitive to increasing and decreasing local demand in different parts of cities. 

Take a mortgage by all means – but don’t over-leverage

One thing that caught out many investors in the last crash was when they were left with a mortgaged unit and no tenant. You can still make money in a rough market if you don’t have any kind of mortgage and can afford to reduce the rent a bit to keep you in positive cashflow until the market inevitably recovers.

Buy a house that works, not a money pit

On the flip side of the coin, it’s often tempting to buy a house with the highest gross yield you can find. However if a house has an on paper yield of 45%, you can put money on it that there is something wrong with it. Be careful of houses in bad condition. Sometimes the tenant will still continue to pay, but any tenant who is prepared to live in a dump is not likely to be your ideal tenant. You are also going to have ongoing issues with the city, and as the house deteriorates, the cost of rehabbing it goes up. Best to just avoid the issues and focus on a house that’s already in good condition that can get you a good positive cashflow.

Take into account the bigger picture

When you are looking at possibilities, check out the broader economy in a city. Is it booming? If so, why? Is that sustainable? How are the city finances? Many US cities can not fund their pension obligations (i.e. Chicago) and could easily end up like Detroit. Again steady she goes is usually the best ‘bigger picture’ to go for – this investment isn’t really meant to be exciting, its meant to let you afford an exciting life.

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