Times of Turbulence Offer Great Opportunities to Invest in Real Estate
By G. Brian Davis
In the aftermath of the Great Recession, for example, US home prices fell roughly 33% on average. But even if listed home prices don't drop a cent in the current pandemic-induced recession, there will still be plenty of opportunities for distressed sales.
With over 40 million Americans out of work, you better believe many will accept a lower offer in exchange for a fast, sure settlement, which real estate investors can provide.
Meanwhile, many investors worry about a coming wave of inflation, as the Federal Reserve has announced indefinite quantitative easing and "printing" new money to inject into the economy. Real estate offers an outstanding hedge against inflation, as rents and prices adjust according to the dollar's changing value.
Yet, for all the opportunity for real estate investors right now, they also face a slew of challenges and unusual risks. Many investors find themselves unsure whether to pull the trigger on deals or wait and see.
As the public health crisis ebbs and the full economic crisis becomes clearer, keep the following risks and challenges in mind — and take steps to mitigate them as you add to your rental portfolio.
Challenge 1: High Unemployment Adds Risk of Rent Defaults
Dizzying unemployment rates cut both ways. They create an opportunity for real estate investors, but they also elevate the risk of rent defaults.
When tenants stop paying their rents, landlords don't stop incurring expenses. They still need to make their mortgage payments, pay for maintenance, repairs, property taxes, insurance, and property management fees. Landlords quickly go from earning money on their rentals to losing it when tenants default.
Bear in mind that jobs and unemployment rates aren't evenly distributed across the US. For a better sense of the geographic distribution of jobs (and lack thereof), see this map of unemployment rates in every county in the US, as of April 2020 (the most recent data released by the BLS):
Mitigating the Higher Risk of Rent Defaults
To begin with, choose neighborhoods carefully. Look for communities with strong demand for housing and low vacancy rates.
With a strong demand for housing comes plenty of rental applications to choose from, so you can pick exceptionally stable and reliable tenants.
This raises the second point for rental investors: screen all rental applications even more thoroughly than usual. Run credit reports, criminal background checks, and eviction history reports, of course. But go further to verify not only their income and employment but the stability of their employer and the likelihood of the applicant's continued employment. Ask what kind of worker they are: do they show up on time to work every day, and how conscientious are they?
You only want to sign a lease agreement with a renter with overwhelmingly high odds of keeping their job and paying their rent on time every month. Even in normal times, hasty tenant screening marks one of the costliest mistakes made by inexperienced landlords.
Also, look into your insurance options. Some property insurance policies may cover lost rents. And you can also buy rent default insurance, to protect specifically against lost unpaid rents.
Challenge 2: Eviction Moratoriums
Eviction is the landlords' only legal mechanism for enforcing the terms of a lease agreement. Without it, leases become unenforceable, a unilateral rather than bilateral contract.
Landlords around the country face multiple levels of eviction challenges. On the federal level, the CARES Act suspends all evictions until July 24th, 2020, for the following properties:
• Properties secured with federally-backed mortgages (Fannie Mae and Freddie Mac loans, FHA loans, VA loans, USDA loans)
• Section 8 properties
• Properties covered by the Low Income Housing Tax Credit (LIHTC)
But many state and local governments have also declared moratoriums on all evictions, with varying expiration dates. Even in jurisdictions without explicit eviction freezes, many have temporarily closed civil courts, which prevents landlords from scheduling a rent hearing — a necessary step in the eviction process.
Even when evictions restart, expect significant backlogs and delays, drawing out the eviction process and the period when tenants live rent-free. Unfortunately, many landlords have subsidized their tenant's rents during the pandemic and will continue to do so for months to come.
Mitigating Eviction Challenges
For new properties, be cautious about buying properties in any jurisdiction with express eviction bans. If you can't enforce a legal contract, there's little reason to enter into one in the first place.
Landlords with vacant properties should, again, screen all rental applications more aggressively than usual. With no way to remove non-paying tenants, do everything you can to avoid that situation in the first place.
Have non-paying tenants in your existing rental units? Once courts reopen eviction proceedings, be the first to file in your district to avoid lengthy backlogs and delays. Serve the required eviction warning notice as soon as it is allowed, wait for the mandatory grace period, and then file on the first day allowed.
Challenge 3: Financing
Mortgage lenders have tightened up during the pandemic, particularly for real estate investors.
Every single one of the rental property lenders we work with suspended new loans entirely in April and May. As of June, around half have restarted lending — but with stricter requirements.
All have raised the minimum credit score that they allow for rental property loans, many from 620 all the way up to 680. All have started charging higher interest, with rates starting around 6.5% rather than 5%. And all have lowered their maximum loan-to-value ratio (LTV) to 75%.
We expect remaining lenders specializing in rental property loans to resume lending by July, at these tighter loan standards. But I don't expect rental property loan terms to loosen until late 2020 at the earliest.
Mitigating Financing Challenges
If you have weak credit, start improving it, because credit scores matter more than ever during recessions.
But you can also get creative with rental property financing. For example, as you make offers, consider negotiating seller financing. That could mean the entire first mortgage, or simply a seller-held second mortgage to help toward your down payment.
You can also tap into existing equity, either in your home or your other rental properties. That could mean a home equity loan, or more flexibly a home equity line of credit (HELOC). "Many landlords are surprised to learn they can take out HELOCs against their rental properties, not just their primary residence," notes Darren Robertson from Northern Virginia Home Pro.
Alternatively, you can get even more creative and use unsecured business credit lines and cards. For example, we work with a company called Fund & Grow that helps real estate investors open between $150,000 - $200,000 in credit lines on average. You can then draw on those credit lines to buy properties outright, put money toward a down payment, or pay for renovations.
Challenge 4: Limited Exit Strategies
In many markets, it's harder to sell properties right now, which makes sense. Soaring unemployment rates mean fewer Americans can afford to buy, and tighter loan terms mean fewer would-be buyers can qualify for a mortgage. According to the National Association of Realtors, pending home sales dropped 21.8% in April.
On the rental side, you have fewer revenue options available as well. With the travel industry still effectively hamstrung, many Airbnb landlords see occupancy rates near 0%.
All of which limits real estate investors' exit strategies.
Mitigating the Risk of Fewer Exit Strategies
First, investors should run the numbers carefully on every property they buy, to make sure they work as a profitable long-term rental. If the numbers only work as a short-term vacation rental, for example, it may cause you to lose money between now and when the travel industry recovers, which could take years.
If you plan to sell a property, consider offering seller financing. Many prospective buyers who would have qualified for a loan four months ago find themselves unable to get financing today.
And with loan default rates higher than usual, expect tighter loan standards for the foreseeable future.
The coronavirus pandemic and subsequent recession leave us in uncharted territory. No one knows if a deadly second wave looms on the horizon, or how long it will take for businesses and job markets to recover.
No one knows with certainty what lies ahead for real estate investors post-pandemic.
Still, investors can rely on a few fundamentals. Neighborhoods with a strong demand for rental housing will leave landlords with plenty of rental applications with stable renters likely to pay their rents on time and in full. Cities and states without active eviction moratoriums allow landlords to enforce their lease agreements.
As you navigate real estate investing post-pandemic, look for bargains, run the rental cash flow numbers carefully, and invest in areas with high demand for rentals and no roadblocks to enforcing your leases. Do that, and you can come out ahead in these times of turmoil.
Are you actively investing in rental properties right now? Why or why not?
About the Author: G. Brian Davis is a real estate investor and co-founder of SparkRental.com, which provides tools and resources to help everyday people build enough rental income on the side of their full-time job to cover their living expenses. In other words, to reach financial independence with real estate. Brian spends ten months out of the year traveling overseas with his family, living the very life he helps other people create with real estate.
If you liked this article, subscribe to Rentometer's email newsletter to stay up-to-date on the latest trends in rental housing.