The U.S. is in a recession by traditional definitions: depending on your source, several months or two consecutive quarters of economic slowdown. However, we continue to see strong employment rates when recessions often carry an increase in job losses and unemployment.
But whether we are in a recession or just a period of strong economic uncertainty, the question remains: What should I do with my investment money?
Specific to real estate and multifamily, the industry I have spent my entire career in, we are seeing shifting fundamentals across the country. The COVID-19 pandemic pushed people to want more space. Additionally, low interest rates made housing more affordable for many, given the lower monthly payments of a mortgage.
Now, with interest rates up, there are fewer buyers. With rents skyrocketing over the last 18 months, more renters are considering roommates, meaning fewer rental units are needed.
With these broader economic risks and the shift in real estate, too, herein lies the catch-22: if you invest now, you are accepting more perceived risk than in an era of economic expansion, and yet the outlook on many investment returns is lower than can be assumed in stronger economies. Investing 101 states that more risk should yield higher returns, but that is not necessarily the case in uncertain times.
I am not a financial advisor, and so this information is purely my opinion on the subject.
When looking at making a real estate investment, you must balance many different factors, which all boil down to taking on or mitigating risks. You essentially have two options: sit on your cash or invest now. Here are some of the ways I view my personal investments today.
Sitting on Cash
The biggest risk here is that inflation continues to erode the value of your cash, and we never see a major drop in real estate values to offset your erosion of value.
The risk here is very real. A lot of real estate fundamentals are very strong. As noted, we have not seen major declines in overall employment. If residents are employed, they continue to pay rent. Many industries are seeing continued strong outlooks, meaning those employees remain confident in the long-term outlook and have been shown to continue spending money, keeping retail earnings healthier than other recessions. This keeps office spaces full and business travel strong, so hotels remain full.
And with the interest rates as high as they are, on top of material and labor prices remaining high, development pipelines have slowed to a near stop, meaning the continued high demand has no new supply to expand into. From here, Econ 101 takes over: Demand that’s higher than supply means higher prices on existing product. When office, retail, industrial, and apartment rents stay strong, along with RevPAR in hotels, values will remain high, and very few distressed assets will enter the market to start affecting prices.
Investing Now
The risk of investing now is the inverse of the above. While spending has remained strong, what if the tipping point is just around the corner? Lower spending means lower sales, which means job cuts and businesses cutting other expenses, too. This could range from culling retail square footage and downsizing office space to more virtual client meetings with fewer travel expenses and lower hotel occupancy.
Conservative operators are assuming this slowdown will come. Rent growth will slow, and occupancy will increase. Because of this, many operators are underwriting lower overall returns than may have been projected 12–24 months ago. Finance 101 states that you should be compensated for your risk, so risks that feel higher with return projections that are lower don’t make sense.
Of course, no one has a crystal ball. We can listen to industry experts, but even those vary in their opinions of the future. Some will be right, and others will be wrong. For my personal portfolio, I am still investing, but at a slower pace. Basically, I am hedging. I don’t want all of my capital sitting idle, waiting for a cliff that never comes. And I don’t want to sink all my eggs into an investment that may struggle along. This is the basic portfolio theory of dollar-cost averaging. While this is typically applied to buying stock over time, I view it the same way with real estate investments. I am looking to continually place capital both in periods of strong optimism and fear.
The benefit of this strategy, given the illiquid nature of the real estate, is that it also helps create investment laddering, or having a steady stream of investments placed over time limits the likelihood of having a major capital event taking all my capital out at once, and introducing reinvestment risk on my entire pool of capital.
Lastly, I always take the Warren Buffett approach: Only invest in things you know and understand. Thankfully, there is a lot of educational content available to help you learn about any area of investing. And I never invest more than I can lose. With my real estate investments, that means asset classes I understand, operators I trust, and time to look into the details of their investments. How are they mitigating risks? How do their assumptions compare to current market conditions and long-term average market conditions? How did they perform during prior recessions?
Sitting on idle capital has rarely proven to be a smart strategy, and those that try to time the market often lose. But being smart with your investments will continue to set you up for a better future.
Written by Evan Polaski, Ashcroft Capital