The stock market is trashed, and interest rates on bonds and mutual funds are still very low, where do you put your money? Real estate is a great way to hedge inflation and ride out the recession. How do you acquire your rental property in a recession? It’s time to think outside of the box. 13 ways to finance rental property in a recession are provided below.
A recession brings both tragedy and opportunity. You can avoid the tragedy and take advantage of opportunities that arise out of the chaos that is a recession.
A financial crisis is in full swing. The good thing (if there is a good thing) is that this is not the first period of high inflation that affects the housing market and it will not be the last. As real estate values adjust to the economic recession, one is reminded of past recessions. At this time the new recession is just entering its beginning phases. Real estate prices will eventually level off as this cycle comes to an end.
Bargains have already begun to appear and it’s time for you to look at rental properties as a way to ride out the economic downturn. (read our article below about prices and perspective).
Rent rates are increasing
As you would expect with rising prices across the board, rents are also rising. In some markets rents, rates were lagging. Many rental property owners are individuals who are generally reluctant to raise rates when they have “good” tenants. You know the ones who pay on time every month. The problem with good tenants is that they are not paying all of your bills and providing a profit.
Property owners have experienced increases in costs so it’s appropriate to increase rents. The opportunity to increase rents is when everything else is going up. It’s almost expected. I have seen several properties on the market with rent rates well below the market rate. That “market rate ” is also on the way up, it’s very fluid.
One reason that investors may find bargains is that owners who are not connected to articles like this one or that are sedentary in their ways, will not understand the true value of their property. If you raise the rents after buying and can get through the eventual exodus of tenants, the numbers you calculated will line up. This is how bargains begin.
Real estate investments are a path to wealth
Real estate investments have traditionally been a path to wealth for people who took advantage of lower prices when the real estate market took a dip. This cycle has repeated itself many times. The first major dip in recent decades came during the late 1990s. The Japanese economy collapsed and their massive real estate holdings in the U.S. crashed.
Japanese sold off the real estate at bargain prices which caused a major reduction in property values.
Many remember the housing crisis generated by the U.S. government when they financed anyone with a pulse. Housing prices dropped fast and billions of dollars in household wealth disappeared. This situation happened almost 10 years after the previous crash. In the interim between 1999 and 2009, values recovered completely and people were riding the tidal wave of equity. Home values soared until they fell.
And yet again, residential real estate climbed during the past 10 years from a low in 2011 to a high in 2021, another 10 years. At this point in late 2022, prices are still up substantially over the previous period. Can you see a pattern here? The best time to buy property is when everyone is selling.
Buy low and sell high or buy low, rent and then sell high
You can get a good deal if you watch and wait for it. The way to build wealth with real estate like any other commodity is to buy low and sell high.
Rental income property is a good investment at any time. There is a significant shortage of housing nationwide and in particular rental housing. What happens when people lose their homes? The rent. When people can no longer afford to buy a house after selling one, they rent until things change.
This means, one of the best investments for your hard-earned cash is real estate investing. Yes, there will be future recessions and if you take advantage of this one, you can do so again. It seems that they are coming to us in ten-year increments.
The first step is to buy a single property. Buy it right meaning at an excellent price. Make sure it is in good condition. Rent it at the market or above and hold on to it until the next housing bubble or economic recovery then sell. This should be part of your financial plan. Now that I have explored with you the general market and the good news that economic conditions will eventually improve, it’s time to discuss how to buy that property.
Long-term trends indicate interest rates will eventually drop
It would be nice if lower interest rates were still with us but that ship as they say has sailed. There is good reason to believe long term, rates will drop. Perhaps not as low as they have been for the last many years but lower than they are today.
Because lower mortgage rates are no longer with us, it’s time to get creative about how to finance your real estate portfolio consisting of existing and potential acquisitions. Property owners should do a few things to make sure they are positioned to take advantage of the shrinking economy.
Consider the following action to take now:
- Take a course to become an expert on an investment property before you attempt to buy the first property. Check out our courses below, and take one or more of our FREE mini-courses. Enroll in our full courses to expand your knowledge.
- Conserve capital – This is not the time to buy unnecessary things or add a room to your home. Build up capital for that great investment. Increase savings if you are employed and sell off unneeded assets such as an unused motorhome, boat, or other valuable items. Remember inflation has made many of these things worth more money.
- Rental rates – If you have existing rental property, increase your rental rates to market or greater. This is a business and you need the additional cash now. Rent rates are going up so take advantage of it.
- Obtain a line of credit on your property – This is a standby line to permit rehabbing of a property or the acquisition of a new property if necessary. Interest rates are higher but your property value is as well and your line of credit will in part depend upon the value of your house. Get it now before the value drops.
- Increase cash flow – Do this by paying off any high-interest credit cards. Don’t use up all of your capital to do this but as much as you can afford. Reduce debt now as interest rates on unsecured lines of credit and credit cards are increasing
- Sell underperforming properties – The economy is transitioning from a seller’s market and you probably have equity in the property. If you have done everything necessary to make it work and it does not move it out of your portfolio now. A good way is to enlist the services of a licensed real estate agent.
- Review your 401k contributions – Equities that were a good buy and were a haven in the past may not be now. Don’t start selling off stock without a plan but you can change what you are investing in now. Stock prices are low so look for values. The worst case scenario is that you do nothing but hope to average out some investments by buying in low now.
- Hold on to that job – Layoffs are coming, and unemployment rates will begin to rise as they always have during similar economic times. Your job will help you retain your ability to accumulate funds for your next investment. There will be fewer jobs available in the coming months.
- Don’t buy a new car, boat, RV, or other large purchase now. Prices will come down and you can buy later just before the extensive recovery. That will be a great time to buy as we approach the next bull market and we will. Remember to conserve capital, you are going to need it to make those investments.
Financing that rental property
Now that we have discussed the preparation, it’s time to talk about financing your next real estate acquisition such as single-family homes, multi-family duplexes, or other residential rental properties. If you have been an investor in the past, you understand the basics of financing an investment house or a second home. Put x% down with a credit score of X and a debt-to-income ratio of x.
[Check out our free financial calculators here]
When these things line up, you begin to qualify. The other point is the income factor. You will need a source of income to repay the loan. If you are working full time with a good salary, credit score and ratios line up, you will probably be approved for the loan.
Yes, mortgage payments have gone up but so have rents. Home prices are leveling off and some markets have already started the inevitable decline associated with a recession.
Real estate agents are seeing firsthand that sellers have lost their edge. This means more opportunities for investors. Finding properties will become easier as property prices continue to decline. The discussion is all about how to get that property financed which is the focus of this article and most conversations in the real estate world.
Investors are exploring alternative finance venues
Time to discuss a couple of financing methods that are becoming more common in this economy. Commercial loans are called DSCR (debt service coverage ratio). The DSCR is a measure of a company’s ability to repay its loans. These loans are given to businesses. You can create an LLC and present a business plan with a forecast for your rental property and request a DSCR. More on this later.
A bank statement loan is also a possibility for higher net-worth individuals and self-employed persons. This loan requires you to demonstrate a significant cash flow with a stable income. An important factor in all of the loan programs is that you are a qualified buyer which means good credit generally above 640 but above 700 is best for rates.
Regardless of the type of loan even when it is not a personal loan excellent credit is the key. Savvy real estate investors know how important it is to have resources including good credit.
Nine (13) ways you can acquire investment property during a recession:
- Cash – You can pay all cash to get the property. Rehab it if necessary then swing a loan at a later date to pull out equity.
- Owner financing – Get the owner to give you a three-five-year balloon note with x% down and a 30-year amortization. This gives you time to increase value and then obtain a long-term loan
- Co-op – An LLC with multiple owners each putting the required funds to buy and close. This reduces the risk to any one person
- Self-Directed IRA – This is a special IRA where you can transfer funds from your existing 401(k) to invest without any tax consequences.
- Second home loan – An ordinary real estate loan for a second home. You can do this just once.
- Conventional loan – The typical method of financing residential rental property.
- Government loan – local programs with zero down payment bank guaranteed. Usually supported by state or local funding.
- FHA loan – Quasi-government financing
- VA loan – For a primary residence that will become an investment property later.
- DSCR – Commercial loan where the income of the property is used to support the loan
- Bank Statement loan – Similar to DSCR but for professionals, self-employed and higher net worth individuals. Use bank statements rather than W2 to support income.
- Hard money lenders – Usually for short-term financing as with a flip. Can be a longer-term
- Hybrid lenders – Kabbage/American Express with high loan limits
- Other – Internet private lenders, short-term or long term
There are some good reasons why lenders will want to work with you. Low vacancy rates are typical, and there is great demand for rental property—student housing, visiting nurse housing, and other niche housing opportunities depending upon your location. There are unlikely to be any subprime mortgages this time around like there were a decade ago.
Lenders are tough on qualifications this time which is good for all of us. Because of the tough requirements, there will be fewer people competing for properties this time around. Property investors must be qualified. If you are, then you are ahead of the pack.
Start your journey by gathering the basics. It’s a good idea to line up your financial details which will be required by your lender.
Your financial personal resources
The stock market has reduced the average 401k by about 35% as of this writing. The last thing you need to do at this point is to cash out your equities and withdraw funds from either a 401k or IRA. There are consequences including income tax and early withdrawal penalties.
You can however borrow from your 401k to buy a principal house and some may permit a second home. The maximum you can borrow is $50,000 (this may increase with new rules). There are no taxes or penalties for this type of withdrawal. This type of loan will not work for most investments.
There is another way to withdraw funds from your 401k for purchase and that is to transfer your funds to a self-directed IRA. There are no penalties for the new IRA to take funds from your 401k as long as it is done between financial institutions. Before you do this, consider the consequences of selling off equities that have been reduced in value. Refer to the first paragraph.
Self-Directed IRA can be a source of funding
If you have funds in a money market or other type of investment in your 401k that has not suffered a significant loss, you could consider using those funds with your Self Directed IRA. You may also be one of those rare people who have not suffered a loss in specific investments and can move those gains over. This program is great for those who have sufficient funds in their 401k or IRA to make a purchase.
SDRAs are a good way to finance your property purchases as long as you understand that the income earned from these loans must go back into your SDRA unless you are over age 59.5 in which case you can withdraw without penalty. Any withdrawal of the profit is subject to your effective tax rate at the time of the withdrawal.
Real estate equity loans are a source of financing as well. You can tap the equity in your own home or investment properties. There are various programs for pulling capital out of your home including a second mortgage or HELOC. Interest rates on these loans are higher than on your first mortgage but may be overcome by the forecasted income on the investment.
HELOCs have become more popular
Pulling equity out of investment properties without selling them has become more challenging recently. There are ways to bundle loans into a single loan and other mechanisms to fund your property. Remember the existing mortgages you are paying before you decide to obtain new first mortgages on existing properties. You may be one of those investors who has a 3% interest rate on your home or rental property.
Many people refinanced at the historic low point of about 2.5% and are reluctant to refinance their homes and pull out cash for investment. Instead, they are obtaining HELOCs or second mortgages to tap the equity. If this is your decision, move fast before your equity erodes more than it probably has in recent months.
HELOCs and second mortgages were not popular in the past few years because people could refinance at lower rates and take out equity. Now the situation is reversed where HELOCs are more popular due to the increase in mortgage interest rates.
Thank you for reading this article. I invite you to read other articles that we have written and will write about this and similar subjects. Please leave comments at the end of the article and register to be notified of future articles.
A few articles that also contain financial calculators related to this article:
Current Mortgage Rates and Housing Prices in Perspective.
How You Should Compare Long vs Short Term Rentals
Best places to buy Airbnb rental properties
Want to become an expert rental property investor? KEYLADDER offers several courses that can help you become an expert at buying, managing, and selling investment property. Click on the button below to take one of our FREE mini-courses or enroll to take our full courses.
Note: This article discusses financial issues and makes some suggestions for you to consider only. KEYLADDER is not replacing a licensed professional CPA or legal counsel. You utilize any information provided here at your own risk.
Trackbacks/Pingbacks