How Real Estate Investors Can Take Advantage Of Any Economic Scenario

February 20, 2014

Over the last few weeks, I’ve been writing about investing in rental real estate. I’m going to conclude this series with a final argument in favor of real estate investing and that’s how it’s likely to be affected by four different economic environments relative to other investments and the opportunities each situation presents to real estate investors. Here are the four different scenarios:

Scenario #1: Prosperity. The economy continues to recover and interest rates slowly move up.

Best performing asset classes: stocks and real estate

Worst performing asset classes: bonds and gold

Opportunity: You can increase your rental income with the improving job market and rising incomes while your mortgage costs remain fixed. The value of your property is likely to increase too.

Scenario #2: Rising Inflation. All the money the Fed has been printing leads to higher inflation and interest rates, slowing the economy.

Best performing asset classes: real estate and gold

Worst performing asset classes: stocks and bonds

Opportunity: As with prosperity, your rents and maybe property values (depending on the effect of higher mortgage rates) will rise while your mortgage costs remain fixed.

Scenario #3: Deflationary Recession. We enter the dreaded double-dip recession with interest rates staying the same or even going lower.

Best performing asset classes: bonds and gold

Worst performing asset classes: stocks and real estate

Opportunity: Yes, real estate is in the “loser” category this time but it’s not as bad as it seems. As long as you can keep a paying tenant, you still have rental income and your property taxes may even go down if the property value falls. If mortgage rates go down, you can refinance and lower your payment. This is also an opportunity to invest in more properties before prices and interest rates go back up.

Scenario #4: Tight Money Recession. The Fed raises interest rates too fast/too soon, causing the economy to dip back into recession.

Best performing asset classes: none

Worst performing asset classes: stocks, bonds, gold, and real estate

Opportunity: As you can see, there is no winner here. The best that can be said is that you won’t lose anything if you still have a paying tenant and don’t need to sell your property. Fortunately, these situations don’t tend to last very long as the Fed usually cuts interest rates, leading to one of the earlier scenarios.

Now, it’s true that many real estate investors suffered during the last recession (which started as scenario #4 and turned into #3) but many of them bought places with negative cash flow hoping to flip them for a quick buck, took out adjustable-rate mortgages that adjusted upwards, and didn’t have enough savings to ride out any vacancies or delinquencies. In other words, the tide receded and we saw who was swimming naked. Smart investors used that as an opportunity to refinance their mortgages at record low rates and purchase more properties at low prices.

Economic recovery? Inflation? Another recession? Who knows (not economists or anyone else for that matter) and for real estate investors, who cares? As long as you have positive cash flow, good tenants and property management, a fixed rate mortgage, and emergency cash reserves, you should be okay regardless of what the economy does.