Welcome to 2023, everyone! Glad to be here with you. As we enter the new year, the world continues to be in a state of economic uncertainty. After posting modest gains in the first few weeks of 2023, NASDAQ, S&P, and other major indices have begun to dip again in response to reduced consumer spending in the closing weeks of 2022. The threat of recession is still quite real. Recently 60% of economists in a Wall Street Journal survey said it's not a question of if we will have a recession in 2023, but a question of when, where, and how severely that recession will hit.
What does a recession mean for real estate investors? It’s nearly impossible to say with complete certainty the specific impact a recession will have on any particular part of the economy. But we are not completely in the dark. A few key indicators are often present when economic slowdown occurs.
These indicators can help real estate investors and real estate investor hopefuls know how to proceed. In a world of inflation, FED interest rate shifts, a slowing housing market, and supply chain issues (to name a few indicators of economic uncertainty), the best real estate investment strategy may not be building a personal rental property empire. Real Estate Investment Trusts (REITs) offer simple real estate investments and a more likely source of passive income that is often closely associated with investing in rental properties. Here’s why.
Are Profits Promised by Real Estate Ownership Slipping Away?
High interest rates have become part of our economic reality in the last year. As the FED looks to fight rampant inflation coming out of the pandemic, they have raised interest rates. In general, this means borrowing money is more expensive. You’ll have to pay a higher percentage on a loan taken out in January 2023 than you would have in January 2022. Mortgages, or loans for real estate purchases, are no exception. The average mortgage rate for a 30-year fixed is 6.39% in early 2023, compared to 3.22% at the start of 2022. Not only are mortgages more expensive, but home prices are still higher than pre-pandemic levels. The red hot housing market has cooled off since summer 2022, but prices are still relatively high. High home prices and high mortgage prices eat into the potential profits to be earned by landlords.
To further eat into these profits, maintenance costs are up due to inflation and supply chain issues. Many raw materials that are necessary to maintain properties such as metal and wood are in high demand and short supply. Costs of goods in general needed to maintain properties cost more due to inflation.
A Caveat on Rising Mortgage Rates
High FED interest rates and increased mortgage rates are the reality in our current economic climate. However, with an economic downturn on the horizon, the interest rate level set by the FED and the national average mortgage rate may stop moving in the same direction.
To be impartial, mortgage rates are not directly tied to the FED interest rate. Historically with a recession coming, investors around the world flock to the security of U.S. Treasury Bonds (the security of securities, eh?). When investors begin to buy up treasury bonds, the yield (the return on investment) of those bonds typically drops.
In the past, mortgage rates have been shown to move in the same direction as bond yields. So as bond yields fall, mortgage rates also tend to fall. Without going too far down the economics rabbit hole, the key reason for bond yields and mortgage rates moving together is because the rate of return on investments tends to equalize in any given market. The market here is securities, where lenders give up present money to receive a greater amount of money at a later date.
Theoretically, mortgage rates falling due to a general shift by investors into treasury bonds could help make purchasing real estate more affordable as economic slowdown hits. This potential is good for the rental property lords and ladies among us. The credit needed to purchase real estate may begin to cost less. Profits from owning and operating real estate may not be as eaten up by large mortgage payments.
The emphasis in that sentence is the word “MAY”. Historically, we have seen bond yields and mortgage rates fall together, but it is not a proven law. More importantly, other factors eating into potential profits from owning and operating rental properties are still very present in our current economic situation.
The combined factors of high home prices paired with inflation and supply chain woes means that the ever hyped passive income of owning rental properties looks less promising as economic slowdown ensues and recession looms.
Recession Proof Real Estate: REITs
A stronger option for real estate investors bracing for economic downturn are REITs. REITs are known for resilience through economic downturn and inflation. In times like these, other investments show a lot of volatility, especially traditional stocks. Investing in REITs during downturns also sidesteps most of the uncertainty and hassle in directly purchasing, owning and operating real estate. In 2023, REITs are uniquely positioned to weather the economic storm because of their strong balance sheets and smart debt structure, allowing for fewer expenses eating into their net operating income.
Fewer operating expenses are great for REIT investors, because a big chunk (90%!!) REITs' taxable income is paid to shareholders in dividends. REIT dividend replicates the regular passive income earned by owning rental properties. Retaining the passive income potentially of owning and operating real estate, while resisting the waves of economic uncertainty? REITs might just be the recession investment you are looking for. As a REIT, we are biased, we'll say it, but we aren't the only ones who think REITs are the move in 2023.
If you are interested in REITs, we have plenty of blog articles about them. We at Reiturn also offer you a chance to get skin in the game at a price accessible for all kinds of investors. Check us out!
