The S&P 500 fell 57 percent during the Great Recession — hardly a comforting thought, if you worry about a recession looming in 2023.
As the Federal Reserve raises interest rates to fight inflation — which includes soaring rents — some analysts see a recession next year as likely.
So how do rental properties fare during recessions? Will they protect your portfolio?In many ways they do, but not in every way. Here’s why.
Rents in recessions
Landlords can breathe easier knowing that rents don’t historically decline during recessions. They sometimes flatten, but never drop.
Take a look at this Consumer Price Index graph of rents in U.S. cities, from the Federal Reserve:
Even in the Great Recession, which was largely caused by a housing bubble, rents didn’t collapse. Rent growth did flatten, but landlords didn’t suddenly start losing money each month from rents falling below breakeven levels.
That removes one risk for rental properties, but not the only risk.
Property values in recessions
Home prices sometimes slump during recessions. That’s the bad news.
Fortunately, they rarely drop more than 5 percent, and often they don’t drop at all. The one glaring exception is the Great Recession, but in some ways that exception proves the rule: The housing bubble caused the recession, rather than vice versa.
Here’s how home prices have moved during recessions for the last 60 years:
Rental investors don’t have much to fear from home prices collapsing under their feet due to a recession. But home values do sometimes dip, and if you don’t have much equity in a property, you could theoretically find yourself underwater.
That could remove an exit strategy from your list of options if you owe more than a property is worth.
Rental vacancy rates in recessions
Landlords do often see vacancy rates spike during recessions.
Which makes sense: A shrinking economy and job market leave more renters unemployed. Even workers who retain their jobs might feel insecurity about their prospects, and fret over possible job loss. That can push many renters to move in with family and friends to save money.
In turn, that household bundling effect leaves less demand for rental properties, and more vacant units.
Don’t assume the same occupancy rate during a recession as you have right now. Make sure you screen renters carefully for stability, job security and a history of never defaulting on rents. You want to rent to the kind of person who would move out if they lost their job, rather than trying to pull every trick in the book to prolong eviction so they can keep living in your property rent-free.
But no matter how well you screen renters, beware of higher turnover rates, rent defaults, eviction rates and vacancies during a recession. All of which can get extremely expensive for landlords.
This is where the true risk to rental properties lies when recessions come calling. Higher turnovers not only cost you in lost rents, but also in greater maintenance and repair costs, such as repainting units, installing new carpeting, and other costs associated with turning over rental units.
Stocks in recessions
With all of that said, how do stock markets perform during recessions?
On the downside, they typically lose value in the year leading up to recessions, and during them. Check out this chart from Darrow Wealth Management:
On the upside, they rebound quickly after recessions end. The S&P 500 has gained an average of 16 percent in the year following recessions.
Stocks and real estate serve different roles in your portfolio. Stock markets are far more volatile than real estate markets, and lose more value in recessions. But that doesn’t mean you shouldn’t invest in stocks, just as the risk of turnovers and evictions doesn’t mean you should avoid rentals.
In fact, with baby boomers so far behind on retirement investing, they should consider both stocks and real estate as catch-up assets, and perhaps avoid bonds altogether.
Final thoughts
One of the reasons I love rental properties is that investors have far more control over their returns than stock investors do. They also provide stability and ongoing income to counterweight the huge swings seen in the stock market.
You can also use rental income to lower your living expenses through house hacking. Whether you buy a duplex and rent out the other half, rent out rooms to housemates, or build out an in-law suite to rent, you can potentially eliminate your housing payment altogether.
That’s the ultimate protection against recessions: cutting your living expenses so you’re less dependent on your job to survive.
How are you preparing for the specter of a recession?
Brian Davis is a real estate geek and co-founder of Spark Rental.
