This is a question I get from folks who were hammered from the last recession in 2008. It’s a valid question and one that should be on the minds of anyone responsible providing for their family. There’s not much we can do to prevent a recession, but there are a few things we can do to prepare for one.
No one really knows when the next one will come, but pretty much everyone knows it will come. Honestly anybody who thinks they know, in my opinion, is full of crap. There are too many external influences that create recessions and no one is smart enough to provide an answer I would believe.
It’s amazing how many people I talked to after 2008 who said they predicted it was coming. I talked to no one prior to that time that predicted it, but looking back, everyone seems to know it.
WHAT IS A RECESSION?
In short, it’s a rapid devaluation of asset value which includes real estate, but other assets as well. Why it happens is beyond my 12th grade education, but recessions come with fear from consumers which reduces spending, and from a macro point of view, affects everything thereafter.
When people stop spending, the economy declines. When the economy declines, it creates less buyers and forces less value. The housing market plays a big role in our economy and when it goes bad the economy will quickly follow.
In 2008, I had five single-family subdivisions with the horizontal development already done and ready to build houses. When Lehman Brothers went down, it triggered the biggest asset reduction I’ve seen in my lifetime. It happened almost instantly and hit hard, especially to real estate developers.
Capital dried up around the world and fear was rampant in the financial industry. The banks had the money but were afraid to use it because of uncertainty going forward. To a developer, this is bad enough, but wasn’t the really big problem. Getting the capital could have been conquered, but when recession hits, there is no exit strategy left because no one wants to buy the houses. Three of the five developments that were shovel ready are still sitting vacant do this day over 10 years later.
In Florida and most of the other cities where there is sun, the real estate values dropped about 40% and have not returned to this date. Some commercial properties got hit even harder. The word, “developer,” to a bank at that time, was a swearword.
Within one month, my personal income dropped 80% as did that of Global Publishing. We had to lay off half the staff in one day. Chaos ensued and many tough decisions had to be made in the following years and everything we thought was normal changed.
Many of my investors lost money as the commercial projects evaporated and I personally lost a vast potential fortune that I would have capitalized on by now had the developments been able to go forward. It was not a fun time but I learned some valuable lessons that will stick with me through life.
Somehow, we made it through the adversity, but every day seemed to be a battle. I wouldn’t want to go through it again, but I can tell you I am a lot stronger for surviving the battle and a whole lot less bothers me than it used to.
SO HOW DO YOU PREPARE FOR A RECESSION?
I’ll give you some thoughts on that but I’m fully aware they will fall on deaf ears because most people assume that recessions happen to other people and not them, therefore, do little or nothing to prepare. If you were to actually follow this advice, your house would be built on a solid foundation not on a house of cards. So here are my suggestions;
- GET RID OF ALL PERSONALLY GUARANTEED DEBT
- I know this won’t be easy, but it should be at the top of your mind with a plan to make it happen as soon as possible. If your debt is on rental houses, maybe it’s time to consider selling them now and paying off that debt. You can buy all the houses you want without personally guaranteeing debt. Sell off the duds and start buying them right.
- You will never get chased by banks or any other lenders if you haven’t personally guaranteed debt to them. They can’t come after you for a debt you do not owe. Yes, it’s really that simple. When you take over a property subject to or buy it with owner financing, you are not guaranteeing debt. At least I better not catch you at it. We don’t guarantee debt on planet Ron, no exceptions!
- I could make the case that this is the right time to sell our houses because I believe we are at the top of the market. Even if I am wrong, I believe you will always find a good use for cash and I will assume you get long-term capital gains to reduce the taxes. If not, consider 1031 exchange.
- These debts will also be removed from your credit report and your financial statement. In case you aren’t aware, you do not report non-recourse debt on your financial statement and of course, it certainly won’t be on your credit report because it’s not your debt. All debt on planet Ron is non-recourse, no personal guarantee.
- STRUCTURE YOUR DEALS SO YOU DONT HAVE TO CASH OUT
- Cashing out as fast as you can is simply a bad habit. When we can structure our deals so we don’t have to, not only are we immune from recession, but will also make a lot more money on each deal. If you are rehabbing houses and selling them to qualified buyers, your business requires you to cash out now. You get no income until the sale and have to pay expenses while waiting plus you risk the market taking a dive and losing your profit and then some.
- I do everything I can to keep from cashing out now. When I do the golden goose dies, the income stops, the appreciation stops, the debt pay down stops, and if I sell in the first year, I have to pay twice the income tax.
- By installing tenant to buyers in my houses, I get a big check upfront for a non-refundable option deposit, often as large as any rehab net check. I get the monthly spread and ultimately the back in payday and allow the goose to live. The value goes up and the debt goes down and usually the tenant buyer moves out before their term is up and I get to go collect another big nonrefundable deposit.
- If you’re borrowing private money to buy houses and you don’t want to sell immediately, then you must structure the loan with a longer-term debt in which most lenders would be happy to do if you make it a requirement.
- If you’re buying houses subject to or owner financing, then obviously you have freedom to stay in it as long as your deal will allow, which is why I structure all of mine for as long as I can. The longer the deal the longer the goose lives
- But here is how this pertains to the message in this article; IF A RECESSION HITS AND VALUES DROP, RENTS DON’T.
- The bigger the recession the more people will need to rent after losing their homes. The more renters the higher the rents. There will always be a need for people who are paying rent, regardless of the economic climate. Since I don’t have to cash out, I simply relax, collect rent and wait until the recession is over and maybe never sell. Occasionally I have a tenant buyer cash me out but you’d be surprised how few actually do and don’t forget they are responsible for all the repairs.
- Of course, this will only work if your cash flow is positive but if it isn’t that should have been fixed going in. Doing no repairs certainly helps cash flow.
- WORK HARD TO INCREASE YOUR PERSONAL INCOME
- Obviously, I would suggest getting good at the art of buying houses and building a huge residual income between rents collected and payments made but there are a lot of ways to create personal income. What can you do to add to yours?
- I am a firm believer in multiple streams of income and a practitioner. I am always looking for the next one and doubt you can have too many as long as they are worth messing with. Golden turds don’t make good income streams.
- So, if you get your income up and your personal debt down and a good cash flow working, you should be OK when the next recession hits. I could make a case that it is a good thing for real estate investors; When recession comes smart investors run toward it not a way from it because it creates a lot of opportunities as long as you’re prepared and not managing from chaos.
- The recession in your home and business is the only one you can control and therefore should require your focus. Perhaps you should think about the answer to these questions:
- What happens if I lose my job?
- What will I do if my spouse dies, leaves me or divorces me?
- What happens if my home and properties lose a lot of value?
- What if I get sick and can’t work anymore?
Ok, I know these are depressing question, so don’t worry about them. Maybe it will all work out. Keep buying lottery tickets. After all, someone has to win.