A couple nights ago an old friend committed to jumping on board with an investment in 210 Holding Group. We're thrilled to have another team member on board! During the course of the conversation, we discussed the risks associated with investing in real estate, particularly now in light of COVID-19. We certainly don't have a crystal ball but here are some of our thoughts about the current environment, risks, and our plans to mitigate those risks.
Recession and COVID-19. Despite the apparent headwinds, we believe we can be successful in this environment. Since the recession in 2008, we've seen strong economic growth and real estate has appreciated nicely on a national level with Texas cities like Austin, Dallas, and San Antonio outpacing the broader market. Based on historical cycles, many people believe we are overdue for a recession. When you factor in the impacts of COVID-19 to include significant unemployment levels, a recession seems inevitable. In our own experience engaging with national and local banks exploring long term commercial financing and lines of credit, we've seen first-hand that banks are tightening lending standards and cutting back on products and lines of credit to mitigate exposure to risk in the current environment. We have successfully acquired the line of credit we sought and gained a local banking partner but it is clear, traditional financing is becoming harder to come by. We are moving forward with full expectation that we are in the beginning of an economic downturn--now what?
So, let's assume we are in the beginning of a recession--what does that mean to our strategy, what are the risks to our strategy, and how do we mitigate those risks?
#1 - Long term buy and hold works in down economic cycles. The graphics below from Recession Proof Real Estate Investing by J. Scott shows the four phases of the business cycle. Most would agree we've been in the peak phase for quite some time. During a recession when overall demand for buying houses goes down, home values can go down until demand picks back up. Strategies such as house flipping and wholesaling become more difficult in this environment. New constructions grinds to a halt. As shown in the second graphic, buying and holding cash-flowing rental properties actually becomes more attractive in this environment as prices come down and we don't require short term appreciation as we intend to hold these properties for several years. Additionally, since we are buying distressed properties, we are already buying properties at sale prices and our risk of "buying high" and then getting forced to "sell low" is significantly reduced.
#2 - But what if we really see home prices drop like in 2008? We don't assess this as likely. We believe we can see some constriction--in fact we hope for it--but overall, we think San Antonio is protected from significant downside risk. At the macro-level, San Antonio is the second fasting growing city in the country in terms of population growth. People are migrating to Texas and San Antonio and those people need places to live--whether they buy or rent. San Antonio is buoyed by a significant military presence, job growth, and affordable housing when compared to other parts of the nation. At the beginning of the year, new construction in the city was projected to grow this year.
The above graphs of the Case-Shiller Index show home prices over time and gives some historical context to what happened to home prices during the last recession. If you compare the charts for San Antonio against markets such as Las Vegas, you see how the Las Vegas market had significant appreciation going into the 2008 recession, following by a huge crash (54% home price decrease). At the national level, we saw a 20% home price decrease. It is interesting how San Antonio saw virtually no negative impact during the previous recession--as the speculation that drove prices higher in other markets did not take place here. This gives an idea of the down side risk in a worst case scenario. Although San Antonio has clearly seen significant appreciation over the last 10 years, we don't believe the same systemic issues in the real estate market in 2008 in cities such as Las Vegas are present for San Antonio. We believe a recession presents an opportunity for long term investors like us to be well positioned to get better deals as flippers and wholesalers exit the market if buyer demand decreases.
From our perspective, the bottom line is to proceed with caution. We do not see significant downside risk in our market and see the broader economic turbulence as an opportunity perfectly aligned with our strategy. When it comes down to it, it is about execution. We must be conservative in underwriting deals to ensure we are not overly ambitious when calculating rent projections and after repair values and we must keep our rehabs on timeline and on cost. We are excited to bring new investors on board and are actively looking for the right property as our next project. We are confident in stepping out despite the broader economic uncertainty. Stay tuned!