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This article has been republished from the June 2023 edition of Your Investment Property Magazine.
When it comes to setting interest rates, the RBA faces the challenge of carefully navigating between slowing down the economy sufficiently to curb inflation, while also avoiding the possibility of plunging it into a second recession this decade.
Inflation remains well above target levels, while the 2022/2023 rate hiking cycle is the fastest since the 1990s. There have been some positive signs in recent months that we’ll be able to avoid a recession, but the possibility continues to lurk.
For millions of Australians, sustained economic down periods pose the threat of unemployment or homelessness, so investors who are likely to have the capital to safely absorb adverse economic conditions without these sorts of risks don’t tend to be high on people’s sympathy lists.
However, those with significant asset portfolios still have reason for alarm. As a shareholder, even if you have unshakeable faith in the durability of the business you are invested in, recessionary times bring down confidence in everything, so the whole share market inevitably takes a solid hit. It’s the opposite of the rising tide that lifts all boats.
Property investors are not immune from these concerns. House prices tend to drop during recessions, while there’s also a greater risk of tenants defaulting on rent. No matter whether your investment portfolio consists of a single-bedroom unit or several properties, you should be prepared for the possibility of tough times to come. We spoke to several property experts to discover what investors can do to insulate their investment portfolios from deteriorating economic conditions.
Diversify with commercial property
Chief Economist of PRD Research, Dr Diaswati Mardiasmo says broadening the types of property you own is a good way to mitigate the impact of an economic rough patch.
“Owning both residential and commercial properties can provide some insulation against a downturn in one sector,” she told Your Investment Property Magazine.
If you haven’t taken the plunge into commercial property, the annual rental yield on assets like warehouses or office blocks is often relatively higher than residential properties, although the higher prices could be a barrier to entry. Investing with partners or a consortium is usually how newbies break into the commercial game. However, Dr Mardiasmo warned caution was necessary before taking the plunge.
“Properties that are primarily used for travel or entertainment, such as hotels and Airbnbs, may struggle during a recession as people cut back on discretionary spending,” she said.
“In addition, businesses that rent office space may reduce their footprint or go out of business altogether, leading to higher vacancy rates in commercial buildings.”
If your portfolio currently consists exclusively of units and houses, your investor brain might be telling you diversification sounds like a no-brainer, making sure you have at least some eggs outside of the residential basket.
Commercial investing carries its own set of risks though, so you’ll need to make sure you are rigorous in your market research. Consulting a buyers agent that specialises in commercial property could be a good way to help you navigate your way through new territory.
Seek out recession-proof properties
Some of you reading this won’t have the capital to leverage large commercial properties, or perhaps you have a steadfast conviction that sticking to residential property is the way forward. People will always need shelter, after all, so you could argue homes are likely to be as recession-proof as an asset can be.
Whatever the reason, should you want to stay residential, there are a bunch of things you should be looking for when seeking properties resilient from adverse market conditions.
Scott Aggett, Founder and Expert Property Negotiator at Hello Haus, says there are several things that can indicate whether a property will hold up better during a recession.
Proximity to major employment hubs
One of the biggest reasons recessions are so daunting is that inevitably, people lose their jobs. As spending goes down, businesses have to lower their output, which often leads to staff layoffs. This can have a knock-on effect on the rental market.
Imagine a rural town where most of the residents are employed at a mine, that has to cut staff. The people that lose their jobs will likely need to pack up and look for work elsewhere, which, as you can probably guess, brings down rental yield and property values.
Suburbs close to areas with lots of work - business districts, for example - are better suited to navigate these situations. Tenants in these areas are more likely to quickly find alternative jobs, which helps to protect against a mass exodus of displaced employees.
Low vacancy rates
This one speaks for itself really. A prolonged spell without tenants is one of the most unfortunate things that can befall a property investor, so you want to reduce the chances of that happening to you. A low vacancy rate means more people want to live in your suburb, so it’s less likely that you won’t be able to find someone to pay you rent. Suburbs with a healthy excess demand in normal periods have more of a buffer when times get tough.
Positively (or close to it) geared property
There are all sorts of things that could trigger a recession, but this is the most likely scenario in the coming months: inflation persists at well above target levels, leading the RBA to continue raising interest rates until many households and businesses can’t take it anymore.
In this case, property investors are stuck with high mortgage repayments as the economy tanks. The RBA is likely to bring rates down in a desperate attempt to stimulate spending once again, but the damage could have been done.
As Simon Pressley of Propertyology has pointed out, the average Australian investment property owner in 2022 saw annual losses balloon out by more than $11,000. A strong cash flow that can absorb elevated interest payments can be a good defence against running into large deficits if rates don’t go down.
Renovation upside potential
Mr Agget’s final point is for investors to remember they are not simply price takers who have to accept whatever the market value of their property is. Developing and renovating is essentially a means to manufacture equity. If you choose a property that you will be able to make extensive improvements to, you have the option to boost value during down periods. You could look for properties with a small land-to-asset ratio, with plenty of room to add a garage or a swimming pool. A big part of this is also making sure you’ll be allowed to make the renovations when the time comes, so you’ll want to check zoning laws and try to get a sense of how likely your plans are to be approved.
Scott Agget’s picks that fit the mould
- Toowoomba QLD
- Ipswich QLD
- Gold Coast QLD
- Tweed Heads NSW
- Newcastle NSW
- Lake Macquarie NSW
- Wollongong NSW
- Greater Geelong VIC
- City of Gosnells WA
Don’t over-leverage
As a property investor, you’re probably one of the wealthier people in Australia, so a recession isn’t likely to mean destitution. No matter how well off you are though, a recession can affect us all. There are some consequences of a recession that can be unavoidable no matter how far in advance you prepare, so it’s important that you aren’t sitting on too precarious a pile of assets. Dr Mardiasmo advocates being conservative with the amount of debt you take on.
“During a recession, property values may decline, making it more difficult to refinance or sell properties,” Dr Mardiasmo told Your Investment Property.
“Investors who are highly leveraged may face difficulty servicing their debt and may be forced to sell properties at a loss.”
Minimising your debt-to-asset ratio, perhaps through refinancing or more considered acquisitions, is worth thinking about.
‘Get on with it’
If you’re a property investor nervous about a recession, Simon Pressley has a simple message for you: don’t panic.
“From a property market perspective, worrying about whether the nation has two consecutive quarters without economic growth is akin to putting off booking a week’s holiday because it might rain during one of those seven days. Get on with it,” Mr Pressley told Your Investment Property Magazine.
Lest we forget, March 2021 marked the end of the fourth quarter in a row the Australian economy declined after the various lockdowns and Covid shenanigans. As Mr Pressley points out, this didn’t exactly sink the property market.
“Whilst we went into recession, the national response produced an economic boom, along with the second biggest calendar year growth in real estate values in our lifetimes.”
Any property investor who ignores market conditions completely is likely to run into problems, but there’s a reason why we say ‘safe as houses’.
Property investing in itself is one of the best ways to protect your asset portfolio; houses are an ‘essential commodity’, as Mr Pressley puts it.
Scott Aggett said that for some people, a recession could actually present a chance to expand their portfolio.
“[Hello Haus] likes to take the contrarian investor view and look at these times as a great opportunity to buy high-quality assets at a discounted price - think of it like shopping on Boxing Day,” Mr Aggett told Your Investment Property Magazine.
