I think we will look back at June 13, 2022, as the tipping point for the next recession. We won’t have an actual recession for a while, because the definition of a recession is two quarters of negative growth, but it now seems inevitable. We averted one in 2020 when the government gave away about a trillion dollars and forced down interest rates to keep the economy from collapsing during the Covid crisis.
This time, with inflation north of 8%, that is not an option. In fact, in 2020, the Federal Reserve still owned 1.4 trillion in mortgage backed securities and was looking to sell off this portfolio and now they own 2.7 trillion. The entire market for mortgage backed securities is only 1 trillion a year, so selling a trillion dollars of them will keep mortgage rates elevated. They will also be raising the federal fund rates which might tame inflation but topple us into a recession which results in higher unemployment and negative growth.
On June 13th, the stock market dropped almost 1,000 points, after dropping 800 points the trading day before, and mortgage rates climbed ½% in a single day: the highest increase in a single day ever. The stock market officially crossed over into a “bear” market since it has dropped more than 20% from its peak. Jamie Dimon, CEO of Chase Bank, said a financial hurricane is coming, and although he is uncertain as to the magnitude of it, he believes it will be substantial.
Inflation is a friend to the investment property owner. If they increase rents close to the inflation rate, they have a nicely performing asset. The value of the property might decrease if property prices soften, but the cash flows should remain strong. We are systematically increasing our rents 10%, particularly since during Covid, we were legally prevented from increasing rents, so we are making up for lost time. There has been an increase in large new apartment complexes throughout the market. These are typically large “wrap” development of 100+ units: a concrete 5 to 6 story garage is built and then wood apartments wrapped around the structure. The rents on these “lifestyle” units are not cheap: $2,500 to $3,000 for a 1 bedroom unit, $3,000 to $3,500 for a 2 bedroom and $4,000+ for a 3 bedroom. These higher rents are driving up rents for older units and particularly single family homes and townhomes with their own attached garage.
In a severe recession, with high unemployment and depressed assets (housing, stock market & bonds), there is a higher vacancy rates and greater delinquencies. Currently, the vacancy rate is down to 3%, in a severe recession, that might climb to 10% for large buildings. For single family homes and smaller buildings, rather than enduring vacancies, owners choose to lower rents to attract tenants, and rent increases subside. Also, tenants tend to add residents in violation of the lease agreement to makes ends meet. Even in these types of trying times, delinquencies, those tenants that need to be evicted due to non-payment may climb to 5% from the typical 1%.
For property management companies, it is during a recession that our services are most needed by self-managing property owners. Tenants stop behaving. Evictions start increasing. Owners have enough margin between what their mortgage is and what the market is, to afford our services. In 2005, when rents were $2,000 and the total mortgage $1,800, our fee could eat up the entire monthly profit. That same property now rents for $4,000, and if the mortgage is largely unchanged and property taxes still low, our fee is now a small fraction of the profit. If prices drop substantially, investors jump into the market and turn owner-occupied properties into rentals.
I do believe that if we experience a severe recession, many people will suffer and suffer badly. Over 64% of households live paycheck to paycheck and can’t afford a slight bump in their financial world. A large increase in their homeowner dues, a major car repair, a health crisis or certainly a loss of income dooms them to financial distress. Others will benefit from a recession and buy real estate, stocks and other assets at a discount. I just hope the many who suffer don’t take retribution on the few who profit from this economic turmoil.