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Types of Economic Recoveries: A Real Estate Investor's Guide


May 15, 2020 by Brad Cartier

We are certainly in the early stages of a recessionary period throughout the world. Only time will tell how widespread, severe, and extended this economic downturn will be. Real estate will be affected, but what does recovery look like for investors?

By now, we've all heard the different recovery scenarios cited in the media, whether it's a V-, U-, W-, or L-shaped recovery. These are all very different, and each will require unique positioning by real estate investors.

Realtor.com recently released their 2020 predictions, noting a potential W-shaped recovery. "We expect home sales to rebound as virus concerns wane, but a later dip in sales as a result of a combination of a future rise in infections and lingering unemployment will lead to a see-saw recovery with ups and downs," they said in the report.

Here's a closer look at the different recovery scenarios, what they mean for real estate investors, and how best to position your investing business amidst the uncertainty.

V-shaped recovery

This is the best-case scenario following an economic downturn. This type of recovery is characterized by a sharp decline followed by a rapid recovery. Given that governments across the world voluntarily shut down economies and quickly implemented austerity measures, many believe that the current pandemic will see a V-shaped recovery.

According to a report by Ernst & Young (EY), most pandemics have resulted in a V-shaped recovery. When surveying private-sector executives, EY found that 38% of respondents said their companies were currently preparing for a V-shaped recovery.

A good example of a V-shaped recovery was the 1990 recession, which lasted only eight months.

The bottom line for investors

This type of recession happens quickly, has a well-defined bottom, and recovers rapidly. This would see housing prices and sales volume pick up in the near future. A V-shaped recovery could see all types of investors back to normal deal flow. That said, because of the cautious nature of economic reopenings, this type of quick recovery may not be viable.

U-shaped recovery

There is the most consensus among experts that we will enter a U-shaped recovery. This scenario is characterized by steep decline, followed by a longer, protracted bottom prior to economic recovery. The bottom in this type of recovery can last years, as we saw during the 2008 credit crisis, which was a classic U-shaped recovery.

According to the above-noted Ernst & Young report, 54% of executives in America are preparing for a longer period of slow economic activity, extending well into 2021. The extended recovery period that characterizes U-shaped recovery fits nicely with the idea that countries, economies, and trade are going to open up very slowly over the next 12 months.

The bottom line for investors

In a U-shaped recovery scenario, the pain for cash-strapped or illiquid investors can be severe. It's critical to maintain positive tenant relationships to help avoid turnover and to be patient with your opportunism if you're looking to acquire discounted assets. Secondary and tertiary markets may present opportunities as cities deal with the ongoing effects of the pandemic.

W-shaped recovery

As you can likely tell from the shape of the "W," a recovery scenario here shows a quick decline and recovery, only to be followed by a second downturn. The economic rally in the middle is stifled by new or recurring downward pressure on gross domestic product (GDP), employment, and trade.

The bottom line for investors

Although this recovery starts out like a V-shaped recovery, it quickly sinks into further economic turmoil. Given the risks of second- and third-wave illnesses with COVID-19, this is a possibility. It's critical for real estate investors not to get too optimistic during a recovery.

Maintain liquidity and prepare for a second wave of economic turmoil. If you have poorly performing assets and the real estate market is rebounding, it might be time to look at your numbers and consider liquidating certain assets.

L-shaped recovery

This is a worst-case scenario due to the extended nature of a downturn. Some bearish economists don't see strong economic activity returning until 2022, which would represent an L-shaped recovery. An example of an L-shaped recovery is Japan in the early 1990s, which is also referred to as the lost decade.

The bottom line for investors

In this scenario, investors must remain highly risk-averse and keep as much cash on hand as possible. Having a robust communication strategy with your tenants is critical, as they will likely be suffering from extended income loss. Stay patient and be hyperfocused on improving your operations, reducing expenses, and keeping tenant turnover to a minimum.

The economic recovery bottom line

Each of the above economic recoveries requires a different strategy from investors that balances liquidity, tenant communication, and opportunism. It's important to remain risk-averse during recovery situations, particularly if you are low on liquidity.

As Warren Buffet says, only when the tide goes out do you discover who's been swimming naked.

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