Tangible Assets in a Shrinking Economy

When the pandemic began upending society, the market sank for a few weeks and then recorded one of the greatest rallies in history. Stock prices rose the day rioters breached the U.S. Capitol, and they were up during the week that protests roiled many American cities after the murder of George Floyd. During this time of great upheaval, the market seemed to flash a contrarian signal that things were going to be OK—economically, at least.

But real-world problems such as inflation, supply chain disruptions, and the war in Ukraine have finally crashed the stock market’s party, prompting the Federal Reserve to raise interest rates significantly for the first time in many years. That action has sent stock prices plummeting. Some experts are even warning of a recession.

The stock market is not a perfect measure of the real economy. Unemployment is low, and consumer spending is still holding up. Still, more than a month of punishing losses can damage the country’s financial psyche.

When the market is soaring, it’s easy to forget that what goes up can also come down. Economic slowdowns tend to be cyclical, which means another recession is in the future. Whether it’s fast approaching or still a way off, it’s wise to be prepared for its eventuality so you won’t join the panicking stampede out of the markets and into cash. Instead, you’ll remember that certain assets can perform well even during a recession. You just need to know which ones.

The 2008 housing market collapse was a nightmare for homeowners, but it turned out to be a boon for some real estate investors. When a recession hits and home values drop, it may be a buying opportunity for investment properties. If you can rent out the property to a dependable tenant, you’ll have a steady stream of income while you ride out the recession. Once real estate values rebound, you can sell it for a profit.

People Always Need Housing

Housing is different from most investments because it is a basic need. People may hold off on buying a car or a new cellphone during a recession, but it would be quite rare for someone to decide to live on the street.

You may hear stories during times of economic downturn of people losing their homes to foreclosure. But in the case of rental properties, there is always someone to replace any tenants who move out. If your rental property isn’t completely neglected, you probably won’t have much trouble finding tenants, even during a recession. In general, though, proper management of your properties (including helping your tenants) is key to real estate success.

Residential Real Estate Can Be More Stable

The pandemic has served as a harsh reminder of why commercial real estate isn’t always reliable. After all, the pandemic forced many businesses to close, even some that had been in business for decades.

The commercial real estate market can be volatile. Commercial real estate is subject to market forces that don’t necessarily affect residential units. Individuals and families are not going to move out on the street because times are tough. But when the burger joint in the neighborhood stops selling burgers because no one is eating out, they may well have to vacate. People will always need a place to stay, no matter what the U.S. average rent may be, which means that residential real estate will remain stable.

As an investment, real estate is widely considered to be a more stable investment because it is tangible. Tangible assets like real estate or gold don’t react as quickly to daily market fluctuations. Because real estate is separate from the daily trading activity that stocks experience, it can provide stability when stocks are volatile.

Real Estate Investing in a Recession

When a recession takes hold, your first instinct may be to do some strategizing with your portfolio. Seeking out recession-proof investments can help balance stock holdings. Real estate is more stable than many other investments when the economy slows down. Rental properties can function as a natural hedge against market volatility. Assuming tenants can keep up with their financial obligations, a rental property can provide a steady stream of passive income even when the stock market is down. And demand for rental properties goes up during a recession because if homeownership is down, then people must live somewhere.

Funding for real estate investments also has many flexible options. Getting a loan is one option for funding a rental property purchase. However, during a recession, lenders tend to tighten the purse strings, making it harder to borrow.

In that scenario, using a self‑directed IRA to purchase an investment pro-perty could make sense and offer some tax advantages. That said, there are some guidelines to keep in mind. First, it’s important to remember that investing in real estate using your retirement funds comes with some strings attached. The property in question must be an allowable investment. That includes vacant lots, raw land, single-family or multi-unit homes, apartments, townhomes, condominiums and foreclosures. Mobile homes and timeshares, on the other hand, are generally excluded.

Next, there are regulations regarding the property’s use. The IRS does not allow you to live in or use a property owned by you. Furthermore, any improvements or repairs to the property can’t be made by you or by a company that is owned by you or another disqualified person. In other words, if you run a painting business, you’d have to outsource painting your rental property to someone else. Otherwise, you’d forfeit any tax benefits associated with owning real estate inside an IRA.

Finally, remember that things like maintenance, repairs, property taxes, and even your earnest money deposit when buying the property must come from the IRA to avoid triggering tax consequences. For that reason, it’s important to make sure you’re planning ahead properly if you’re considering using a self-directed IRA to buy a rental investment, and be certain your IRA has enough funds for any of these types of expenses.