It’s pretty tough to find the right answer when you’re asking the wrong question.  The other day, I received an email from an investment fund asking if I was prepared for the next recession.  Shouldn’t the question really be, “Are your investments prepared, and how will they react in the next recession?”  Then my thoughts turned from my personal investments to our company’s buy and hold fund, and I asked myself, “Are we prepared?  Is our buy and hold fund prepared?”  The answer is a resounding “yes,” because our fund is actually set up to be recession-resistant.  You’ll see why later in the article.

We all know it is not a matter of “if” but “when” the next recession will show up, though none of us know how long or bad it will be.  Are your investments prepared?

Cleaning up a dirty word

“Recession” can feel like a dirty word, or you may feel like a “doomsday” person for talking about it.  But like all things in life, the economy has its own cycle. Inevitably, periods of expansion (growth) are followed by periods of contraction (recession).  After a recession, the economy licks its wounds and begins the recovery process.  It continues the upward climb of expansion toward the “boom,” and after everything is maxed out, the economy begins to contract, sliding down into another period of recession.  This cycle – recovery, growth, recession – repeats to greater or lesser degrees as part of the natural economic cycle.

We all know the recession is coming, but it’s far more difficult to know how it’s going to play out.  We could have a short “burp” in the economy and move back into expansion, or it could become prolonged with deeper implications.

Keep in mind, economists can’t identify recessions in real time, so a recession isn’t typically recognized until months after it starts.  If we were at the start of a recession right now, we might not know it until we’re all out buying Christmas presents in November.

We have been in an expansion period for the last 116 months — since June 2009 — making it the second longest expansion period in recorded U.S. economic history.  This graph charts the U.S. economic expansion periods since 1854.

Asking the Right Questions

I mentioned earlier that we consider our fund to be “recession-resistant.”  (Note that I did not refer to it as being “recession-proof!”)  While you can never have certainty in any investment, we’ve built a few safeguards into the structure of the fund that will allow it to continue to produce consistent investor returns even during an economic downturn.

We started with the end goal in mind, which is to produce consistent net returns for investors, and we tried to ask the right questions to determine how to get there.  We asked things like, “Which housing category offers stability and profitability, even in a down economy?  Where can we find these homes?  What is the profile of the ideal tenant?  What else can we do to protect investor principal while still producing healthy, consistent returns?”

While Hughes Capital’s buy and hold fund might not have the impressive, rip-roaring return that some other investments do, our fund offers consistency, safety, stability, and downside protection during a recession.

Finding the Right Answers

In asking the right questions, we were able to come up with a successful investment model that continues to meet or exceed our goals, month after month.

  • We learned that the affordable housing category offers the greatest stability as these homes don’t fluctuate in value.  They might not be the most luxurious, but they’re good, solid homes that people can afford to live in.  (And, they have much better rent ratios than you’ll find with more expensive homes.)
  • We determined that having a cash flow rental model, as opposed to an appreciation model, provides the most consistent, stable returns.  (Cash flow is much easier to account for and to control, unlike appreciation, which is too much like gambling.)
  • We’ve zeroed in on homes in the $30,000 to $75,000 price range. Properties in this range are somewhere in the middle of the affordable housing band.  We select properties that require less time-intensive rehab, so we’re able to keep them occupied, producing a return as quickly as possible.
  • We’ve found that the U.S. Midwest provides a virtual bounty of homes in this category.  We currently purchase in 9 cities in 7 states throughout America’s heartland; 6 of our cities were recently listed within the top 50 “surge cities” in the U.S. – cities experiencing the most economic growth.  Of course, purchasing in various geographic locations keeps the portfolio of homes diversified, further protecting the overall investor return.

Here are two other things we considered in making the fund recession-resistant:

Affordable housing “wins” in a downturn.
When a recession hits, people don’t upsize their homes, they downsize.  This means that the need for affordable housing will usually increase during an economic decline.

Our tenants often don’t need a paycheck.
A significant percentage of our tenants do not rely solely on a paycheck to cover rent. Instead, some receive social security or disability, and some qualify for Section 8 housing and receive some type of subsidy.  This provides an extra measure of security, should there be a job loss in one area or another.

What questions are you asking to ensure that your investment portfolio can stand up to the next economic downturn?

No investment is risk-free, but we feel confident that the buy and hold fund will be operating in a “business as usual” fashion, even in the next downturn.