The concerns surrounding COVID-19 continues to increase and with that, people continue to find the right information, both regarding the global effect of the virus and their own physical and economic well-being.
If you are interested in reading about an update on the real estate space and how the major asset classes will perform in the coming weeks/months, then this article is for you.
Of course, there’s no doubt that health is still the primary concern. But once those concerns have been addressed, then the safety of our investment capital comes next. There are risks that comes with every economic and geopolitical risks and this pandemic has altered the Overton Window in terms of potential economic outcomes. The most noteworthy one so far is the significant difference between revenue reduction that is common during a recession and a complete falloff of income that was made not because of a decrease in demand but by mandatory shutdowns and shelter-in-place orders.
Because of this economic standpoint, there’s no doubt that a surge in discussions about the chances of a recession have become even bigger. Will this downturn end up in a depression or a recession? With this, federal and state governments have taken matters into their own hands by stimulating the economy to reduce the forthcoming blow that it projected to endure.
In the real estate world, the transaction volume has started to come to a halt. Some lenders are still willing to lend in this environment, but syndicators are committed to securing a great deal for their investors. Before you start investing, it is best that you have a clear vision of value creation, cash flow during the hold period, and the talent to buy an asset at a discount to market. The low transaction volume has made it difficult to establish an accurate “market pricing” in today’s environment. Additionally, real estate is traded on a multiple of income, and once that income is no longer reliable, the usual income formulas are no longer a method of price discovery.
The pandemic has affected every industry and market in the planet, whether it’s just a small ripple effect or a big tidal wave. This is the reason why a holistic view of the real estate market is critical, which includes identifying several asset classes within the sector.
Multi-Family Apartments
Over the years, apartment buildings have had an exceptional run in both cap rate compression and net operating income (NOI) – and for good reason. There is an increasing number among young people, wherein they prefer to either rent or are unable to purchase a home, which makes the multi-family investment thesis to become even more compelling. This becomes more applicable to the workforce and affordable housing, wherein they cater to households receiving close, or below, median area income. The thesis is solid with a proven track record and has pushed the market to face a significant challenge: The shutdown has placed a major strain on this tenant demographic because many have no additional funds to rely on if they lose their jobs.
The government has taken a look into the situation and has made necessary actions to mitigate the damage done to a huge segment of the economy. In March, the Coronavirus Aid, Relief, and Economic Security (CARES) Act has allocated over $2 trillion to the sector who have been severely impacted by the pandemic. Specifically, it has been allocated to those who have lost their jobs or are struggling in a medical sense caused by the virus. Then, on April 9, the Federal Reserve announced another round of initiatives to give the U.S. economy a boost, which includes an additional $2.3 trillion program that can provide significant liquidity to the market and the economy.
To avoid the liquidity crunch back in 2008, many lenders have created debt forbearance programs so that property owners can provide more flexibility plans to their tenants. When tenants can’t afford to pay, property owners can’t as well, which could lead to the ultimate decision of banks forcing to foreclose those properties. There’s no doubt that this government action and the availability of such programs can provide enough liquidity to the necessary institutions to reduce these concerns.
Despite these actions, we need to anticipate the continued downward pressure on rental income collections through at least May and June as tenants will struggle in making their first full monthly payments after COVID-19.
Owner/Operators have made it their goal to keep their tenants in place. This has shown an increase in concessions to ensure assets won’t experience a drop in occupancy and retain those tenants in the upcoming months. If occupancies continue to rise, once the shelter-in-place orders start to lift for each state, we can expect that the upward trajectory of multi-family will continue based on the favorable supply/demand position of affordable housing.
Self-Storage
This is one of the preferred CRE classes that suffered the least price devaluation in the public markets. Sponsors who have cumulatively owned nearly $1 billion in self-storage have reported a normal or even increased property-level activity over the last few weeks. Individuals moving residences are the ones who demand self-storage, and the dates of those moves are usually pre-determined and based on 6-to-12-month leases. This has caused the move-in/move-out dates to not be postponed or altered. Also, there are universities that have shut down early so it created an early surge in demand that was originally slated for late May or June.
Self-storage tenants would usually visit their unit twice: once to move in and another when moving out. The negative impact of the shelter-in-place orders has been sidestepped in this area and the same thing goes with the on-site contamination.
Mobile Home Packs
The thesis for the mobile home park business includes both an investor-favorable supply/demand disequilibrium along with a recession-resistance component. They can create the tailwinds for an asset class can could soften the concerns that surround the long-term economic blowback linked to COVID-19. Tenants who earn on an hourly basis will take a huge hit in the short term because it’s likely that their employers are forced to close.
Local, state, and federal governments are aware of the toll that a job market seizure will inflict on the low and middle classes and have quickly pivoted to reduce the damage as much as possible. A lot of the recent government programs put emphasis towards the tenants of mobile home community tenants.
Senior Living
The risk to this sector is unique since it is not focused on NOI. Many tenants would pay their rent through a combination of savings, social security, and immediate family members. The challenge comes when the tenants of this sector are at a higher health risk because the virus is dangerous to the elderly and immunocompromised. Of course, this is common to most senior living communities.
This allows owners/operators to not anticipate significant reduction in income since their concern is mostly focused on the contagion, the health of their tenants, and the ability to lease up vacancies during the shelter-in-place orders.
With this, many investors are interested on this asset class wherein there is a strong growth over the last few years. This is due to many factors, which includes the extremely significant demographic shift happening as senior citizens start occupying a large percentage of the overall population than ever before in the U.S. A report by Marcus & Millichap has shown that more than $1.3 billion in transactions have taken place in the senior living sector in February 2020. This is more than 18% from the same month last year. The trend is expected to continue once the uncertainty surrounding the virus starts to subside.
The senior living sector were given more than $600 billion in grants and loans as part of the recent stimulus package, along with other substantial benefits of the Paycheck Protection Program (PPP). These funds are focused on helping this sector and ensure that they won’t go through hardships during this crisis.
Additionally, owners/operators are already equipped with the right protocols and resources to deal with property-level contagion, depending on the sector in which they work.
Retail
Retail shopping centers are facing an uphill battle during this particular crisis. Business owners must embrace a 23-25% reduction in revenues because of the unforeseeable recession or other property-specific risk. But before COVID-19, envisioning a thesis that would result in a 100% collapse of all in-store revenues would have been challenging. This caused a huge percentage of retail tenants to request for debt assistance, forbearance, and forgiveness.
It is important to know the difference between a typical recession due to a business cycle turnover versus a mandated shutdown. Many of these businesses are not struggling because of a decrease in demand, or a non-profitable business model, but a hyper-specific issue that is sure to be resolved.
Property owners and lending institutions realize this, and they are sure to provide flexibility to their quality tenants. The actions of the federal government have given them the opportunity and ability to do so.
Every uncertainty comes with an opportunity to purchase distressed assets at a significant discount. These developments in the retail sector will continue to be monitored, just like it did in the last few years.
Distressed Debt
Of all the asset classes, this one is more likely to present a clear opportunity in the wake of COVID-19 because it has been predicted that the distressed debt space will reveal the most viable prospects for pricing arbitrage. When jobless claims continue to reach all-time highs, defaults on debt obligations are sure to follow.
The main concern about this specific space is the regulatory hurdles that are linked with debt collection, especially right after a pandemic. Recent events have shown that the federal government may be quick to enact sweeping laws that can create a moratorium on standard collection practices or could inspire borrowers to use this pandemic as a way of justifying a stop in remitting payments to their debt obligations. This space worries about the regulatory risk but it has become more pronounced during this crisis.
Thriving During a Crisis
The economic and health-related pressure during this pandemic is strong enough to create tertiary challenges in all of our lives, especially those that are related to anxiety, stress, and going slightly crazy. However, there are steps that can help ensure to help us not only remain optimistic but also thrive during a crisis. Physical exercise is important to mental health, especially when you’re at home for most of the day. Also, meditation and visualization are proven techniques that can provide lasting positive impacts on mood, cognitive ability, and even physical strength.