April 2020 Edition - Impact of the Coronavirus (COVID-19) on Multifamily Investment Activity in the Carolinas & Virginia
(Prepared for Multifamily Owners and Prospective Owners)
It’s week three for my working from home due to the spread of the Coronavirus. I’m sure most of you are doing the same. Best to be safe and not sorry, Right? It’s not bad, working at home, and I am getting a lot done. My kids are grown and out of the house so it’s just my wife and. The house is quiet. In fact, it’s a little too quiet. As long as I have my cell phone with my office phone forwarded to it, my computer and internet access to the electronic files at the office I’m good, except the phone is not ringing as much as normal and my incoming email load is down significantly. I hope you are all well out there. I am working so please call on me if you need me. I’m looking forward to getting back to the office and back to a normal life.
Our country is going through something that is unprecedented in our experience. No one could have imagined or planned for the severity of the events of the past few weeks. We are all operating under extraordinary circumstances and we really don’t know when this national emergence will end. Our President is hoping to be able to reopen the country by Easter. That would be wonderful but what if it is Easter of next year? I just heard on the Glenn Beck radio show this morning that some authorities are predicting the national unemployment rate will be over 30% by June. This is particularly concerning when you realized that at the peak of the Great Depression in 1933 the unemployment rate was only 24.9%.
What should we be most concerned about as we watch our economy? A lot of attention is given to the stock market and its daily fluctuations but the stock market is not really the main area of concern. According to an article recently published by Nareit, the worldwide representative voice for REITs and publicly traded real estate companies with an interest in U.S. real estate and capital markets, the three areas of most concern to be aware of in the months ahead are:
Cashflowsandliquidityshocks.
The resiliency of the financial system under a time of stress, and
Economic fundamentals prior to the spread of the virus and the effect on
these fundamentals as a partial or complete shutdown of sectors in the economy take their toll.
The impact of the shock on cash flows is the primary driver of the economic ramifications of the crisis. As retailers, restaurants, hotels, airlines, etc. lose customers their revenue shortfalls make it difficult for them to meet their financial obligations to their employees, suppliers, lenders and landlords. If the revenue shortfalls are large enough, this can cause a chain reaction of financial strains throughout the economy. This brings us to “The resiliency of the financial system”.
Cash shortfalls mean that businesses are likely to make unprecedented demands on the banking system. The resiliency of the financial system, the ability of the banks to meet these needs is a critical linchpin that may determine how widely the financial crisis spreads through the economy, and how deep is the resulting damage. Fortunately, our financial system has an advantage today that it did not have when the 2008 recession began. The banking system today is much better capitalized and regulators have scrutinized bank risk positions much more carefully.
Economic fundamentals, prior to and after the spread of the virus are important. Fortunately, our fundamentals before the start of the virus were exceptionally strong. They continue, at this date, to be relatively strong but they are just at the starting point of the strain they will be under. At the first of the year, the U.S. economy had low unemployment, good job growth, good wage growth, and a household sector that was living mostly within its means. Both businesses and households were in a better position to weather this crisis than they have been for many years. However, unemployment in the U.S. has skyrocketed in the last few weeks and there is little expectation that layoffs will subside in the near term. I just heard on the Glenn Beck radio show this morning that some authorities are predicting the national unemployment rate will be over 30% by June. This is
particularly concerning when you realize that at the peak of the Great Depression in 1933 the unemployment rate was only 24.9%. This will undoubtedly impact the multifamily asset class in the short-term. To what extend is unclear, given the uncharted waters we are in.
CoStar estimates the demand growth expectations at the national level for multifamily could be cut by between 10% to 20%. Retail and hospitality workers are on the front line of this at the moment. These are some of lowest wage earners tracked by the U.S. Census bureau. This implies that the earliest hits in fundamentals may actually occur in lower quality buildings. Class C buildings will be hard hit, as these typically have tenants with little to no financial reserves. Class A properties will also take a hit. Developers need high rents to substantiate the investment. Class A tenants can always adjust by moving down. Class B properties, which for many investors has been the sweet sport, are home to entry level professionals and the blue-collar workers who may or may not be able to work at home. This group will depend heavily on the government’s stimulus package to maintain their household. How long they can weather this storm will test our resiliency.
In the longer term, expect rent growth projections for the year to be tempered. CoStar says, its national daily rent series is already beginning to reflect reduced multifamily demand. Based on daily rent inputs from about 50,000 communities, many of which are high-end, rent growth has paused. This is unusual as historically rents tend to rise from January to August with March as a particular bright spot. This year week-over-week rent growth has gone negative, something not seen in previous years. For the moment, there is little guidance as to how multifamily will react to the high levels of unemployment and the economic downturn.
Investors and lenders are, in general, hitting the pause button as they take time to survey the new landscape. A lot of deals are getting put on hold. In some cases, the slow-down in deal flow has been due to lenders becoming more cautious about underwriting. Despite the Federal Reserve slashing interest rates to near zero, bankers have pressed the brakes on originating new loans as the economic environment becomes more uncertain. Banks are struggling with valuations. With an event like this with such a big unknow to cash flows, it makes it very difficult for
banks to come up with a proper value. Bankers are very reluctant to loan. With the low interest rates and the decrease in property prices, there are just more questions to be addressed.
The cash flow question is also an issue for the investor. If you are expecting to buy a property at X price with a Y cash flow in place and a projected vacancy of Z your short-term cash flow projections can be substantially off because of the coronavirus crisis and the resulting inability of tenants to pay rent. There really is no safety net for the investor short of undervaluing the purchase price of the property. A solution that is not acceptable to the current owner looking to sell. End result, it’s just going to be very difficult to buy a property in this environment.
On the more positive side, although there has been a slowdown in lender quotes, most lenders are still quoting deals. There will be a short-term disruption to the market, but private lenders are saying the underlying fundaments are still very strong at this time and there is a huge amount of private capital looking for opportunities to invest. Many experts believe this economic disruption will be brief.
It will be the presence or absence of second-round and third-round effects of the business shutdown that will ultimately determine how deep and long-lasting will be the damage from this crisis. How we, as individuals and businesses, respond to the crisis will ultimately determine how deep and long-lasting will be the economic damage.
What will be the “new normal” after the crisis passes and how long this “new normal” will lasts is anyone’s guess, but one thing is certain: the commercial real estate business never stops. Multifamily investors, owners, advisors, brokers, developers, and property managers are improvising, adapting and overcoming the challenge on a daily basis. Deal flow hasn’t stopped and panic hasn’t yet set in. The weeks and month ahead will be slower than normal as everyone waits to see what happens next but deals will still get done. The market is generally pausing and assessing the situation, but underlying fundamentals remain strong. This period shall pass and business will get be back to normal.
When asked by GlobeSt.com if in a year from now we would be talking about the coronavirus, Shlomi Ronen of Dekel Captial responded; “No. If you are buying real
estate this isn’t going to change how you are buying over the next 10 years. We will get back to some sort of normal pretty quickly.”
“Just-In-Case You Missed It” is a monthly letter prepared for multifamily owners and prospective owners. It is a compilation of multiple articles from multiple sources. Its purpose is to present both facts and opinions that may influence our multifamily business in the Southeastern U.S. If you have any questions and/or would like to discuss any of the comments above, my conclusions or your multifamily business, please contact me at your convenience. I can be a valuable resource to you without adding any expense to your budget. I look forward to speaking with you and having an opportunity to meet with you. I am always at your disposal to assist you with your multifamily business. If you would like to review previous editions of my monthly “Just-In-Case You Missed It” letter please refer to articles on my LinkedIn site.
Respectfully,
Rick
G.F. Rick Baker, CCIM
Multifamily Specialist/Investment Advisor
www.RickBakerMultifamily.com
2504 Tinderbox Ln.
Greensboro, NC 27455
Cell: 336.549.6083
Email: rickbakermultifamily@gmail.com
Per NC Real Estate Law, please review the "Working with Real Estate Agents" agency disclosure. We are available to discuss the contents of the disclosure after you have had an opportunity to review.