The news these days is moving rapidly and making fools out of Wall Street analysts, hedge fund managers, and yes, even us real estate investors. Back in March, Goldman Sachs produced “research” that described that the U.S. economy would likely experience a “V”-shaped recovery as Covid-19 was only a short-term anomaly. Many in the real estate industry ran with that information. They were eager to set their investors’ minds at ease so they could run off and raise capital for the next big deal.
But anybody who has been paying attention to the macro-picture over the past couple of years could see the that we were nearing the end of the business and credit cycles. The piling debt, the negative rates of change on corporate earnings, and the inverted yield curve back in 2018 were all signals that the economy was due for a reset.
Covid-19 was the black swan event that accelerated the long overdue, economic reset. It hit us like a sledgehammer. Just take a look at this chart below on unemployment claims. This is unprecedented to say that least. (Chart as of April 30, 2020)
As real estate investors, we care about a lot about employment numbers because it directly impacts demand in every part of the economy, not the least of which is housing. This chart is very sobering. In the near term we see some relief coming from the Cares Act, but the big question is how many of these jobs are lost forever? That remains to be seen and it’s something that we’ll be watching very closely. But, you don’t need to be a rocket scientist to understand that home prices will need to re-adjust. Demand is going to take a hit. Take a look at this next chart below showing the steep decline on mortgage applications in March and April.
Mortgage applications are a leading indicator for the residential housing market. Over the summer, we’re going to see softening demand for residential homes in many markets. Those who were considering the purchase of a home, but were renting an apartment, may now consider waiting until their job prospects improve. In addition to this, there are huge numbers of homeowners requesting forbearance. According to Aly Yale at Forbes, 4% of all mortgage holders are in forbearance. (source: https://www.forbes.com/sites/alyyale/2020/04/13/nearly-4-of-all-mortgage-loans-now-in-forbearance/#3856bea95497)
What Does This Mean for Multifamily Real Estate?
I’m not a big fan of making market calls, so I won’t do that here. But I will share data on what I’m observing both in my personal portfolio which I own here in Texas, and in our commercial portfolio of multifamily properties in Texas, Florida, and Arizona.
First of all, occupancies are constant. We’re noticing the residents are choosing not to move right now. This makes sense for a lot of reasons. Most of our properties are least above 90% so this is a positive development, but given the massive job losses and temporary shutdown, occupancy doesn’t tell us what we need to know. The economic occupancy is the key metric to watch. Economic occupancy tells us who, among our residents, are still paying consistently. What we are observing is that across most of our properties, our economic occupancy is down 5-10%. On the one hand, this isn’t terrible. But on the other hand, this is only one month of reporting, so we will have to see how this changes over time. But, one thing we’re seeing is that in the very short term, multifamily revenues are performing quite well relative to other business revenues. The sheer destruction of business revenue that is occurring right now is unlike anything we’ve seen. While this destruction doesn’t seem to be currently priced into financial markets, it’s only a matter of time.
Multifamily is Set Apart from Other CRE
Another observation is that we’re seeing a massive divergence among assets types in commercial real estate. Much is being written about the industry suffering as a whole, but it’s a mistake to paint that suffering with a broad brush. Strip malls, office, hospitality and high-end luxury are getting crushed right now. In multifamily, Class A is under more stress than Class B. Class C is experiencing more lost rent revenue than Class B. This is the climate where operators will get the opportunity to earn their recession/crisis management badge. But not matter what type of commercial real estate it is, the amount of leverage the project is carrying and the operators’ ability to manage through will determine the success, failure, or survival of the project.
Finally, I think it’s important to underscore what is meant by multifamily being recession resistant. Too many investors have gotten it into their heads that real estate, and especially multifamily apartments are recession proof. That’s going too far. Recession resistant means that relative to other types of assets, multifamily can perform well. But that doesn’t mean it will be untouched. I have a jacket that’s rain resistant, but in a torrential downpour it can be pushed to its limit. We’re entering an economic torrent right now. The apartment deals that will weather this storm well are the ones that are well-located, well capitalized and well led.