I hope you are doing well and staying safe during these challenging and uncertain times.
As concerns surrounding coronavirus (COVID-19) continue to increase, people are rightfully searching for accurate information, both about the global effect of the virus as well as their own physical and economic well-being.
This short article is meant to serve as a quick update around what we are currently seeing in the real estate space and how we anticipate the major asset classes of our portfolio to perform in the coming weeks/months.
Of course, the most pressing concern is our health. If those concerns can be addressed, the safety of our investment capital is the second priority. While every economic and geopolitical shift has its own unique risks, this particular pandemic has drastically altered the Overton Window in terms of potential economic outcomes. The most noteworthy, and the first of its kind in history, is the significant difference between a revenue reduction that is typical of a recession and a complete falloff of income that was created not by a decrease in demand but by mandatory shutdowns and shelter-in-place orders.
Given this economic reality, discussions about the likelihood of a recession have turned to an even greater question: Will this downturn result in a recession or a depression? As such, federal and state governments have taken unprecedented action to stimulate the economy in an effort to soften the forthcoming blow it’s projected to endure.
In the world of real estate, we have seen transaction volume essentially come to a halt. While it is true that some lenders are willing to lend in this environment, we as syndicators are committed to securing a great deal for our investors. Prior to investing, we want to ensure that we have the following: a clear vision of value creation, cash flow during the hold period, and the ability to purchase the asset at a discount to market. Due to a low transaction volume, it is very difficult to establish accurate “market pricing” in today’s environment. Furthermore, real estate is traded on a multiple of income, and if that income is no longer reliable, the typical income formulas are no longer a method of price discovery.
Every industry and every market is going to be impacted by this pandemic, whether it is a small ripple effect or a huge tidal wave. At Asym Capital, we are dedicated to having a holistic view of the real estate market, which includes understanding several asset classes within the sector, each of those are facing different challenges.
Many of the concepts in this article have been discussed at length with economists, investors, and sponsors on our program, Cash Flow Connections Real Estate Podcast.
For the last decade, apartment buildings have had an exceptional run in both net operating income (NOI) growth and cap rate compression—and for good reason. As we have seen an increasing number of young people either opt to rent or be unable to purchase a home, the multi-family investment thesis has become more and more compelling. This is especially true of workforce and affordable housing, which cater to households receiving close, or below, median area income. A solid thesis with a proven track record, this market is now facing a significant challenge: The shutdown puts a major strain on this tenant demographic because many do not have additional funds to pull from in the event they lose their jobs.
The government understands this challenge and has taken unprecedented action to mitigate the damage done to this significant segment of the economy. In March, the Coronavirus Aid, Relief, and Economic Security (CARES) Act allocated more than $2 trillion to those who have been negatively impacted by COVID-19. More specifically, it was allocated to those who have lost their jobs or are struggling with medical hardships as a result of the disease. Then, on April 9, the Federal Reserve announced another round of initiatives to bolster the U.S. economy, which includes an additional $2.3 trillion program focused on providing significant liquidity to the market and the economy.
In an attempt to avoid a 2008-like liquidity crunch, many lenders have created debt forbearance programs so that property owners can provide more flexibility to their tenants. When tenants cannot pay, property owners cannot pay—therefore, banks are forced to foreclose. We are confident that this government action and the availability of these programs will provide enough liquidity to the necessary institutions so this concern is mitigated.
Despite the actions that the Fed has taken, we anticipate there will be continued downward pressure on rental income collections through at least May and June as tenants make their first full monthly payments post-COVID-19.
Right now, the goal for owner/operators is to keep tenants in place. We have seen an increase in concessions to ensure assets do not experience a drop in occupancy and to retain tenants through the next few months. If occupancies can remain high, once the shelter-in-place orders begin to lift on a state-by-state basis, we anticipate that the upward trajectory of multi-family will continue based on the favorable supply/demand position of affordable housing.
Self-storage, one of our preferred CRE classes, has understandably suffered the least price devaluation in the public markets. We have conversed with several sponsors who cumulatively own nearly $1 billion in self-storage, and they all have reported normal, or even increased, property-level activity over the last few weeks. Demand for self-storage is primarily created by individuals moving residences, and the dates of those moves are typically pre-determined and based on 6- to 12-month leases. As a result, these move-in/move-out dates have not been postponed or otherwise altered. Furthermore, many universities have shut down early, creating an early surge in demand that was originally slated for late May or June.
In short, self-storage tenants typically visit their self-storage unit twice: once to move in and once to move out. By and large, the negative impact of the shelter-in-place orders has been sidestepped in this area, as well as concerns about on-site contamination.
Mobile Home Parks
The big-picture thesis of the mobile home park business includes both an investor-favorable supply/demand disequilibrium along with a recession-resistant component. Together, these create the tailwinds for an asset class that should help cushion the concerns surrounding the long-term economic blowback associated with COVID-19. However, tenants who earn hourly wages will likely take a significant hit in the short term as their employers are forced to close.
Local, state, and federal governments are well aware of the burden that a seizure of the job market will put on those who are in low and middle classes, and have quickly pivoted to limit the damage as much as possible. Many of the recent government programs (addressed above in the Multi-Family Apartments sections) are also geared towards the tenants of mobile home community tenants. Most notably, the forthcoming $1,200 check issued per adult could equate to up to three months’ rent in many mobile home parks across the U.S. In two-adult households, another potential $1,200 check will be cut, equating to up to six months’ rent in many markets.
The risk to the senior living sector is unique in that it is not as focused on NOI, as many tenants pay rent through a combination of savings, social security, and immediate family members (many of whom likely hold jobs that can be completed from home during this time). The challenge here is that the sector’s tenants are at a much higher health risk, given that this particular virus is most dangerous to the elderly and immunocompromised. Of course, this is the general makeup of most senior living communities.
As such, many owner/operators are not anticipating significant reduction in income, but are more concerned about contagion, the health of their tenants, and their ability to lease up vacancies amid shelter-in-place orders.
That said, the investor demand for this asset class has seen strong growth over the last few years. This is the result of many factors, including the extremely significant demographic shift taking place as senior citizens begin to occupy a larger percentage of the overall population than ever before in the U.S. According to a recent report by Marcus & Millichap, more than $1.3 billion in transactions took place in senior living sector in February 2020. This is up more than 18% from the same month last year. We anticipate this trend will continue once the uncertainty surrounding coronavirus begin to subside.
More than $600 billion in grants and loans are available to the senior living sector as part of the most recent stimulus package, along with the substantial benefits of the recent Paycheck Protection Program (PPP), one all businesses with fewer than 500 workers can apply for. Many of these funds will be used to help this sector and ensure that it thrives through this crisis.
Additionally, experienced owner/operators are already well prepared with the resources and protocols to deal with property-level contagion, given the sector in which they work.
Retails shopping centers, particularly those that are not anchored by grocery stores, are facing an uphill battle with this particular crisis. Many business owners may be prepared for a 25-35% reduction in revenues due to an unforeseeable recession or other property-specific risk, but prior to COVID-19, it would have been challenging to envision a thesis that would result in a 100% collapse of all in-store revenues. Because of this, a high percentage of retail tenants are requesting debt assistance, forbearance, and forgiveness.
One important thing to note is the distinction between a typical recession due to a business cycle turnover versus a mandated shutdown. Many of these businesses are not struggling due to a decrease in demand, or even a business model that is not profitable, but a hyper-specific issue, one that will certainly be resolved.
Lending institutions and property owners understand this and will likely show quick flexibility to their quality tenants. The federal government’s actions have provided them the opportunity and ability to do so.
Where there is uncertainty, there is almost always an opportunity to purchase distressed assets at a significant discount. We will continue to monitor new developments in the retail sector, just as we have for the last few years.
Out of all the asset classes that are likely to present a clear opportunity in the wake of COVID-19, we predict that the distressed debt space will reveal the most viable prospects for pricing arbitrage. When jobless claims are consistently reaching all-time highs, defaults on debt obligations are certain to follow.
The main concern we have about this particular space is the regulatory hurdles associated with debt collection, especially following a pandemic. Recent events imply that the federal government may be quick to enact sweeping laws that could create a moratorium on standard collection practices, or even inspire borrowers to use the COVID-19 pandemic to justify a stop in remitting payments to their debt obligations. Regulatory risk is always a concern in this space, but it is especially pronounced during this crisis.
While we have not significantly participated in this sector of real estate, we have been reviewing opportunities with various operators for quite some time. We believe we have identified a few potential partners if such an opportunity were to arise, and it is highly likely that this opportunity is now here.
Following the Data
It can be very challenging to follow accurate data with so many opposing narratives available to us during the Information Age. Once resource that I have been tracking closely is JP Morgan’s coronavirus (COVID-19) research compilation, particularly the infection tracking charts, which are updated daily.
Hopefully, we will see these numbers come down in the following days and weeks, and then begin to create a clear pathway to a new normal.
Another data set that I am focusing on is state-specific information and how each state’s reactions to COVID-19 will impact its contagion rate. While it is very early, it does look like New York, the U.S. epicenter of the pandemic, is showing promising signs of leveling off the number of new cases.
Thriving During a Crisis
The economic and health-related pressure surrounding COVID-19 is strong enough to create tertiary challenges in all of our lives, particularly related to anxiety, stress, and going a bit stir-crazy. However, there are a few steps we can take to ensure that we are doing our best to not only remain optimistic, but truly thrive through a crisis. Physical exercise is paramount to mental health, especially while remaining at home for the majority of the day. Furthermore, meditation and visualization are proven to have lasting positive impacts on mood, cognitive ability, and, yes, even physical strength.
As with all investors, I look at things on a risk-adjusted basis. In my opinion, there are very few more favorable risk/return ratios than taking 10 minutes to sit in silence, especially if done with the help of a meditation app like Headspace or Calm.
Thank you for taking a moment to review this summary. I hope you continue to monitor the situation closely, as having a thorough grasp on how the situation changes will empower you to capitalize on what is almost guaranteed to come from an investment perspective. In the meantime, stay safe.