I started my career in real estate in 2009. For the first 11 years, I enjoyed one of the longest expansions in history. I remember thinking in 2015 that assets were expensive and good opportunities were hard to come by. I’m not sure where that came from. Perhaps it was purely the fact that assets in 2015 were much more expensive than they were in 2011? Regardless, I never pretended to know where we were in the cycle. Here’s what I wrote in 2015:
I have no idea “what inning” we’re in. Market pundits spend a lot of time talking about what inning we’re in and whether or not we’re in a bubble. Personally, I have no clue what inning we’re in and to be honest, it doesn’t matter much. Ultimately the cycle will not define us; our strategy, ability to identify value and risk, and execution will.
I always believed the Atlas model; raising capital from HNW individuals on a deal-by-deal basis, maintaining a lean shop, deal flexibility, and the ability to act quickly, positioned us well to take advantage of disruptions in the market. When the next downturn inevitably arrived, I said, we’d be ready.
And here we are!
The coronavirus has caused a disruption in the market, unlike anything we’ve experienced in history. It’s accelerated trends in the market, crushed seemingly good businesses, and without a doubt will create opportunities.
Over the past few months, most firms have been overwhelmed with triaging their own deals; watching collections daily, working with tenants, adjusting operations, and negotiating forbearance agreements with lenders. Outside of asset management, everyone is tracking the news trying to make sense of everything that’s going on. It’s largely a futile exercise.
While everyone is doing that, we’re getting back on the offensive. We’re formulating a business plan around a new investment platform, having conversations with investors, talking with brokers, and diving into our markets. Now is the time to get ahead.
The challenge today is understanding what the opportunities will be and how to position yourself to take advantage of them. In his most recent memo, Howard Marks talks about the uncertainty around a post-Covid future. “The post-Covid future doesn’t exist. It will exist only after we’ve made it.” This concept is important. We may make the right prediction based on the information we have today, but that prediction may be right or wrong based on what happens between today and the day the future arrives.
In a real estate context, there are many factors that will directly impact the performance of each asset class and market;
- In multifamily, will the moratorium on evictions continue to be extended? Will the additional Federal unemployment benefits be extended through the end of the year?
- In student-housing, will campuses re-open in the fall? Will the shift to online learning reduce long-term on-campus enrollment?
- In hospitality, will lenders extend forbearance? Will companies allow business travel?
These are just a few of the variables directly impacting the real estate sector and potential investment opportunities. We expect an evolving set of opportunities, but here are a few thoughts on each asset class.
Multifamily has held up well, despite the unprecedented level of unemployment which has disproportionately affected renters. Very few transactions are taking place and there remains a wide gap between what sellers and buyers think properties are worth. Agency debt remains plentiful and extremely cheap with rates on 10-year, 65%–75% LTV deals at 2.80% – 3.20%!
While we don’t expect much distress in the multifamily sector, there are a few subsectors we’re tracking.
- Class B value-add bought at the top of the cycle. Pricing was getting frothy in late 2019 and early 2020, pre-Covid. Operators who stretched for deals may find themselves in trouble over the next 12-18 months as rents come down and vacancies increase. This may be especially true for select syndicators who make a lot of money on the buy through fees.
- New construction (non-institutional) in over-supplied markets. I wouldn’t want to be doing a lease-up in today’s environment. New developments with a high basis due to high land and construction costs may experience slow lease-up velocity and rents below what they had underwritten.
- High-basis deals with near-term debt maturities. Although debt is cheap, increased delinquency rates, vacancy, and slow rent growth will impact values and refi proceeds.
It’s been well-documented that hospitality is in a challenging position. Occupancy, ADR, and RevPar are down across the board and nearly every hotel is experiencing some level of distress. While ‘drive to’ leisure hotels seem to be bouncing back, luxury hotels and conference hotels are in for prolonged pain.
- Conference hotels that are reliant on group business travel.
- Luxury hotels that rely on international travel.
- Hotels that were struggling pre-Covid in over-supplied markets.
- Hotels with near-term debt maturities.
- Older branded hotel owners with a PIP coming up.
The student housing sector has been weakening for years pre-Covid as supply increased and enrollments began to decline. The student housing CMBS delinquency rate stood at 10.8% as of April 2020, the highest of any asset class. While it’s still unclear as to whether students return to campuses this fall, student housing is extremely vulnerable. Will there be opportunities?
- 2nd tier universities that may go out of business, but that have strong conventional multifamily fundamentals.
- Class B deals in over-supplied markets near large universities.
- Newly built class A deals that aren’t walkable to campus.
Retail is another asset class that has gotten absolutely crushed and fallen out of favor with most investors. Covid has accelerated the shift toward e-commerce, but most retail cannot and won’t be lost to e-commerce.
Retail will continue to face severe near-term headwinds, but select assets bought at an attractive basis can make great investments.
- Corner restaurants in high street locations.
- Well-located suburban centers that can be repositioned into mixed-use with multifamily, office, retail, and entertainment.
There is still a lot we don’t know and it’s difficult to predict how this plays out, however disruption leads to opportunities. Groups that are well-positioned with access to capital, the infrastructure to execute deals, and the risk appetite to act with imperfect information will reap enormous rewards.
As Howard Marks says at the end of his latest memo, “we may not be able to predict the future, but that doesn’t mean we’re powerless to deal with it.” This is the moment I’ve been waiting for.