I started my career in the real estate business in 2009, the bottom of the Global Financial Crisis. It’s been a historic 10+-year run for the multifamily sector. The combination of economic growth, organic rent growth, compressing cap rates, and sustained low interest rates lead to great returns. That’s easy to say looking backward. There were many moments over the past 10 years where it felt like pricing was frothy and the music was ready to stop.
My career has always been underscored by the risk of a recession driven by an unknown catalyst. I graduated from college in 2008 and saw friends’ job offers disappear when Lehman went under and watched family members lose their homes. Although it’s been 10+ years, those events are engrained in my memory.
We’re now almost certainly heading into another recession, the first of my career. Things are going to get a lot worse before they get better as we’re going to be forced to shut everything down. The Federal Government provides cash assistance to those most badly affected, but it’s impossible to predict the full impact. Market panic will continue to drive policy panic.
Every asset class in every market is going to be negatively impacted. Goldman Sachs estimates Q2 GDP to be -24%. This is unprecedented.
At a time like this, it may feel silly writing about the impact this pandemic will have on workforce housing, but this blog has always been a forum for me to share how I feel about the real estate business in the moment. Hindsight bias will make it easy to look back and construe a logical story around how events unfolded, but it won’t be a reality. Today, on March 22, 2020, we have no idea how this is going to unfold.
I’ve always liked workforce housing from an investment perspective because of the affordable rents and “recession-resiliency” that creates. I’ve touted that the investments provide strong “downside protection” and generate solid “risk-adjusted returns”. Over the next several months, we’re going to see how true that is.
These are uncharted waters for the economy and the market, and the range of outcomes is wide. Workforce housing is in for a world of pain, over the short term, but will outperform over the medium- to long-term.
At the property-level, we’ve taken many proactive measures:
- All amenities and common areas including the leasing office are closed. All tours are virtual.
- All non-essential capital projects have been paused.
- We’re approving all payables and limiting variable expenses to hoard cash.
- We’re lowering rents and increasing concessions, eliminating renewal increases, waiving late fees, and will not be charging month-to-month fees.
- We’re offering all scheduled move-ins the opportunity to move in early, free of charge.
We have significant reserves on hand for all deals, moderate leverage, good relationships with our lenders, and a strong corporate balance sheet. I believe we’re well-positioned to weather this storm.
Delinquency at our stabilized deals will jump from 1-3% to 10-50% and vacancy will grow from 4-8% to 10-30% over the next 3-4 months. New leasing will come to a screeching halt. With the courts closed and a moratorium on all evictions, residents have little incentive to pay. Residents who have lost their job or had their hours cut are going to prioritize other bills and stop paying rent altogether. We’ll have fewer move-outs and a higher renewal rate, which will buffer the blow slightly.
April collections will be down significantly, and May and June will be even worse. However, we’re going to see lenders work with borrowers and defer loan payments. Cash flow will turn negative and there will be no distributions to investors in Q1 or Q2. It’s going to be rough and more painful than most owners anticipate.
However, we’ll get through this short-term pain. As long as we don’t have to turn keys over to the lender, we’ll be just fine.
That said, bear markets which are accompanied by a recession have lasted 18 months, on average. Things will not miraculously go back to normal later this summer. It’ll take a while for performance to re-stabilize.
That’s when the value of workforce housing will shine through. People always need a place to live and in a recessionary environment, they will choose value over shiny new amenities or new homes. Occupancies will stabilize, rents will grow again, and we’ll see Class B multifamily outperform Class A.
We have a very challenging road ahead of us, but I remain optimistic about our investment thesis. What matters in times like this is family, health, generosity, and community. We’re all in this together.
I hope you’re all staying safe & healthy.