THE CORONAVIRUS’ IMPACT ON INVESTING: THE GOOD, THE BAD, THE OPPORTUNITY.
How is the staycation going? Those who invest in any asset have been predicting – almost waiting for – a market correction, but this? It is practically a scene straight out of Hollywood. I have been reading and listening to some well-informed people of late and wanted to share some take-ways concerning the impact of the COVID-19 on real estate. The stock market is a leading indicator due to its real-time trading capability. What is it indicating? Other than the economy taking a serious hit, it illustrates how panicked and unsure investors are right now, and for that reason, it is time to take a collective breath.
It is time to evaluate the damage, be grateful for what we have, and position ourselves actually to benefit from this event. We know that the world has braced itself, and the economy and millions of jobs are on hold because of it. In the world of real estate investing, when people cannot work, people cannot pay the rent. That is The Bad. However, in many ways, apartment investing is built to withstand these sorts of events – The Good. As unfortunate as it is, some have overextended themselves. Also, some sellers will panic and sell at a discount, while many buyers will be too afraid to jump in. And therein lies The Opportunity. This opportunity may come soon
When people ask do you want the good news or the bad news first, I always want to get the bad news out of the way. So here we go:
• You can pretty much throw that T-12 out the window because we are in uncharted waters, and what happened during the prior year has no reflection upon the current and near-future environment (T12 or Trailing 12 is the term for the data from the past 12 consecutive months used for reporting and projecting financial figures).
• It is nearly impossible to underwrite anything right now, due to the uncertainty.
• The best-case scenario is that this will be a sharp fall-off like a cliff, but hopefully for no more than 60 days, once we get some good news. Some are calling for a severe “V” shaped dip in the economy, while others are predicting more of a “Nike Swoosh," with a longer recovery.
• The next 60 days will be a very unpredictable time to buy anything.
• C class may get hit the hardest. Blue-collar, service jobs, retail.
• We are in a recession.
• Prep for a nasty April and May, as tenants may stop paying without the threat of Eviction. Apartment owners may stop paying their mortgage in June, because of the bailout of small business (apartment communities fall into this).
• An option provided by the government is “Forbearance” - tacking on the delinquent portion of loan onto the back of the loan.
• One strategy offered for non-paying tenants: provide 1-month free rent, with the agreement that the lost rent will be catch up over the following five months
• As mentioned before, apartment investing sets up to withstand these sorts of events. A good deal projects conservatively, leaving plenty of margin for error or added profit. Cash reserves are required upfront and also built up over time, to cover for periods such as these. If tenants temporarily stop paying rent, cash flow drops, and this adversely affects the property. Operating income ($1000/door upon purchase of the building), and additional cash reserves ($300/door per every year of operation) pencil into the deal for this reason.
• Keep in mind that interest rates are dropping, and this causes the mortgage to lower and improve cash flow on a floating rate (as with bridge debt). If you have a fixed-rate, then it might become attractive to refinance and lower the mortgage that way. While terms are in a state of flux now, as things begin to stabilize, rates and conditions will become more favorable.
• When interest rates drop, so do cap rates. And when cap rates drop, values go up.
Thus, the news isn't all bad. Rent payments may temporarily halt, but operating and cash reserves somewhat neutralize this. The lowering of the cap rate (thereby increasing the value of the asset), also offsets the lost income.
With your kids at home, I want you to break out some of their poster paper, a giant magic marker and put Warren Buffet's quote up on your wall:
“Be fearful when others are greedy and greedy when others are fearful.” – Warren Buffet.
• If the steps the world is now taking become effective, the economy’s slump could be sharp and fast. If this is the case, things might look good in as little as a few months. Put me in the Nike Swoosh camp, with a sharp decline and a lagging recovery. There will be real buying opportunities as early as quarter 3 and 4.
• The market will soften. There are already buying opportunities for the very brave.
• Embrace this opportunity to spend with your loved ones, to think, to reassess, to clean out your garage, to read, to play guitar. I would say to surf, but they have shut down all the beaches.
One more quote that you can put up on that poster:
"Fool me once, shame on you. Fool me twice, shame on me." (Not the way George Bush Jr said it)
Think back to the 2008 recession. Were you kicking yourself for not taking advantage of the massive amount of real estate opportunities that existed during the years following? That was a time for acquiring assets. Could we be on the precipice of something similar? Take advantage.
One plug for multifamily. I do mean this respectfully. For those that did lose 40% of their stock portfolio in the last month, please consider the high degree of certainty you can achieve by investing in apartments. Even in this market, you maybe will earn 3 - 5% less of your targeted returns in multifamily investments - meaning you will not lose money; you may not make as much. If you choose your deal operator/sponsor carefully (you cannot underestimate this), they will have over-raised on capital, so there will be plenty of cash reserves to weather storms like this, more than covering the lost rents and debt. They will have invested in an asset that cashflows from day one. In other words, the qualified operator is not going to lose the building, and thus your investment. Check out the graphic below, provided by the people at Think Multifamily.
For now, stay home, stay safe, unlike those people you see on those Florida beaches. If you do have some money left in the stock market, hopefully, you have the majority in Netflix, because the world now has much time on their hands to binge-watch. Prepare for this opportunity, and do not have fear. Life may have an excellent upward trajectory coming out of this thing.