Potential COVID-19 Effects on the Multifamily Real Estate Market

Creating a Flight to Safety or just Operational Turbulence? 
A number of investors have inquired about our view of the effect of this new coronavirus strain on their real estate investments, workforce multifamily specifically, and real estate in general.  Frankly, it is still too early to tell.  That said, based on the limited real-time information available in real estate, below are some factors and our thoughts on what we believe will be significant over the next 6-12 months.

Flight from risk: investor capital flowing out of equities and corporate debt. Clearly the black swan event of COVID-19 has caught the markets by surprise (with the NYSE & CBE hitting the circuit breakers multiple times in a few days), an arguably over-levered corporate sector has already seen bond spreads widening.

Government/central bank reaction is critical: there is not much left in the traditional monetary policy toolkit, but we could see central banks reverting to risky asset buy-back programs and/or additional non-conventional programs to facilitate end point lending. Substantial fiscal policy announcements have already been made, but likely much more will have to come to better provide a temporary social safety net given the general lack of sick leave and healthcare availability to many in the U.S.

Perhaps a Flight to Safety?
Though we are seeing a flight from risky assets generally (with the 10-yr US Treasury already trading well below 1%), and considering there are no guarantees for any at-risk investment, investors have a heightened need to put capital to work to meet future liabilities.

• The generic thesis behind our core workforce multifamily real estate investment strategy - namely that people must live somewhere (making multifamily non-discretionary) - in our opinion, has not changed in the new reality.
• The U.S. 10yr Treasury spread (yielding 0.88% as of 3/12/2020) to nationwide apartment cap rates (5.5% average during 2019) historically has averaged between 250-300bps and is currently at approximately 450bps, an attractive risk premium by historical standards.
• Because of the above, we believe there is a chance that we could see significant continued reductions in cap rates ahead (i.e. continued rally), as there is a flight from equities/corporate bonds into income generating real assets like real estate, and within real estate more broadly, into non-discretionary sectors like multifamily.
• Long-term interest rates are at all-time lows and unlikely to rise significantly until there is an increase in economic growth and inflation (both of which would be beneficial for multifamily).
• Because there is not the same over-leverage in the real estate market (as in the lead up to the Financial Crisis) borrowing costs have dropped substantially.
• We are yet to see the full effect in real estate lending, but anecdotally, in the same day (1) we were offered 2.4%-3% fixed long-term financing today (where historically we have been borrowing in the mid-4% context); (2) we also saw a small credit union back off lending entirely until they get more comfortable that we are not in financial met down.

​Operational Turbulence: 

• Employees struggling to work given a lack of childcare as schools close, making leasing, move-ins and turns more difficult.
• General asset purchase/sales process slowing as parties involved in closings (i.e. inspectors, lawyers, bankers) become less available.
• Residents out of work for extended periods of time with limited sick pay and low savings rates, forced to seek government aid.
• Government aid coming on stream, but perhaps slowly (yet to be seen).
• Possible increase in bad debt as a result.

What we are hearing from elsewhere in real estate:

• Office Space: the short-term push to have more people working from home will be a wake up call to many companies as they realize that they can reduce rental overheads (even at the slight cost to productivity) by having more employees work from home for the long-term or from “hot-desk” locations.
• Hospitality: clearly first hit - click here to learn more.
• Development: highly susceptible to labor shortage, inspector delays, likely too slow project progress.

At Ballast Rock Capital we help originate and distribute countercyclical and recession resilient real estate funds.  Please feel free to connect to learn more about how we work with experienced real estate professionals to offer investors the opportunity to invest in income producing assets with a positive social impact.

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Footnotes:

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