Economic Cycles & Real Estate Investments
Real estate investing is, in essence, the art of determining the value of a cash-flow asset through a progression of time that includes: past, present, and future. An investor must have the mindset to comprehend the economic phases of the real estate market in order to better determine how the asset will perform on an ongoing basis.
The residential home market is more localized and impacted from community/regional economic data; however, the multi-family and commercial markets are driven by the broader national and global economies. Long term economic stability is an important factor as it relates to businesses that employ the tenants, who contribute to investor revenue/cash-flow. When the overall economy suffers a downturn like we experienced in 2009, the effects on investor assets can take a severe hit. We all know the COVID-19 crisis has devastated the world in a relatively short period of time. Many tenants stopped paying rent as a result of the job loss, cutbacks, business shut down, and some just refused to pay to take advantage of eviction moratoriums. We are unsure what will transpire in the coming months with the implementation of FDA-approved vaccines, but the dye has pretty much been casted for what is now considered COVID-19-related economic phases.
We are currently in what is called the Stimulus Phase as the Gross Domestic Product (GDP) has now been replaced with stimulus funds pouring into the economy because the government had no choice. The Fed has been purchasing treasuries, mortgage-backed securities, and commercial mortgage-backed securities to keep the national economy from sinking like the Titanic. This has caused the Fed’s balance sheet to increase from about 4 trillion dollars prior to the pandemic to 7 trillion dollars. The current phase has been a shock to the systems we hold dear. The overall economy is experiencing inflation at rate of about 1% with corporate profits experiencing positive growth, and construction spending up due to continual building throughout the country.
Deficient spending has now led to rise in consumer prices that have many experts concerned about escalating inflation. The Fed has a benchmark percentage for inflation before they slam the door on spending. Real estate investors should keep an eye on inflation because when it reaches 2 percent, the Fed plans to stop purchasing securities. The result will be a rise in interest rates that will have a long reaching effect in the housing and commercial real estate markets. Not long after the Stimulus Phase, we will enter into a dark period known as an economic market phase of Insolvency. During the Insolvency Phase, which we are moving at a fast pace towards, we will see more small retailers, restaurants, and businesses in the travel/lodging industries take their last gasp of economic breath before they finally sink. Many will fall into bankruptcy and there will be massive job losses that will lead to the next phase and yet another set of perilous circumstances. The Debt/Asset Deflation Phase will create an economic environment where there is likely a large number of REO’s in the marketplace; however, many experts do not believe we will see the volume of mortgage defaults on the level of the 2008-2009 downturn. Lease renegotiation will become more prevalent than we see in commercial sector. The multi-family housing market will likely experience a decrease in valuation of assets. A phase of Reinflation or Asset Reinflation will follow where the economic cycle will adjust to reflect a rise again in housing prices.
We currently see some segments of the real estate market on an upswing due to the massive printing of money; however, the printing and propping will at some point cause a rise in inflation based on the same formula we see in the residential housing marketing: supply and demand. Low interest rates have driven buyers to the table with offers, while sellers have, for the most part, stayed put resulting in low inventory and high demand. This trend has continued throughout the fall months and the current seller’s market is likely to roll right along throughout the winter. Other segments of the economy experienced stretched supply that resulted in high demand where we saw supply-chain limitations in products like toilet paper, sanitizer, and masks, which resulted in augmented prices throughout the retail industry.
As a real estate broker, I am tasked with reviewing market charts to best decipher business/economic cycles that are good indicators of buy, hold, or sell phases. We usually considered the ‘yield spread’ (difference between the short and long term rates – 3 month Treasury Bill rates compared to 10-year Treasury Note rates). In January 2019, the yield spread dropped to .34%, a sharp reduction from the 2018 spread of 1.17%. Descending yield spreads usually mark a potential recession within a 12 month period. COVID-19 came along earlier this year and obviously shook things up across global financial markets. The buy phase is a period we usually see cyclically lower prices, low interest rates, reduced sales volume, high inventory, and low buyer demand. Current market data shows none of the above as trends of a buying phase with the exception of low interest rates. The selling phase is typically sparked by rising prices, plunge in yield spread percentage, low inventory, high mortgage rates, and reduced monthly year-over-year sales volume.
The period of 1999-2002 reflected a hold phase in the housing market as sales volume descended and the yield spread was below 1%. The recession forecasted for 2001 did not come about because the Fed propped up the economy after the September 11 attacks. When the Fed slows the economy by design, smart investors hold their cash and assets for the most part. A buy phase occurred from 2002 through about 2004 when the yield spread increased over a six month period. Prudent investors brought assets in late 2001. The sell phase took place in 2005 when sales prices increased and home sales volume numbers (most accurate indicator a sell phase is ending) dipped lower than the previous year. Whenever the Fed increases short-term rates for a period of six months or more, investors may need to consider selling.
What you as a multi-family investor should be evaluating is where your property or portfolio is in terms of current value and where the valuation position of the asset(s) might be in the future. Much depends upon what your motivation is for investing. Many investors buy and hold real estate assets over the long term for the purpose of necessary cash flow to supplement current income/retirement. Others are considered value investors who consider high equity positioning for their assets and do not require a great deal of cash flow. The big question has always been ‘when is the right time sell?’ Well, there is a different answer to that question for each investor. Equity investors should not only review their high equity position but consider the amount of return on equity. There are instances when the return on equity diminishes, in which case it might be a good idea to exchange to higher priced assets to produce higher return.
There are some cash flow investors that will suffer from the effects of COVID-19 due to tenant protections in place to restrict evictions and cannot survive supplementing rent payments for defaulting tenants. The best option might be to exchange to another asset class such as industrial or multi-family investment out of state where properties produce a more cash flow and higher rate of return.
The Global Realty Group Commercial Division team is highly qualified to assist you in determining your investment goals for the coming year, whether that be how to address concerns about non-paying tenants, approaching your lender on loan forbearance, financial analysis of your asset, or preparation of an annual statement of return. We have partnered with a team of commercial real estate professional with over 30 years of experience in the business. My experience as a real estate broker includes 12 years in the multi-family sector as a real property asset manager. In 2011, I took home the top award issued by the Apartment Association California Southern Cities for my work in re-positioning properties owned by the City of Los Angeles Housing Department. I have worked as an expert witness in hundreds of Unlawful Detainer cases and hold certifications as a property manager (C.A.R), Occupancy Specialist (National Center for Housing Management), and Real Estate Investment Planning Specialist (National Commercial Real Estate Association).
Call today for a free consultation (310) 753-2751
By M. A. Williams, Broker/Owner
Commercial Division Global Realty Group