Understanding Real Estate Market Analysis Strategy
This will be our first post on our JB2 Investments Blog. I will share the ins and outs of apartment investing and our journey in general. I will give you my outlook on today’s market, especially in these dire times. In this first piece, I will focus on where the market is and what we are hearing broadly through a vast array of news outlets, podcasts, conversations, and webinars.
I will start with where things are at for us and my synopsis of all the information we have digested. In this time of Covid-19, we haven’t even gotten to a place of price discovery. What I mean by that is sellers don’t yet really want to discount their prices YET. Buyers like us are needing to be more conservative on our analysis and need those discounts to make the deals pencil. At this time there is a disconnect between buyers and sellers. Therefore, the markets have been in a pause unless you are time-constrained in a 1031 exchange. Secondly, the debt markets are now more constrained. For example, with agency debt we are now required to put up reserves for Principal/Interest as additional collateral, putting us in a place where we need to raise more funds - making deals less economically viable. Hence the further need for sellers to give buyers discounts.
On top of all of this, collections in April and May have been at normal levels and for some even better. This is due to all the government stimulus from the Cares Act. What’s going to happen once all the stimulus runs out? Where will unemployment be when the bazooka stops firing? What happens if we have a second wave of the virus? If we are still in double digits plus unemployment after the stimulus ends, we will start to see some pain in collections, vacancy, debt issues, and the economy suffering more broadly. Keep in mind that during The Great Recession we topped out at 10% unemployment. Currently, we are at about 15.8% unemployment which we haven’t seen since the Great Depression. This level of unemployment needs to be dialed back as we reopen before the stimulus ends. We expect some expansion of cap rates during this temporary pain and subsequently downward pressure on values. What is tough to forecast is when and how long this pain will occur and how painful it will be? When will sellers truly be in distress, will it be in Q4, beginning of 2021 through most of 2021, and will values come down by 15-25%? We don’t have a crystal ball but those are questions that the most knowledgeable people cannot answer right now.
With all this uncertainty, our strategy is to look at deals even more conservatively. We are contemplating what it would look like to have no rent growth (unless rent growth comes from value-add activities), higher vacancy, larger reserves, and longer periods for the value-add process. Even if we were to close on a project now and values come down, as long as we bought on more conservative numbers, we would easily ride out any storm. In due course, we are going to have a lot more clarity on the economic situation once the stimulus sunsets. What’ll happen once some owners become in distress because their loans are becoming due and struggle to Refi? Will there be opportunities to assume loans to buy at favorable prices so sellers don’t get hit by yield maintenance pre-penalties? There are many questions yet to be answered. Ultimately, we believe Multi-family will take a hit and it will create one of the greatest buying opportunities of our lifetime. We are continually fine-tuning our systems and getting prepared for what is to come.