As 2020 comes to a close, I think we can all agree that this has been a challenging year for a variety of reasons. The most glaring challenge that we’ve all faced and that’s changed the way we live and invest, is of course the global COVID-19 pandemic. As we write to you, we hope that you and your family are safe and healthy and that the effects of the pandemic have not put additional economic stress on you. As it pertains to our business of real estate investments and syndications, the pandemic has certainly had an effect on the way we do things and the kind of opportunities we pursue. In this December edition of The Harbor Drive Investor, we’re going to take a look at how the pandemic has effected the entire real estate industry including our business over the course of 2020, and make some predictions on how the pandemic will affect the multifamily investment space moving forward in 2021 and beyond!
Impact of COVID-19 on Apartment Investments:
As mentioned, 2020 has been a roller coaster ride for many people in many different industries. Multifamily real estate investment and syndication has been no different. Early in the pandemic (March/April 2020), the immediate affects of this crisis showed themselves right away. Multifamily transactions came to an abrupt halt (sellers weren’t selling and buyers weren’t buying). Furthermore, the golden standard Agency lenders (Fannie Mae & Freddie Mac) made drastic and frequent changes to their lending criteria and guidelines. This of course is understandable as lenders are in the business of making a profit and protecting their own investors. Some of the notable lending changes were lenders requesting that borrowers put up an additional 12-18 months (depending on the deal and the market) of principle and interest debt service payments, taxes, insurance, and replacement reserves. This was a tremendous hurdle for investors to overcome and in some cases meant that the borrower would have to bring an additional $1 Million or more in investor equity in order to close on a deal. As you would guess, this was a serious blow to investor yield and overall returns. What’s the fix? Lower prices of apartments of course (Hooray!). However, sellers didn’t want to reduce their pricing and therefore we witnessed a ‘stalemate’ in the markets over the several month period between (roughly) March-June 2020. Transaction volume came to an abrupt halt while sellers, buyers, and lenders were all looking at each other and waiting to see how the very fluid pandemic situation unraveled.
What Happened Next?
Slowly, lenders began to update and change their lending guidelines to make borrowing more feasible and to increase the transaction velocity on Multifamily investments. They did this by loosening up some of their reserve requirements by reducing the amount of reserves needed from 12-18 months of reserves, to 9-12 months of reserves. Some of the lenders even dropped the need for reserved taxes, insurance, and replacement reserves on a given deal and only required 9-12 months of principle and interest debt service payments. This was a bit of relief to investors like us and it began to open the markets up again. From that point, we saw a flood of sellers come into the market offering their apartments for sale. Much of this was likely due to pent-up sellers waiting on the sidelines for the previous 3-4 month period. It was at this point, that investors began to pay extremely close attention to the income and delinquent rents on projects being underwritten. Each new month was a collective ‘hold-your-breath’ moment as everyone waited to see the damage done by all the jobs being lost at such a historic rate. However, collections never fell off a cliff, and outside of a handful of cases, the majority of tenants in every market continued to pay their rent. This may be a byproduct of the CARES act that was introduced by the Congress in late March which provided millions of Americans much needed financial relief. Because income remained relatively healthy across most apartment investments, we did not see much (if any) downward pressure on pricing of these assets through the summer and fall.
Apartment Investments in 2021: What’s Ahead?
The whole investing world has been waiting for pricing adjustments as a result of COVID. The reality is, we just haven’t seen that yet….We believe that there is more economic damage to come and that many of the affects of the pandemic will have lagging economic indicators. Although the CARES act was created to help millions of Americans in financially stressful situations who were impacted by the pandemic, we also believe that the CARES act has artificially kept investment real estate pricing inflated. We believe in helping those in financial need which the CARES act most certainly did. However, the federal government cannot continue to provide this kind of federal relief indefinitely…. At some point, the lagging indicators and affects of COVID will catch up and we believe there will be some kind of pricing correction in the multifamily investment world. That may come as early as 1st or 2nd quarter of 2021, or it may take a bit longer. In any case, we feel that there will be some tremendous opportunities to acquire some very high quality apartment deals in 2021 at discounted rates.
In the Meantime…
At Harbor Drive Holdings, we continue to look at the real estate investment opportunities everyday. We have adjusted our underwriting and projections to reflect our opinions about the future by doing things like holding back on any proposed value-add opportunities during the first year of operations, paying very close attention to apartment delinquency and making sure we are well capitalized in a given investment, and adjusting our exit CAP rate assumptions in order to realistically project investor returns based on forecast inflation rates (which will affect interest rates and subsequently real estate CAP rates).
Real estate investing is a long-term commitment. We believe real estate is one of the greatest investment vehicles that investors can use to achieve generational wealth and freedom. We are very bullish on the future of multifamily real estate investing with the caveat that it takes disciplined underwriting, and a clear understanding on all the market forces that affect cash-flow and equity appreciation.
Until next time…..