The top story on all news feeds over the past several weeks has been about the coronavirus. While the concern about the virus is deepening, it is impacting the economy in many different ways. For example, I personally pulled all of my money out of the stock market before the first crash, as I saw how the international concern would negatively impact the stock market. The market has since seen its worst drop in value since the Great Recession of 2008.
I also began to wonder how the crisis might affect real estate investing as well, and feel that it will impact real estate in several ways. Please note that my personal opinions are based on my experience in real estate investing and what I’ve seen happening so far.
Possible Impact No. 1: Real Estate Prices Will Go Down
I believe we will see commercial real estate prices dropping as foreign equity, which is constantly looking to buy real estate in the U.S., will have issues with accessing U.S. markets. The outbreak will affect their ability to invest overseas. Flying to the U.S. to and from Asia and Europe is becoming more and more problematic, which hurts foreign investors’ ability to do business here in the near future. Since many foreign investors look for much lower returns than local investors, they are able to offer higher prices for multifamily properties. With a decline in foreign investments in the U.S. market, the demand to purchase multifamily properties will experience a decline, resulting in lower prices.
Possible Impact No. 2: Vacancy and Bad Debt Rates Might Increase
Vacancies in multifamily properties might increase, particularly in submarkets where employment is dependent on entertainment. I say this cautiously, but I believe that there is a good chance that these events will trigger a recession due to the massive disruption in the global supply chain. Since entertainment is considered a luxury, most people tend to cut entertainment expenditures when there’s a recession. Unfortunately, if that happens, many employees who work in the entertainment field will lose their jobs.
When people lose their jobs, they aren’t able to pay their rent, which leads to higher vacancy rates, as some tenants will be forced to move out to a cheaper apartment. It also leads to higher bad debt, as non-payment of rent is considered a bad debt, and many property management companies work with collection agencies to collect those debts. Also, with layoffs and unemployment, there wouldn’t necessarily be qualified new tenants available to replace those who are evicted for bad debt.
In addition, high vacancy rates can wreak havoc with a property’s net operating income, and if it’s significant enough, it could seriously impact investors’ ability to pay the mortgage debt. This domino effect can cause serious problems, and in extreme situations, foreclosure by the lender if the loan can’t be repaid.
Possible Impact No. 3: Increased Demand from Local Equity
A positive impact could be an internal capital flow toward real estate. Many U.S. investors will do what I did, which is pull their money out of the stock market. Those investors will be looking to put their money into real estate, which historically is more stable than the stock market. I believe that more capital will flow into multifamily real estate from local U.S. investors, which can counter the decline in demand for multifamily and might be able to stabilize prices or prevent a major decline in property values.
So, What Can You Do?
If you are looking at prospective deals, write very conservatively; account in your analysis for rising vacancies and bad debt. If the deal still works, then it’s a good deal. Be even more conservative in your income projections; in a recession, you might have to give higher discounts to bring in new tenants.
The coronavirus has not only become a major health problem around the globe, but it has also taken a toll on the stock market, and real estate might also be affected by it. We might witness a drop in real estate prices, as the spread of the virus will prevent foreign investors from investing overseas. In addition, traveling to the U.S. to view potential investments is becoming difficult; so many investors from abroad won’t be able to view potential investments, making bidding on them less likely. Additionally, vacancy rates will rise if these events bring on a recession. This will impact markets where entertainment is a key to the economy, and will result in layoffs. That will lead to bad debts for non-payment of rents, which could lead to even bigger financial problems for property owners. On a positive note, I believe that there will be increased demand from local investors as more pull their money out of the stock market and will look to deploy it into real estate.
The bottom line is that there is tremendous uncertainty in various markets, including real estate and housing. Be conservative when you buy and have processes in place to deal with the virus if it becomes an issue in your property.