Is There a Pandemic/Recession Resilient Asset Class?
No doubt that Covid-19 threw a wrench into the wheels of global economy and brought with it dramatic health and economic crises. US real estate was no exception, or was it?
A few “fun facts” to remember:
The US is expected to have a shortage of 4,600,000 apartments by 2030.
The demand is coming from various sources: millennials (who delay their marriages and family creation towards their very late 30s); empty nesters/baby boomers who got sick and tired of paying mortgages and property taxes and prefer to forego the “fun” of doing projects around the house every weekend; natural population growth and immigration
At the moment, roughly 38.8 million people live in apartments, and the trend is on an upward trajectory as the population is expected to grow by 9.79% by 2030 and the demand for apartment living within the same time frame is expected to grow by 20.4%.
Yet, the pace of construction lags the demand by approx. 100,000 units/annum which means that the above inventory deficit is only going to increase with no apparent solution, thereby exacerbating housing accessibility and affordability issues.
Add to the above the fact that approx. 50% of the apartment inventory was built before 1980 and needs various levels of renovations in order to stay in business and you get a close to “perfect storm” for apartment investors. Or do you?
Indeed, not all markets have been created equal as the propensity to rent is on an increased level in high growth and high cost states as well as in border states (e.g. in Texas the demand for apartments is expected to grow by almost 32% by 2030; Georgia 31%; South Carolina 25; North Carolina 37%) however even within the markets that have grown more than others construction and land costs are on the rise which reduces the returns on investment in new construction projects.
Additionally, most often than not, the older properties are better located than their newer counterparts and are situated in more mature and stable submarkets which in turn reduce the risk associated with investing in them without reducing the returns either on current cash flows or capital gains.
A recent CBRE research paper (“2021 US Real Estate Outlook”) projects a strong recovery in 2021 for US multifamily and a continued trend of compressing CAP rates which represent an increase in values. However if we look deeper we see that the properties that were hit the most during Covid-19 were newer and more “amenitized” Class A ones that suffered an exodus due to inability to pay rents and Class C properties that suffered a high rate of delinquencies, not to mention the shadow vacancy due to the eviction moratorium. The “winners” were the slightly older B class properties that didn’t experience the hardship of the other asset classes and per CBRE are expected to recover the fastest and even outperform in 2021. Historically these were also the properties that were the most resilient during the 2008 crisis and have provided (and still do) supersized returns in relation to the multifamily sector risk profile which to begin with was the safest of all real estate sectors and asset classes.
That said, if one is to opt into investing in the slightly older Class B properties it is imperative to invest with a sponsor who has ample experience in value add properties as the success of these projects/investments will rely heavily on the sponsor’s ability to execute the value add program and stabilize the asset as a higher quality one with a better market positioning. In such cases the sponsor’s ability to renovate the apartments with minimal impact on occupancy and rent levels is critical; The same applies to its ability to streamline expenses and augment Other Income sources.
More so, that experience and expertise are required when selecting the right investment property as here come into play strong demographic considerations either before or after the value add program has been executed as well as the ability to identify a property that is truly a value add candidate rather than merely an advertised one.
The U.S. Multifamily sector will continue to grow if only for the simplistic reason that has been valid since we were all cavemen – everybody has to have a place to sleep and when there are more and more of us there will be more and more demand. How you choose your cave and what mural you will paint on it, is increasingly becoming the realm of the experienced professional and an investor is strongly advised to deploy his portfolio allocation with such a professional.