You’ve likely heard that workforce housing real estate investing is a safe and durable strategy because, relatively speaking, it truly is. However, because of COVID-19 and its severe impact on public health and the economy, real estate portfolios are being stress-tested in real-time.
In light of the rapidly changing landscape, we are sharing four key questions we’re asking as we proactively manage our 1,400+ residential units and evaluate capital deployment on an ongoing basis.
01 Will tenants have the liquidity to pay rent in an economic downturn?
As an operator of workforce housing, many of our tenants work in blue-collar roles in various sectors of industry. They are largely low-to-moderate income workers with little cash buffer. The onset of COVID-19 quickly sounded warning bells for affordable residential landlords: will tenants be able to pay rent?
We have thought long and hard about this in recent weeks and have come to the conclusion that the vast majority of our tenants will be able to pay rent in April. Indeed, we are encouraged several days into the month that tenants do generally have the capacity to pay. This is because most work stoppages took place in late March, so reductions in hours will generally be reflected in paychecks that tenants receive in April, after rent is already paid. Perhaps some will not want to pay because of uncertainty regarding future income, but current cash on hand is generally sufficient to cover rents that are due in April.
Additionally, an ongoing in-depth portfolio assessment of the sources of income for our tenants is revealing an encouraging insight: we believe the majority of our tenants will have relatively little disruption to income in Q2. Be it through social security, welfare, or programmatically subsidized housing, there is a significant portion of our tenant base that already receives governmental support as a material contributor to monthly cash flow. We also have notable tenant concentrations of pensioned retirees and individuals employed by major corporations in the healthcare and financial services sectors; we believe these will be mostly unaffected in the near-term.
Lastly, our tenants are targeted beneficiaries of the CARES Act. Direct payments will likely be received by nearly all our tenants in the month of April, and therefore we believe they will be able to pay rents due in May, as well. With respect to the capacity of our tenants to pay rent in the second quarter of 2020, the passage of the CARES Act is surely a tremendous help.
02 When will America’s economy resume standard operations?
In recent weeks, it became painfully clear that the spread of COVID-19 would cause deep ripple effects through every nook and cranny of the American economy. In order for our tenants to continue paying rent in the third quarter of this year, absent an additional large-scale governmental response, we will need to see businesses return to a state of consistent operations. The liquidity that will come from the implementation of the CARES Act provides the short-term bridge to subside this concern momentarily. However, to resume economic activity, society will either need to revert to a version of previous norms or innovate in such a way that economic growth can occur without physical mobility. The latter seems unlikely, so we are directing our attention to monitoring the former. We are hopeful that the near-term stimulus will be enough to encourage a V-shaped recovery in the second half of 2020. While this is consistent with what most economists are forecasting today, we believe we need to be prepared for the worst. It is simply too early to tell the pace at which normalcy will return, and we have to acknowledge the possibility of extended stoppage. This perspective leads us to conclude that the most prudent action we can take today is to conserve liquidity at every possible opportunity, valuing cash at a premium and constantly stress-testing our own models until we have more clarity around the time horizon of the economic shutdown.
03 Will real estate capital be mobile during COVID-19?
We are keenly aware that access to capital is the single strategic advantage that allows some real estate investors to survive economic downturns and is similarly the primary reason that others will experience hardship. We are well-capitalized today with diverse relationships and very healthy liquidity ratios prior to COVID-19. Even so, we are actively cultivating all capital markets relationships to decipher appetite for risk, but the clear conclusion is that capital will not move quickly right now. As of the date of this writing, the reality is that most lenders and investors are in “wait and see” mode – just as we are. We are all monitoring the market to determine how we should price risk and what capital we can allocate to taking on risk vs. what we need to keep on the sidelines due to broad uncertainty.
By the nature of our business, we are always a buyer and a seller. Given that our investment vehicles are in relatively early stages of fund life, and that we intend to have long holding periods, for practical purposes we are more of a buyer than a seller. It’s natural, then, that we are attempting to identify market consensus around what the events of COVID-19 mean for asset valuation. Given the uncertainty regarding national and global economic outlook, it is virtually impossible to validate the most fundamental assumptions in our typical analysis. As such, we are pressing pause to allow the marketplace to provide consensus. Until that happens, real estate capital will move very slowly, and we are preparing to operate within such an environment for an extended period of time.
04 Will market participants work together to achieve mutual benefit?
One of the most interesting facets of the current crisis is the extent to which pain is shared. As has been stated by many at this point, there is not one citizen that is isolated from this struggle. Whereas the dotcom bubble burst of 2000 was sector-focused, and the Great Recession of 2007-2009 was a credit crisis in financial markets, COVID-19 plays very few economic favorites. We are truly “all in this together,” which begs the question – will we work together towards a common economic good?
After three weeks of discussions with players at all levels of our organization’s external ecosystem, the answer to this is a resounding “yes.” Thus far, we’ve witnessed a remarkable level of empathy between vendor and customer, government and constituent, borrower and lender, tenant and landlord. We’re directly experiencing a sweeping cultural movement to work through unforeseen challenges to achieve win-win and have as many survive as possible. In an environment where harsh near-term realities necessitate collaboration, a continued pervasive posture of mutual empathy will go a long way towards achieving survival for as many as possible. It’s our opinion that we will continue to witness broad adoption of a collaborative posture for the time being, but that we should be prepared for increased rigidity and self-preservation should the crisis linger into Q3.
In closing, we will continue to monitor these key issues closely and will adjust our posture as additional information becomes available. We believe that we will weather the storm and emerge stronger on the other side. Our stress-testing is encouraging: we believe that multifamily real estate will outperform in this down market as it has in the past, and that workforce housing will be viewed as a haven of safety once velocity returns to capital flows.
If you’re an accredited investor and would like to learn more about Birgo Capital’s private equity real estate funds, please contact us to set up a brief introductory meeting.