Amidst a global pandemic, a volatile stock market, and a broadly uncertain economic future, these are undoubtedly stressful days for the investment community. Individuals are not only trying to protect their physical well-being from COVID-19, but after the stock market plunged in mid-March, they are also trying to preserve their wealth.
These events are causing investors to ask, “How can I keep my money safe? Short of burying it in the backyard, how can I protect my wealth during a down market?”
In this three-part series, we’ll share Birgo Capital's point of view on the risks and rewards of real estate investing in light of current circumstances, recommendations on the safest real estate investments during economic volatility, as well as how Birgo Capital is actively navigating this season.
First, we want to acknowledge there are many consequential unknowns around this pandemic, including the impact on human lives and the economy at large. We can’t predict with any degree of certainty what the coming weeks and months will hold; similarly, we recognize there are external factors that are out of our control.
Secondly, as we shared with our investor partners, it’s important to note that we believe we are well-positioned to traverse these elements with relatively modest impact to our portfolio because of 1) the rigorous risk-managed investment standards we have upheld since Birgo Capital's inception, and 2) the active measures we are implementing today to maximize our performance in this environment. We’ll discuss these points in part three.
But first, let’s address the question at hand:
Is now the time to invest in real estate?
Below we’re highlighting both the risks and rewards of real estate investing in this specific economic climate. We’ll also share our conclusion on whether now is a good time to invest in real estate based on the information shared.
Risk #1 - Potential impact on rental collections from tenant income disruption
COVID-19 is an unprecedented pandemic impacting mankind worldwide - physically, financially, socially, and emotionally. And it begs the questions: “Will tenants be in a position to pay their rent? How many will experience job loss due to temporary or permanent closures? Will they default on rent until the worst has passed?” These are valid concerns which give rise to risks an investor must consider.
Birgo Capital’s partners have analyzed this in depth, and you can read their full perspective on how this risk will directly impact Birgo Capital here. (Good news: the data suggests that Birgo tenants will continue to be able to pay rents for several reasons.) Furthemore, April’s rent collection numbers indicate closing out the month at an astounding 99.8% of budgeted collections, and May looks to be on track for even better performance.
Risk #2 - COVID-19’s influence on the asset valuation process
With rapid changes in the overall landscape, many real estate investors are pressing pause to consider how this will affect the asset valuation process. The general uncertainty in the national financial outlook makes it difficult to validate the basic assumptions for due diligence models. Firms are also prohibited from on-site inspections in many regions, so many are slowing the process to make calculated, conservative acquisition decisions in light of the uncertainty.
Risk # 3 - Sluggish capital movement’s leading to reduced ROI
Access to capital is critical for a real estate investor to overcome these circumstances; conversely, lack of capital is a main contributor to difficulties. Most lenders are evaluating numerous factors to determine how they should price risk and what capital will be available to them to lend, while measuring the health of their current loans. As such, obtaining loans can be incrementally challenging for real estate investors in this environment.
Reward #1 - Privately held real estate is typically less volatile than the stock market
Investors in real estate don’t see a daily valuation status reflecting asset performance as they would for a stock, but rather, they review monthly or quarterly financial and project updates. Because returns in real estate are created over the long term, the daily ups and downs are immaterial. Additionally, rents generally remain steady with modest increases year after year, providing a stable source of cash flow.
Given the rapidly rising unemployment rate in the U.S., a repercussion of COVID-19, it begs the question: how will this impact tenants’ ability to pay rent? This was addressed in Risk #1 above.
Reward #2 - Residential real estate has a low correlation to other investment types
Robert Shiller, distinguished economist, Yale University professor, and co-creator of the Case-Shiller Home Price Index, explained there is little correlation between home prices and the stock market as supported by over 50 years of data. The chart below demonstrates real estate’s steadfast annualized returns regardless of the stock market’s highs and lows. (Please note real estate’s annual returns in the chart below only showcase appreciation.)
Context is key here - these insights reflect residential real estate returns and excludes other types of real estate such as industrial warehouses, offices, storage, retail, etc. Additionally, it looks at the housing market as a whole, which is distinctly different from looking at the return of one single property (individual properties can be negatively or positively impacted by a myriad of factors). When considering adding real estate to your portfolio in order to weather economic downturns, ensure diversified, residential real estate drives the portfolio.
Reward #3 - Real estate can serve as a hedge against inflation
A decrease in inflation during a recession is not a given, particularly in light of the excess liquidity injected into the economy by Federal Reserve actions. Real estate can be a smart way to surmount inflation’s potential future impact. This is because borrowing costs can be fixed at low rates, while rental rates can be increased over time to keep pace with inflation.
So, is now the time to invest in real estate?
We are not financial advisors, but we would encourage anyone considering making a material illiquid investment to evaluate the level of liquidity potentially needed in the next 3-5 years, especially in an uncertain market with increasing unemployment rates.
If this evaluation confirms there is discretionary capital that could otherwise be earning you passive income…
What criteria should an investor prioritize in a real estate investment to recession-proof their portfolio?
Join us next week as we discuss four strategies to stabilize your real estate portfolio in the midst of economic headwinds.