In the June Issue
- The Deep Impact of Covid-19 in Rental Sectors
- How This Impacts the Stock Market
- Federal Government Stimulus & Unemployment
COVID-19 Impacts on U.S. Government, Real Estate, and the Stock Market
This month we’re discussing the far-reaching, all-encompassing impact of Covid-19 on investing, taking a close look at the multiple downsides and sources of devastation in key investment sectors, while also bearing in mind (with an air of optimism) that with such significant loss better deals are going to be available later in 2020 and in 2021.
We’re in an odd time in many ways, but one of the unanticipated anomalies has to do with the fact that residential real estate is still performing well all over the country due to limited supply.
However, even this is expected to soften over time. Likewise, commercial real estate is expected to soften even more due to the fact that so many assets are in a sort of forbearance in which lenders are delaying and giving borrowers more time.
Resultantly, current deal flow appears to be limited. In addition, lenders are not lending and are cautious for good reason although there appears to be a move towards re-opening. Transactions are down in general because buyers don’t want to pay the pre-Covid price, nor do sellers want to simply give away the farm.
The Deep Impact of Covid-19 in Rental Sectors
Obviously, this data and our assessment of it are approximate in nature in that we’re currently observing the shocks and aftershocks while we’re living them. The information and data we’re receiving is changing at warp speed. As a result, this overview will provide somewhat of a generalized take on what is happening with different types of asset classes in the commercial and residential spaces.
Let’s start by looking at rent payments. In terms of single-family and multi-family residential rentals, the impact has not been overly severe. There are some assets that are reporting 100% collection while others are reporting a decline of between what I call a soft range– 5% – 15% –in collections (these are places where people live).
Office space, on the other hand, is different in that we’re observing fairly solid collections on the assets that we have. Some offices with corporate tenants (not retail) which have long-term leases are still paying on their leases.
Despite the fact that the demand for office space will soften over time, we’re still seeing fairly good collection rates in the short-term. While many or most tenants are paying in full, there are some who are delaying. I’m cautiously optimistic that the range will be similar to residential rentals, somewhere between 5%-15%. This is all to say that thus far we have not seen office rentals collapse overnight.
We do have a number of investments in plazas, and collections vary from asset to asset quite drastically. In the case of those collecting well, say 65-70%, the shopping plaza is typically anchored by a good grocer. On the other hand, those without strong anchors are struggling, and we’re seeing collections go down, anywhere from 30-70%.
So, it’s a broad range of assets, from very low, 30-70%, collections to let’s just call them 65-70% collections. In the case of the latter, these retailers are able to pay the mortgage and virtually all of them are requesting forbearance from their lenders.
Whereas in the residential sector, forbearance (up to six months) is required, that’s not the case in the commercial sector where it’s not mandatory but encouraged. Thus, banks are getting requests from the Fed and their regulators to grant forbearance, so that these tenants will have a chance to survive.
Enclosed Malls & Hospitality: Where the Real Struggle Exists
These assets have been hit the hardest and collections are down, in many cases, 75-90%. Of course, this has to do with the reality that many enclosed malls are shuttered altogether. Hotels, likewise, are not operating at any kind of decent occupancy; the word is, anecdotally, that the industry is at 90% plus vacancy, operating at 20% capacity which implies 80% vacancy.
These sectors are significantly stressed, and forecasts indicate that will be the case for the foreseeable future. Who among us is willing to travel and stay somewhere for vacation, let alone get on a plane with confidence?As such, tenants in this sector are simply lawyering up and not paying.
Overall, if there’s a bright spot, self-storage is doing fairly well, collecting on par, and in some cases, improving with lease rates up on the whole. Traditionally, self-storage rarely declines during a recession, so it has been a reliable source for collections thus far.
Net Operating Income and Cash Flow Issues
From our chart, you’ll notice that when rent collections dip a bit, net operating income declines quite a bit. This stems from there being a cause that can’t be eliminated. Sure, you can defer for a while, but if you pay your mortgage, taxes, and insurance, cash flow drops quite a bit.
The projected long-term impact of Covid is that many tenants are expected to default or downsize. Sadly, many businesses will not be able to reopen. For example, there are currently theories circulating that roughly 50-70% of dining establishments in New York City will not be able to survive. As I’ve said before, during better times, I have no crystal ball to forecast the future, but expectation is that significant downsizing in the retail sector is inevitable.
Let’s carry this a little further. Re-leasing rates are projected to be down anywhere from 30-40%. This means that many assets will incur debt challenges, and highly-leveraged assets may not survive eventually facing the bank on foreclosure proceedings.
When the aforementioned mortgage forbearance cycles are over, additional difficulties will emerge. Liquidity pain will set in when there is no revenue. That will lead to motivated sellers–as I mentioned above, they’re not motivated to transact at the moment, but I’ve outlined some of the key drivers that will lead to that eventuality.
How This Impacts the Stock Market
How is it possible that the stock market managed to stage a massive recovery in April and May? Here are some of the reasons why.
It may not be justified, but the market is hopeful of a V-shape recovery. Companies like Amazon, Google, Microsoft, Zoom and others driven by technology don’t really rely as much on physical presence and are doing astoundingly well. They continue to go higher because they’re capturing the business from some of the companies that are losing. This illuminates the shift from losers to winners regarding revenues and stock prices in times of crisis.
Likewise, the expectations for corporate earnings may also continue to be better than initially projected. When the market collapsed, there was a pervasive air of gloom and doom, but now that we have achieved some slight distance, there has been a reset of expectations and earnings may be better than expected.
We also know that cash has to work somewhere. The question is where? It takes time, energy, and know-how to invest in alternatives, so those are out. As interest rates drop, bond yields are exceptionally low, so that option is out as well. As people pull cash, they’re putting it back into the market which has benefitted from this infusion.
The Fed’s action in response to the crisis has been extreme. They are currently pumping obscene amounts of cash into the markets. They’re also buying mortgage backed securities and municipal and state bonds. Basically, they’ve supported the economy to the ‘nth degree. Again, the question remains whether this will continue or not. Severe recession is still the likely outcome. There’s also the possibility that the stock market may lose its healthy glow and move into negative territory.
So… this could be the quintessential “dead cat bounce,” in a manner of speaking, in which just cash went back into the market, without fear, giving the perception that things are looking better. We’ll have to see whether or not this is a small, short-lived recovery rather than an actual reversal.
Stock Market Valuation looks even more expensive now, call it Post COVID vs. Pre COVID. Investors are paying greater multiple of earnings now than before COVID. No crystal ball here, but it feels like the market needs to correct again as it is overpriced or relative basis
Unemployment Nears Great Depression Levels
The current situation with unemployment is alarming. As of this newsletter, it has surpassed 40 million and is rising. We haven’t seen this level of unemployment since 1929-1930, something most of us were not around to experience, so this is unparalleled in our lifetime. We’re talking about 20-25% unemployment. To make it worse, many businesses are unlikely to survive, so those jobs will not be coming back. Business sectors such as hospitality, travel, and retail are likely to be severely depressed and will not be re-hiring anywhere near full capacity. Businesses will do what they can to survive at a lower level of staffing, going lean and mean.
To complicate matters, sporting events, Broadway shows, and the restaurant and travel industries, to name a few, will all have to deal with the concern of social distancing, heightened cleaning requirements, and how to reduce the risk of infection/reinfection. It’s too early to say where we’re going, but, obviously, this is all of significant concern.
It is projected that only 50-60% of currently unemployed people due to COVID will go back to work. Basically, 40%+ of currently unemployed people are likely to stay unemployed. These numbers are huge, and we might wind up re-stabilized unemployment at the level of 8-10%, a severe recession level.
Federal Government Stimulus & Unemployment
In the meantime, government stimulus efforts have created a bizarre situation in which they’re providing an extra $600 a week in addition to state level unemployment which is giving many people an income a lot higher than the minimum wage.
This has led to an environment where many people don’t want to go back to work and would rather stay on unemployment. In a manner of speaking, it’s helicopter money which has left people feeling good despite the broader circumstance. The question is whether or not this can continue which is highly unlikely.
It’s a significant concern for the Government to compete with small businesses that need to hire and need to bring employees back as they reopen. So, this is a temporary reality, and I believe, in the long run, the government will not be able to extend it. I don’t know off the top of my head when it runs out, but there are rumblings it might be soon.
The initial idea of $600 a week sounded great, but it’s far beyond the ability of the US government to pay this on a long-term basis not to mention the fact that it’s competing with the businesses trying to as they re-open. There is bipartisan support in congress to pass a bill to provide incentives to both businesses and employees to go back to work. Hopefully, they will pass a good package that will encourage immediate re-employment.
State and Local Government Impacts
The other significant concern is that many state and city budgets are broken, with no tax revenues coming for a number of months. And I think there will be further federal help to keep those things afloat, but they’re dealing with massive problems on the state and municipal level and with hospitals, too, because they staff a lot of their elective surgery and other profitable activities. So, we’re dealing with lots of risks and again it will all create a recession of the environment as a result of these types of economic problems.
To summarize, we have all of these different things currently supporting the economy, and perhaps one could draw the conclusion that the virus doesn’t appear to be as deadly, or at least the initial panic has passed.
Perhaps, as well, we start to feel like we can manage being semi-open for quite some time. Couple that with the possibility that the medicines being developed are temporarily approved by the FDA, research on vaccine advances, hospital capacity stabilizes, and all of these things start to promote investor- confidence. Then, possibly, we reach a place like Sweden did without completely closing in which we continue to manage the reopening. We take into consideration the possibility of a second wave in light of these things, and perhaps have the ability to manage them without shutting down again.
The pandemic has impacted the economy in many ways and the real estate space as you can see, so we are going to delve into CAP rates and drivers of distressed debt with real examples of distressed debt opportunities in the next month’s newsletter.
Contact Us if You’re Interested
If you’re interested in investing or want more information, you can contact Mike Zlotnik at Mike@TempoFunding.com or by phone at 917-806-5029. You can also schedule a time to chat via bigmikecall.com.
Also don’t miss the latest Episodes on Big Mike Fund Podcast. GREAT upcoming episode #061 around June 9th-10th, with the repeat guest Frances Newton Stacy, frequent guest on CNBC, Fox Business, and CBSN. This episode will dive into more economic impact of COVID. Please tune in at BigMikeFund.com
Thanks for reading!
CEO, TF Management Group LLC
This newsletter and its contents are not an attempt to sell securities, nor to sell anything at all, nor provide legal, nor tax accounting, nor any other advice. The presenter is a private lending and real estate fund management business, and the information represented herein are purely for educational purposes and represents the opinions of the presented. Prior to making any investment or legal decision you should seek professional opinions from a licensed attorney, and a financial advisor.
TF Management Group LLC (TFMG) is an investment fund management company that specializes in both short-term debt financing for real estate “fix and flip” projects, and long-term “value-add” equity deals.