Much has changed since my first post on the Coronavirus on March 12, 2020. So much so, that I felt it necessary to update that post. The short term and long term effects on the real estate market will be significant.
As of this writing according to worldometer.com, There are now more than 1.2 million cases of infection that have resulted in 65,900 deaths worldwide. Whether or not you agree with the government’s decision to shut down all businesses and force people to shelter at home, the impact on the economy has been and will continue to be profound.
Real estate prices have always been a function of interest rates, mortgage availability, and unemployment. Let’s take a look at how each of these factors has changed in recent weeks.
Interest rates, specifically mortgage interest rates, were already historically low before the shelter in place and lockdowns began. The Federal Reserve has already pumped more than $1.5 Trillion into the financial markets so it is safe to assume that interest rates will remain fairly stable, at least in the short term.
The Fed has recently been authorized by Congress to increase its balance sheet by an additional $3 Trillion. This will surely have inflationary consequences but it is uncertain as to where that inflation will appear.
Although the banks have more than $1.5 Trillion in reserves, they are by their very nature risk-averse. As such, lending standards have been tightened and for some banks, no new mortgage applications are being accepted pending the outcome of the shutdown.
First-time unemployment claims increased by 3 million in the first week of the shutdown, and by 6.6 million in the second week. The unemployment rate has increased to 4.5%.
The longer the shutdown continues, the more severe the unemployment will become and the longer it will take for the unemployment to decline. Small and medium-sized businesses create 70% of the jobs in the USA, yet they are the most vulnerable in the current climate.
Congress has authorized a $2 Trillion package to compensate for the economic damage to the economy. Previous experience indicates that the majority of these funds will go to large multinational corporations, Wall Street, and the banks. This does not bode well for the small business owner.
Unemployment is predicted to rise to anywhere from 10% to 30%. These are levels not seen since the Great Depression.
How Will the Coronavirus Effect the Real Estate Market?
None of the three factors above are positive. Therefore it is reasonable to assume that real estate prices will decline over the short to medium term.
Because of the inflationary pressures resulting from the increased money printing, it is important to look at prices on an inflation-adjusted basis.
During the past 10 years since the last financial crisis, the inflation created by the various QE programs of the Fed has either been exported or appeared in higher asset prices, namely, equities and real estate. Will this continue to be the case? Time will tell.
Who Are The Most Vulnerable?
Vacation Property Owners
Both in the short and medium-term, the most vulnerable are the owners of vacation rental properties. Travel bans are in place. Tourists and travelers have canceled their plans and are sheltering at home.
Owners of vacation rental properties are dependent on the rental income to make their monthly mortgage payments. Should the shutdown be extended for any significant length of time, a spike in mortgage defaults and foreclosures is likely.
For more information on how the default on vacation property loans could affect the entire real estate market, go here.
Real Estate Professionals
With everyone sheltering in place, the real estate market has ground to a halt. No one is even thinking about selling their home, and buyers are too afraid to go out and inspect properties.
Consequently, appraisers, mortgage brokers, real estate attorneys, and title companies have little or no work.
The Long Term Consequences to the Real Estate Market
We are currently in uncharted waters so it is difficult to predict what the exact long term consequences will be. There appear to be three possible scenarios:
1) Sustained high unemployment and deflation.
Should the shutdown continue for a significant period, many small businesses will be forced to close and the job losses will be permanent. Higher unemployment will reduce the demand side of the equation as there will be fewer buyers who can afford to buy a home. This will place downward pressure on prices.
Demand for rentals will increase but rental rates will be forced down as family income declines as a result of the higher unemployment. Landlords will either see more tenants per unit and/or a higher vacancy rate as renters can no longer afford current market rental rates.
With an estimated $6 Trillion being added to the money supply, there is a risk that confidence will be lost in the US dollar. As such, investors will sell US dollar assets, reducing the value of the dollar substantially which will, in turn, push interest rates and prices much higher.
Stagflation is defined as persistently high inflation combined with high unemployment and stagnant demand in a country’s economy. This is the most likely scenario.
Demand for big-ticket items, such as homes and cars, will decline, resulting in lower prices. At the same, demand for perishable consumer goods such as food and clothing will remain the same and prices will increase as the value of the dollar declines.
With inflation creeping into the general economy, the key question will be, can the Fed hold down interest rates? If the answer is yes, then the effect on the market will be diminished.
The second key question will be, will wages keep pace with the rate of inflation? History has shown that until recently, real wage growth was essentially zero since 1975. The chart below shows that real wages declined from 1975 to 1995 and did not reach the level of 1975 until 2015.
The end result will be an inflationary rise in home prices, but that rise will not likely keep pace with the rate of inflation in the general economy. The end result; a decline in home prices in inflation-adjusted dollars.
How Can You Profit From the Current Coronavirus Environment?
Because of the uncertainty of the long term consequences resulting from the damage to the economy, it is prudent to proceed with caution. From the chart below, it is clear that the market was due for a correction. The average market price was higher than in 2008 before the current crash. The coronavirus threat is likely to accelerate this correction.
At the moment, cash is king. The US dollar remains the cleanest shirt in the laundry hamper. As a result, capital has been flowing into the US dollar-based assets. The dollar is close to all-time highs against other currencies. You want to conserve cash.
Purchasing Real Estate
All real estate purchases should be placed on hold until the shutdown ends and the dust begins to settle. If you have recently purchased a property but you have not closed the deal, walk away and sacrifice your deposit. This sounds extreme but the potential losses from price reductions could be significantly greater than the amount of your deposit.
Have you purchased and closed on a property that you are currently renovating and planning to flip? If so, there are 2 options.
a) Complete the renovations as quickly as possible and be prepared to put the property on the market as soon as the shutdown ends.
b) List the property with a wholesaler and attempt to sell as-is. You will likely get a lower price and may sustain a loss. Again this loss could be substantially less than the loss realized from a market downturn.
If you own rental property and have owned it for more than 5 years, this could be a good time to sell. However, if you are one of the fortunate few who own their rental property free and clear, you are in a good position to ride out the coming change in the market.
Commercial property should be avoided. Many workers are currently working from home during the shutdown. This will have long term consequences. As managers realize that productivity is as high if not higher with workers working from home, they will begin to reassess their need for office space. Commercial office space should see a sharp decline in demand and a consequent drop in prices.
Retail property was already suffering before the coronavirus crisis. As consumers are sheltering in place, they are purchasing even more online. That trend is unlikely to change after the shutdown ends.
The Bottom Line
We are entering a period of great uncertainty. Managing risk has never been more important. The most obvious way to manage risk is to avoid it. Unless you can purchase property with cash (assuming you are getting a great deal), don’t buy. Conserve your cash and wait for the market to turn positive.
If you currently own property, consider selling it as soon as the shutdown ends. In the event you are not interested in selling, make sure you have sufficient reserves to cover a year of operating expenses. Anything less will substantially increase the risk.
Owners of vacation rentals should seriously consider either selling their property or at the very least convert it to an annual rental.
The worst thing you can do is nothing. If you think that everything will return to normal once the coronavirus has run its course, it is not going to happen, at least not over the short term.
One of the most important factors in successful real estate investment is the ability to prepare and adapt to changes in the market. Change is coming. Be prepared.