We will continue to provide perspective on coronavirus market impact and implications for real estate investors. Please feel free to send any questions to firstname.lastname@example.org.
If you are an active investor, you have likely received a deluge of emails in the past few days from investment advisors, asset managers, and investment industry talking heads. Most fit within two dominant narratives regarding the global viral outbreak:
- “Our philosophy and approach make us uniquely qualified to weather a storm like this, and that’s the way it’s always been.”
- “You can’t plan for something like this so let’s not lose any sleep. Stay the course!”
Neither storyline is particularly reassuring. As we’ve said before, no one can tell you exactly how or when an economic expansion will end. In retrospect, the financial collapse of 2008 was inevitable, but most industry leaders missed the warning signs. The outbreak of the novel coronavirus that causes COVID-19 is a far less predictable event that will impact markets in ways we may not fully understand for weeks or months to come.
This crisis will have an influence on economic activity that may adversely impact real estate values. In the short run, curtailed business travel and tourism will hurt hotels. Dampened consumer confidence will hurt retail while social distancing may put additional stress on regional malls. Supply chain disruptions will continue to impact industrial markets. However, not all impact will be negative—as food shipments to Asia were halted over the past month, industrial cold storage facilities saw record demand for space; with more people choosing to work from home, multifamily properties are seeing increased use of common area spaces which could serve as a more attractive amenity in the future. While no one can predict the full magnitude of the economic fallout, it is important to note that near and long term impacts can be both positive and negative for commercial real estate. Alternatives like private, illiquid commercial real estate investments have historically exhibited less volatility than public equities and may help insulate your portfolio against risk during times of public market instability.
Further, there are fundamental aspects of EquityMultiple’s origination philosophy, underwriting, and structuring of investments that investors should take heart in at times like this:
While this current outbreak will indeed impact economic growth, the long term effects are yet to be determined. In originating, underwriting, and structuring investments, we have operated for some time under the assumption that real estate markets are at or near the top of the cycle. For this reason, we have prioritized investor protections by participating in more senior portions of the capital stack.
At EquityMultiple, we seek to mitigate risk at the asset level through the following measures:
- By conducting exhaustive diligence on every investment we consider, ultimately selecting around 5% of investment opportunities;
- By seeking to work with only experienced, reputable real estate firms and operating partners;
- By stress testing our underwriting assumptions;
- By considering the “last dollar basis” of the investment;
- By negotiating and structuring investor protections.
More information on these practices can be found here.
Multifamily: A Historically Low-Volatility and Resilient Asset Class
The multifamily asset class has historically exhibited lower volatility, higher resilience, and greater demand elasticity (with respect to rent levels) than other core real estate asset classes. 1 This stands to reason—while demand for retail and office space may be adversely impacted by macroeconomic or global shocks over a shorter timeframe, renters will still need a place to live. Though a prolonged downturn will eventually have a broad impact on multifamily rents, operators can mitigate risk with rolling lease expirations. Larger multifamily properties with dozens or hundreds of units offer operators and investors the opportunity to mitigate vacancy risk through a diversified tenant base. The single-family residential market may be severely impacted by a downturn, as would-be homeowners put their search for a home or rental property on the backburner. In some cases, multifamily assets may benefit, as risk-averse renters opt to stay put or even downsize to apartment rentals from single-family homes.
Because of this consistent demand through market cycles, multifamily has historically exhibited the best risk-adjusted returns among core property types. In the 25 years ending in 2017, multifamily led all commercial real estate property types in average total return with the second-lowest volatility. 2
Multifamily assets represent a plurality of the EquityMultiple portfolio. In many cases, we have targeted the types of multifamily assets that may exhibit particular resilience in times of economic upheaval, such as student housing, workforce housing, and manufactured home communities.
Hotels: Proactive Asset Management
Business travel and tourism have been significantly curtailed, immediately impacting the hospitality industry.
EquityMultiple’s Asset Management Team has proactively reached out to each individual Sponsor in this property type to assess the level of impact from the coronavirus outbreak. Since each investment is unique according to strategy, geographic market, and capital stack positioning, the impact will vary significantly. Our #1 priority at the moment, with respect to hotel investments, is preservation of capital.
Interest Rates Hit All-Time Lows
This crisis has led to a sharp decline in U.S. Treasury rates, which has driven down interest rates on real estate loans. On Sunday, the Fed slashed interest rates again, lowering the benchmark rate to close to 0%. Many borrowers who were already in the process of refinancing existing loans will reap the benefits of these lower rates. If rates continue to stay low, more borrowers will rush to refinance and lock in rates that are at historically low levels.
With lower rates, Sponsors will now attain a higher Debt-Service-Coverage-Ratio (DSCR) which, depending on our positioning in the overall capital stack, materially enhances the likelihood of a pay-off to our existing investment. As a reminder, Sponsors have several levers to pull to potentially repay investors—while sale of the asset is one option, another is to refinance the loan after value creation.
In recent weeks, several investments were re-negotiated and ultimately benefited from more favorable interest rates, with lower levels of debt service and consequently higher projected returns to investors than had been projected during the original underwriting.
Illiquidity & Historical Risk-Adjusted Returns of Real Estate
Private real estate remains a stalwart for investors seeking strong risk-adjusted returns across market cycles. In the 20 years ending in 2018, encompassing the Great Recession, private commercial real estate delivered stronger average income returns than all other major asset classes and over 3x public equities. 3
Realized returns from private commercial real estate are a function of manager skill and demand trends in the built environment. The illiquid nature of real estate insulates investments from the speculation and market sentiment that drives public equities markets. As such, private real estate has exhibited far less volatility than equities over the past 20 years, as well as a far lower correlation to public equities markets than publicly-traded REITs.
A Nimble, Forward-Looking Approach to Origination
Since inception we have offered investors not only access to professionally managed, private commercial real estate, but also to a diversity of property types across the country, including emerging asset classes like data centers, manufactured home communities, and infrastructure.
As a hypothetical example, demand for data centers may increase as companies invest in remote work and high-throughput videoconferencing infrastructure, leery of work stoppages at physical office locations due to future public health threats. Again, we do not know what the specific long-term economic ramifications of this black swan event will be, but a diversified approach—alongside a substantial allocation to illiquid alternatives like private real estate—should serve investors well throughout market cycles and unpredictable economic headwinds. We have and will continue to source investments across a broad range of property types and markets, affording our investors the highest degree of diversification possible.
The Bottom Line
Though this may be obvious, it should be stated—the human cost of this crisis looms far larger than any financial ramifications. We hope for as swift a resolution as possible. At EquityMultiple we have mandated that all employees work from home until further notice. While this measure was taken in the interest of the health and safety of our team, we are also using this period as an opportunity to further improve our already robust remote work and collaboration infrastructure. Many companies, large and small, are doing the same. In the long run, this may serve as a wakeup call to corporate executives, prompting greater investment in telecommuting infrastructure and technology and better definition of protocols that can help reduce cost while protecting the mental and physical health of employees. This could amount to a shift in demand for certain kinds of workspace. Ultimately we may see many such silver linings for forward-looking real estate investors as the coronavirus market impact becomes more clear. The U.S. economy is diverse, dynamic, and buttressed by constant technological innovation. The same can be said for EquityMultiple’s portfolio and our approach to real estate investing. In this uncertain time, our number one priority is managing our existing portfolio. However, we will remain vigilant in the new pricing environment that emerges and as new opportunities develop amid dislocation.
Our portfolio is a diversified pool of assets invested across property types and geographic locations in the U.S. These investments include multifamily, assisted living and health care facilities, industrial, manufacturing housing, self-storage, student housing, condos, office, and others located in 27 different states. EquityMultiple’s Asset Management Team has been actively engaged with our operating partners and is closely monitoring each investment’s performance. During times like this, our primary goal is to ensure the safety and well-being of all tenants and occupants. As such, we’re reaching out to our sponsors to ensure that they are:
- Providing public health guidelines from the Centers for Disease Control and World Health Organization to all occupants and ensuring protocols are being followed;
- Working to ensure public areas are properly clean and sanitized; and
- Providing adequate training to staff so they can answer questions from tenants and guests.
We are working closely with sponsors to monitor property financial performance; ensure sufficient working capital and liquidity is available to maintain smooth operations; and to align on strategy in advance of upcoming financial covenants. In our hospitality portfolio, hotel performance is tracked daily and some operators have implemented wage freezes for the near term as well as considering potential layoffs in areas that have major declines and cancellations. Five of our eight hotel assets are invested in the senior part of the capital stack and have greater risk protections against potential loss. We’re tracking these investments closely and are ready to work with sponsors to address any potential issues. With our hotel investments projected to mature or exit in 2021 and beyond, the potential to overcome the impact from the crisis and protect our investments increases.
We are resolved to continue transparent communications as events warrant. Please know that we remain as committed as ever to protecting investor capital and to vigilantly monitoring the status of our assets on our investors’ behalf. In these uncertain times, please stay safe, and take care of yourself and your family.