Real Estate Market 2020 Onward
Real Estate is the largest asset class in America. For those who know me personally or professionally, you know that I’ve spent the last few years learning about real estate in depth. I’ve been fortunate to learn from the best and have been given access to data, trends, and wisdom from people who’ve built wealth through building and managing real estate portfolios.
It’s quite difficult to accurately speculate on something which is actually a catch-all term. Real estate is a vague asset class and contains many subclasses which all behave relatively differently and respond to negative shocks and expansions differently. Even subclasses have subclasses. When you’re talking about Commercial Real Estate which is a subclass of the broader real estate market, you’re grouping together office buildings, multifamily housing, medical centers, malls, and many other types of assets which can behave differently.
The pandemic and resulting lock downs this year have had people looking at three specific types of real estate very differently. One, which seems to be most people’s favorite, is single family housing. Another is multifamily housing. Third, office spaces. I’ll be discussing office spaces and multi family housing aspects briefly, then largely focus on single family housing in this post as that’s what I’ve had the most experience with in my career.
With a lot of companies forced to go fully remote, there seems to be a lot of speculation on the future of office spaces. With announcements of Twitter, Facebook, and Slack going fully remote going forward, many big brains with bigger mouths are now saying office spaces are going to be no longer a thing or way less of a thing.
That won’t happen.
Leases might be renegotiated in the short term but in the future the office space will still be a reliable future source of income for building owners. Keep in mind that although WeWork’s valuation was massively inflated, their growth and expansion was real, and there was very strong demand for their services from people who had opportunities to work from home full time.
Take it from someone who’s been working for a fully remote since 2019, pre-corona. I was part of a fully remote company, but we still used shared workspaces as a service simply because there are things that are lacking when your team is fully remote- your culture gets diluted quickly, you burnout more easily, you’re not as productive, and there’s more miscommunication. Humans are social animals and we want to physically be around other humans who are motivated toward the same goal. This is why most people pay for a gym membership instead of having a home gym.
What’s likely to happen, which honestly has already happened for the last 2–3 years is that there’s going to be a partial remote element to work. Feel free to come to the office whenever you want, feel free to work at home whenever you want unless there’s an important meeting or clients are in town. Companies that haven’t adopted this will need to start adopting this, or you’re going to lose talent. Companies that traditionally had an office that all of a sudden decide to go fully remote without an office will lose talent to those who crave human interaction and a physical office space. Market forces at play.
Let’s also discuss the scenario where some people in a company with a physical office do leave San Francisco or New York to go fully remote in a more affordable market such as Phoenix or Las Vegas. The seat that you think you’ve saved in your San Francisco office is going to be replaced by a seat you’ll be renting in a shared workspace in Vegas.
Multifamily housing (apartment complexes) is going to take a hit in most major markets, if it hasn’t already. Most people were already being priced out of rentals as tenants over the last two years. Unemployment and being forced remote will accelerate if not deepen the damage.
There’s going to be multiple phases of blows to landlords. First, delinquencies due to being furloughed or fired. Second, a significant drop in lease renewals. Third, there’s going to be a delay in getting vacant units leased because we’re now in mass speculation phase as to how much lower rents can drop. Why would I renew or sign a new lease when I can save $300 a month if I wait a few weeks and just crash at my parents place in the meantime?
Rents have also been overvalued in many bigger markets for the past few years so I won’t expect a quick recovery back to pre-COVID levels.
Tough time to be in multifamily as your yields and occupancy are not in the same ballpark as what you had modeled out last year.
Single Family Housing
Good news for landlords in this space. Tenant demographics here (families) are different than in multifamily housing (more single people and couples with no children). This has a very real impact on rent delinquency and we are seeing it play out as most single family rentals have rent delinquencies in the lower single digits.
If you own a house and are renting it out, your rents most likely won’t drop with negative shocks, and if they do, it won’t be by much. Even in the most dramatic housing crash in 08 and 09, rents on a national level held relatively steady and then grew in subsequent years. Of course, keep in mind that that’s on a national level and not true for all markets. There are markets where rents are fundamentally overvalued so those will adjust back to reasonable levels for the tenant.
How about price or home value? We know that even in the worst of times, rents won’t dramatically drop on a national level (it’s still possible at a local level), however, we’ve all seen what happened to home values. So will this time be the same?
The quick answer is no, there won’t be a dramatic drop. And this crash will not be the same as the last crash. There are very obvious answers for this. First, we need to understand what actually happened in the last crash.
A Look Back At The Last Crash
We can safely define an asset bubble as an occurrence of when prices are currently being valued and/or transacted at what they’re fundamentally worth. In the years leading up to the financial crisis, homes were in fact being transacted at levels in which the buyers realistically could not afford.
Predatory lending was rampant to make mortgage backed securities look good on paper with assistance of rating agencies being fraudulent. Hence, people went into bidding wars, driving up transaction prices without even thinking about how they’re going to afford the house in the future.
Obviously this lead to mass defaults on mortgages and lenders (banks) repossessing the house with no intention of becoming landlords. What do they do? Sell it as soon as possible, even at a loss. The market had a huge increase of supply and not enough buyers willing to pull the trigger. Prices dropped dramatically over the next 4–5 years.
Why This Time Is Different
The single family housing landscape is very different than in the early to mid 2000’s. There are many markets today where average home prices are not even at 2007 highs.
Limited supply coupled with strong migration in attractive markets is what is driving price, which is more organic than the last crash. In addition, we have historically low rates which creates demand to transact, oftentimes at higher than list price, in order to lock the rates in.
Single family rentals have more or less become an asset class that larger institutions are more open to owning in recent years. There are a lot of firms and individuals who were able to lock in great deals during the financial crisis and that has set them up in fantastic position to do so again.
Success stories with rentals have somewhat created FOMO and there’s now crowding in the single family rental space with many firms raising large chunks of capital in search for strong long term yields. They’re ready to pounce on any reasonable deal that the market is willing to provide. There’s also new technology that is able to automagically underwrite investment properties and sniff out deals, accelerating these firms ability to buy all over the country.
Market By Market Basis
I can always talk about what happens on a national/macro level but people will always care more about what happens on a local level and market by market basis. So let’s talk about that and where I believe the market is headed the next few years.
Ultimately speaking, if you want to get a good look at which markets are affordable and which are not, you can do a quick google search on American urban migration patterns. Overpriced markets such as New York, Los Angeles, Chicago and San Francisco have negative net migration and reasonably priced markets such as Atlanta, Sacramento, Phoenix and Las Vegas have positive net migration. Migration was traditionally driven by job opportunities due to less technology but as of late have been driven by quality of life and cost of living. Companies have been more accommodating in hiring fully remote workers and this trend is only expected to increase.
If I’m going to make guesses of which metros whose average home value will absorb shocks or even increase price over the next few years, I’m going to pick Phoenix, Las Vegas, Salt Lake City, San Antonio, and Dallas/Fort Worth.
If you want to know which cities I’m bearish on, google the top 5–7 metros in negative migration. You can expect the negative migration trend to continue sticking in these same markets. Demand in both home buying and renting will drop in these markets. Prices will drop but not dramatically.