Path of COVID-19 having a material impact on economic recovery, future real estate trends
State of the Economy
The sudden economic crisis in the wake of an unprecedented pandemic leftthe
U.S. economy reeling in the second quarter of 2020. GDP dropped at an annualized rate of 32.9%, easily the fastest decline ever. But May, June, and July also offered hope of a rebound, as declining infections and reopening economies culminated in three straight months of job gains totaling 9 million workers. The unemployment rate declined 4.5 percentage points as furloughed employees returned.
Still, as Jerome Powell said after the Federal Reserve‟s July meeting, the path of the economy is very closely linked to the virus. Cases have surged in the southern and western U.S. and nine states have been forced to roll back reopening plans. Economic data showing retail visits and driving mobility has moderated, and in some of the worst affected areas, declined.
Coronavirus Infections by Geography
A recovery relies on a clear path forward, as businesses will struggle with policies that unpredictably force them to open and close, and consumers will pull back spending. As virus mitigation policies remain inconsistent, government relief can, and has, stepped in. Without federal aid provided in the CARES act, total disposable income in July would have been 3.3% lower than in March. Instead, disposable income increased by 5.4%. Consumers are nervous, and the savings rate is still 1.7% above its pre-pandemic record, but retail sales have largely returned and multifamily rent payments have largely held up.
The economy has remained mostly functional, despite the size of the shock, not only in consumer markets but financial markets as well. The stability and relief from the Fed and the government has allowed a robust jobs recovery thus far, particularly in some of the worst hit parts of the economy. Some of the worst-hit categories such as leisure and hospitality, other services (e.g., hairdressers and mechanics), and construction, have been beneficiaries of the majority of the jobs recovered.
Multifamily Investment Outlook
Multifamily fundamentals withstood intensifying infection rates in the second quarter, bolstered in part by the strength of the aforementioned CARES Act to do so. The stimulus provided to residents has now come to an end with lawmakers unable to settle on a replacement prior to the deadline at the end of July. This is a concerning development for many lower-income renters who depended on the checks to pay rent. The halt to stimulus payments is of less concern for investors and renters in 4- and 5-Star assets, as the lockdowns have been far less impactful on professions with high median incomes such as tech, finance, and professional services.
Overall, rent growth rebounded slightly during the quarter as 93% of renter households paid rent on time in July and economic restrictions looked to be easing. Now the near- term looks more moderate. Vacancies nationally are nearly 7%, the highest since 2010. More than 94,000 new units delivered during the quarter, offset by only 49,000 units of absorption. Though the pipeline is largely concentrated at the top end of the market, with some 80% of the 611,000 units under construction currently classified 4 or 5 Star, it's very likely that developers will press pause on, or cancel outright, current projects as they reassess potential demand and economic conditions. That should help ease supply worries for luxury units.
A good amount of pent up demand exists, as many renters who are now spending the majority of their time working from home find themselves increasingly cramped. Further, increased birth, marriage, and divorce rates in downturns often spur increased demand, and the widespread availability of concessions and falling rents will likely be a strong driver of absorption in the medium term.
Transaction volumes for multifamily are sometimes indicative of the uncertainty surrounding the financial strength of renter households and softened rent growth. Volume for the quarter was $12.4 billion, well below the
$46.5 billion reached in 4Q19 for instance. Historically, multifamily valuations recover fastest among the major property types due to stable rent rolls and shorter lease terms that allow for pushing rents more quickly in an improving market. For the limited amount of pricing discovery that has been exhibited, there has been little, if any, discounts to market values, further bolstering the sector as a safe haven for investors.
In Focus: Back to the ‘Burbs?
A major shift in demand drivers could be underway for multifamily residents and investors across the country. The widespread lockdown of local economies due to the pandemic means a high proportion of multifamily residents are now working from home, many with school-aged children or younger similarly restricted to staying inside. A number of companies have indicated a return to the office is far from imminent, with a smaller, but influential, subset of firms telling employees that working from home is now permanently on the table. Urban dwellers may feel more uneasy about transmission rates of the virus in higher density areas. Unsurprisingly, the question that arises from all these factors is whether the suburbs are likely to see a boost in demand as renters move away from the urban core in a reversal of recent trends.
Downtown Demand Drops as Suburbs Gain
The short-term answer appears to already favor the suburban story, with quarterly demand for prime urban seeing negative movement in the second quarter. Simultaneously, suburban demand has picked up significantly since the beginning of 2020, with quarterly change in occupied units nearly tripling. Despite this, broadly, urban demand remains stable and positive, as does demand for prime suburban units, i.e. those denser, close-in suburbs like Greenwich and Darien in Connecticut or Cupertino and North San Jose in California.
Of further consideration is a shift in how far renters are willing to live from their places of employment. If high numbers of employers allow their workers to work from home on a more regular basis post-pandemic, a longer commute time could become more palatable and expand the distance renters are willing to consider. For Atlanta, seen above, that radius could be significant depending on how much longer of a commute renters find tolerable. Despite these changes, the long-term outlook for urban living is likely to be more positive once the economy returns to normalcy and growth. There are distinct advantages for renters in areas of high density that suburbs cannot offer including better building amenities, short commutes, and vibrancy of individual neighborhoods. For the short-term, suburbs should continue to see increased interest, possibly extending farther out than prior to the pandemic, particularly for families and workers who are likely to continue working from home with higher frequency than before. This should spur institutional investors to increase their exposure to suburban multifamily, allocating a higher percentage of capital to suburban acquisition and development going forward than they have in the previous decade or more. Simply put, if these trends do hold up, it could be reasoned that prime suburban multifamily will play a larger role in a core multifamily strategy than it has in the past.