“The most reliable way to forecast the future is to try to understand the present.” – John Naisbitt
Investment Real Estate Outlook for the Rest of 2020 and Beyond
On Sunday, I briefly answered a question sent in by P.J., who asked: “What do you think about real estate, given what seems like an inevitable recession and possibly worse?”
I explained that I am concerned – very concerned – for two reasons:
- The economy – the real economy, not Wall Street – is in serious trouble. We have huge unemployment and record levels of small businesses shutting down for good. That’s bad for a good swath of real estate: all the buildings that cater to smaller businesses.
- The extended shutdown has given tens of millions of American workers and thousands of companies the opportunity to experience business with an office-less office. We’ve learned that so much of what was being done in the office can be done just as well remotely. We’ve also learned how convenient it is to have everything we consume – food, clothing, toys, entertainment, etc. – delivered to our homes. This has already had a huge impact on the way we work and live. I’m expecting to see more employees working from home and less office space leased per dollar earned.
These two realities are definitely going to affect the real estate market. So today, I’m going to give you my off-the-cuff thoughts on what those effects will be.
The Real Estate I’m Worried About
High-End Shopping Centers
Three of my book club friends have made their fortunes developing large-scale, luxury shopping centers and strip malls. They are partly retired now, so I suspect their current positions in these properties are limited. But I’m going to ask for their thoughts at our next meeting. If I owned a lot of that kind of real estate now, I’d be worried.
Class-A Office Buildings
During an extended recession, many businesses are forced to cut down on all non-vital expenses. Given this, and considering what I said about so many people working remotely, I would not like to own a lot of such buildings right now. I am not predicting a collapse of this kind of property. But if the economy stays sluggish and GDP stays low, we will likely see steeply dropping ROIs as tenants do not renew their leases.
Luxury Single-Family Homes
I have another friend that’s been doing quite well building and selling million-dollar homes for the last 10 years. This has been a side business for him, but it’s netted him a profit of about $500,000 per home. At breakfast recently, I asked him how he was doing. “I was between houses when this thing started,” he told me. “I’m not going to do anything until the economy starts moving again.”
High-End Residential Developments
From about 1990 to 2004, I was a regular investor in a friend’s residential real estate developments. He built and sold 100- to 400-unit developments at $400,00 to $600,000 a door. And even though those units are worth more than a million each now, I wouldn’t invest a dollar in a new project like that today.
Other Luxury Properties
I just spoke to a guy that wants to build a $32 million, super-duper sports complex here in Delray Beach. He sent me the brochure. It looks amazing. He’s going to ask me if I want to invest. I’m going to say no.
Middle-Level Commercial Properties
If Class-A commercial isn’t appealing, Class-B commercial is even less attractive today. My experience with that kind of income property is that it is much less resilient than residential properties during a recession. You can keep your houses and apartments rented during economic slumps by simply lowering the rent. You can’t do that with middle-level commercial properties. They can sit unoccupied for years.
The tenant in a commercial building that I own in Delray Beach has been asking me to sell him the building for more than five years. I was getting a great return on this investment, so I wasn’t interested. Yesterday, I signed it away.
Hotels (and Motels)
What have I forgotten? Oh, yes, hotels! That’s an easy one. If I were invested in hotels, I’d definitely be worried today… Hey, wait! I just remembered. I am invested in hotels – at least a half-dozen of them through my brother. So I am worried! But for him, not me. Since I’m a limited partner in these properties, my potential losses are limited to my original investments. But as the general partner, he’s on the hook. Big time. Right now, he’s jumping through hoops to keep the doors open. He’s doing a great job of that, but if occupancy drops by, say, 50% for the next several years, things could be bad.
I don’t own REITs (I don’t think), because I own so much property directly. But if I had a significant position in REITs, I would want to check the sort of property they were holding and measure it against the concerns I’ve mentioned above.
The Real Estate I’m Not Worried About
Working-Class Apartment Buildings
I’m not worried about the apartments I own in working-class and middle-class neighborhoods. The rent rolls would probably go down in an extended recession, but not hugely, because new construction would come to a halt. Since my total debt load on those properties is less than 5%, I’m confident I’ll be able to maintain them even at a rent reduction of 50% or more. Plus, the asset value should return when the economy returns.
Company-Occupied Office Buildings
I’m not at all worried about my investments in the dozen or two office buildings whose tenants are companies I own or control. These have always been my favorite properties because my partners and I can control the rents and mandate payments. Plus, most of these companies are in the digital-information business, which has not been badly affected by the Corona Crisis and will probably do okay going forward, even if we enter into a period of economic doldrums like we did after 2008.
That said, I just put a $14 million project on hold in Delray Beach because my partners and I want to see what happens with the economy and our local businesses before moving to the next step (construction).
And finally, I’m not worried about the properties I’ve bought over the years for “land banking” purposes. These are well-situated lots and acreages that provide no income but cost very little to maintain. Since they were always long-term plays – and by that I mean 20 to 50 years – I’m not sweating about them now.
What All This Amounts To
I believe that many parts of the real estate market are going to be hurting over the next few years – principally, the high end.
I believe there is a good possibility that the shift towards working at home will continue, and that will temporarily drive down income from office buildings and reduce the size of that market over the longer term.
I have the same long-term concerns for high-end and even middle-level retail real estate.
But even though my partners and I have had some rent deferrals and vacancies in our residential properties, I’m not worried about those investments because of the safety margins we operate with.
When it comes to investment real estate, I’ve always been very conservative. I invest primarily for income (not growth) in income-producing properties for which there will always be a demand. And I use leverage (mortgages) on a temporary and limited basis.
My formula is not optimal for increasing wealth in an up market. But it is good for reducing my exposure to a long down market.
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