As the world looks to a time when COVID-19 is no longer a crisis, my view is that there will be a “V-shaped” recovery in economic activity. However, consumer confidence won’t quite return to where it was two months ago. People will remain cautious even after the pandemic is over. The recovery will therefore look more like this:
Most economists now admit that we are currently in a recession and could be headed toward even more bleak economic conditions in the short-term and potentially the long-term. I view multifamily investment, especially affordable housing like mobile home parks, as a hedge against these looming conditions.
Additionally, opportunity still exists. Mobile home parks are often overlooked, roughly 80% of them in the hands of non-institutional owners. Lenders, while reluctant today to assume risk, also view this asset class favorably. The historic default rate is remarkably low due to high tenant demand, producing recession-resistant revenue streams.
Read on for more insights on the environment we find ourselves in today, how investors should prepare themselves going forward, and recession-resistant investing:
Economic Overview
I will spare you the statistics on known positive COVID-19 test result and death counts. The numbers are staggering, and we haven’t yet reached the “eye of the storm.”
As of last week, almost 10 million Americans have filed initial jobless claims. According to J.P. Morgan, 10 million workers accounts for 6% of the U.S workforce of 167 million people. April’s jobs report will be released a month from today (May 8) and should more accurately reflect the state of the job market than the March report, which reflected 701,000 non-farm payroll jobs lost.
According to the Wall Street Journal, economists anticipate 20 million jobs could be lost by the time the April report is released, reflecting unemployment rates well into the double digits (12%). To put the loss of 20 million jobs into perspective, 9 million jobs were lost during the entire Great Recession, which lasted from 2007 to 2009.
Enacted last month, the $2 trillion COVID-19 rescue bill (known as the CARES Act) launched its Small Business Administrative initiative on Friday of last week. Its flagship initiative, the Paycheck Protection Program (PPP), allows companies with fewer than 500 employees to seek special loans from banks designed to offset the financial pain caused by the pandemic.
Since the launch, the Small Business Association has been overwhelmed with applications and has returned to Congress for more money, over and above the $350 billion already designated to assist small businesses as part of this program. According to Barron’s, within the first weekend of the launch, Bank of America had received 178,000 applications from firms seeking $32.9 billion in loans.
Both Treasury Secretary Steve Mnuchin and Senator Marco Rubio, who authored the program, have asked Congress for an additional $250 billion to fulfill the unanticipated needs of small businesses nationwide. Both sides of the political aisle agree that this additional funding is necessary, and they hope to approve further funding for the PPP during the next scheduled Senate session, Thursday April 9.
Real Estate
The health of the economy drives real estate values, due to the fact that a building’s value is created by the tenants that occupy the building. Small businesses employ 50% of the workforce in the U.S., and are therefore critical to the health of the real estate sector.
Unfortunately for real estate owners, the Paycheck Protection Program has left them out of its relief package. According to the CARES Act, owners of apartment buildings, mobile-home parks, and even campgrounds are labeled ‘passive businesses’ and are therefore ineligible to participate in the Paycheck Protection Program. A “passive business,” as defined by the CARES Act, is a business where more than half of its revenue comes from rent rather than receivables charged for services. That means landlords are out of luck. So are developers, unless the developer is strictly defined as a ‘fee developer.’
However, multifamily landlords with federally backed mortgages can take advantage of the CARES Act in a different way by requesting a forbearance on their loan payments for up to 90 days. In exchange, the multifamily owner may not evict a tenant for non-payment of rent until after the 90-day period. As of Tuesday April 7, Freddie Mac alone received requests for such relief from 105 multifamily borrowers holding $810.2 million in mortgage loans, according to Fitch ratings.
Forbearance on a loan does not mean forgiveness, nor does it protect borrowers from effects on their credit scores. On day 91, when the loan forbearance period ends, do landlords owe four months of mortgage payments (including next month’s payment)? Landlords should talk with their lenders and make sure that their delayed payments are due at the maturity of the loan and that their credit score will not be affected. Otherwise, a struggling landlord should try to work out some type of payment program to pay back the forbearance mortgage payments over time as opposed in lump sum.
Landlords who apply for forbearance may also run into problems during their next loan application. He/she will have to respond “Yes” to questions regarding past participation in forbearance or loan modification programs, responses that lenders tend to see as red flags.
It remains to be seen whether non-federally backed lenders are willing to be lenient with their borrowers. According to The Real Deal, New York Community Bank, one of NYC’s largest commercial lenders, is offering borrowers affected by COVID-19 two options: six-months of interest only and escrow payments; or deferral of principal and interest for six months, payable at maturity. Hopefully other lenders follow suit, but if not, buyers will start seeing opportunities to assume notes or acquire properties from a lender upon default.
Lending
Amid the once unimaginable numbers being thrown around in today’s economy, on March 15 the Federal Reserve also dropped its benchmark interest rate to 0.0%. Despite this historically low interest rate, one that hasn’t been seen since 2008, banks are still skeptical about the environment as it stands. Banks already face a large increase in payment deferral requests, along with the challenges of remote staffing due to shelter-in-place restrictions in 45 out of 50 states. Worries also abound about the solvency of the mortgage market if the downturn is not short-lived.
While they continue to lend, banks have drastically tightened up their lending requirements. One large Boston-based multifamily lender I spoke with has increased its vacancy rate underwriting assumptions from 5% across the board to 10% downtown and 15% in the suburbs. In addition, their debt service coverage requirements have increased from 1.25 to 1.30, a requirement far more difficult to attain given the conservative vacancy rate applied in underwriting.
Similarly, life insurance companies are still active in the debt market, but with tighter underwriting assumptions, chasing low LTV core assets with limited leasing risk. Fannie Mae and Freddie Mac continue to lend, but they require significant cash up-front—six to twelve months of debt service in reserve. As mentioned last week, CMBS and debt fund lenders have largely “hit the pause button.”
In Connecticut, hard money lending for single-family flips has either completely dried up or has become drastically more conservative. Two months ago, hard money lenders were lending on a 10% down payment of the purchase price with all-in debt up to 75% of the after-repair value (ARV) at a 7-12% interest rate.
Today, hard money lenders are requiring a 25% down payment on the purchase price, the loan principal capped at 65% of ARV, with 10-12% interest and 3 points paid up front to the lender. Given flips take 3-5 months to complete, lenders want to be compensated for the back-end risk of delivering the product into a down market.
Investors and lenders continue to be bullish on multifamily property, especially affordable housing,. Affordable housing assets are well-occupied and resilient investments during downturns because rents are below market. In fact, demand often grows for these properties as Americans lose jobs and seek lower housing payments. The mobile home park, while not the sexiest asset class, is another example of an affordable housing investment vehicle.
Mobile Home Parks
Mobile home investing flies under the radar relative to other commercial real estate investment vehicles. That said, large real estate private equity groups and REITS have invested capital into the mobile home space over the last couple of years, accounting for 17% of the transaction volume in U.S. in 2018.
Key players in the space include firms like Equity Lifestyle Properties (REIT); GIC (the sovereign wealth fund of Singapore); and The Carlyle Group, Blackstone, and Apollo (private equity groups). Warren Buffet’s Berkshire Hathaway led the pack in 2003, purchasing Clayton Homes, today the largest builder of manufactured housing and modular homes in the U.S. Clayton Homes also operates the two largest mobile home lenders in the U.S., 21st Mortgage Corporation and Vanderbilt Mortgage.
Today, roughly 17.5 million Americans live in mobile homes, one of the most cost-effective housing option. The median household income for mobile home residents is $34,000 per year. Nearly one quarter of mobile home residents live below the poverty line. As of 2016 there were only 44,000 mobile home parks in the U.S., and that number declining every year as more parks are being shut down than built nationally.
The development of mobile home parks is costly (extensive plumbing, lot pad build-out, landscaping) and difficult to justify given the low lot rents and relatively slow lease-up pace. Also, zoning boards and other local government bodies are reluctant to issue permits to new communities because of the stigma that mobile home communities often carry.
Mobile home parks have been regarded as a recessionary hedge for investors and lenders alike. These parks tend to have the lowest default rate of any major real estate asset type due to their sticky tenancy, high occupancy rates, low operating expenses, and low capital expenditure exposure. According to research done by Green Street Advisors, the manufactured home sector is the only major real estate asset class that has not experienced year-over-year decline in net operating income in any year since 2000. Occupancy is consistently high at most well-managed parks because no cheaper living option exists and most tenants cannot afford the $5,000-10,000 cost to relocate.
Residents at these parks often include the exact demographics that have experienced the most negative effects of the COVID-19 crisis: service workers and employees in industries like restaurants and hospitality. Fortunately, mobile home parks provide a viable housing option for these demographics. In the 100 largest U.S. metros, mobile home residents spend an average of 40.5% less on housing costs than those living in traditional, site-built homes in the same area.
Conclusion
In a white paper released by the American Enterprise Institute last week, the authoring doctors and scientists argue that social distancing requirements should only be lessened after a minimum of 14 days of decline in the diagnosis of new cases. In the U.S., that means we should anticipate shelter-in-place requirements to continue through at least May. But then what? How will consumers respond, and how likely is a second wave of the virus to occur?
The virus ripped through China three months ago, and through South Korea two months ago respectively. Economists look to those countries to extrapolate the path back to normality for the U.S. In South Korea, the country’s consumer confidence index has fallen to its lowest level since 2009 according to the Wall Street Journal.
Meanwhile, China has shown progress in the last week. Key consumer confidence indicators such as coal consumption, property sales and traffic congestion have climbed as high as 90% of 2019 levels according to J.P Morgan. Also, in the city of Wuhan, where COVID-19 originated, authorities ended a 77-day lockdown today and allowed inbound and outbound travel for healthy people.
Many, especially leaders in the White House, question the reliability of any reports from China. Without question the effects of the economic downturn on the consumer psyche will linger in the U.S., especially if they anticipate another outbreak.