As we make our way through the current crisis, many owners are asking themselves what will happen to all the equity they earned in the last 10 years. The sad truth is that values will drop for the foreseeable future while the pandemic spreads. And after it is all over, we are likely to see a recession, which will soften values even further. We are estimating that it will take at least several years to get values back to where they are today.
The local multi-family market has been climbing for 10 years, and an overdue exhale began slowly in 2019 as values dropped about 13% in the commercial multi-unit sector. This time, the drop will be fast and immediately noticeable.
Arising Issues
The primary issue facing multi-family owners will be tenants. Tenants are the backbone of our business. Values are based around rents and what a multi-family apartment building can earn. We are going to see a lot of owners take a hit on their rental income in the coming months as many of our tenants lose their jobs and cannot pay rent.
It is also likely that the governor will issue a statewide eviction ban for those tenants affected by the COVID-19 virus. Owners will likely be left out of any government assistance as rents go unpaid. Some mortgage relief may be available, but relief does not mean forgiveness. Mortgages will need to be kept current for apartment owners, regardless if rental income dries up.
Rental Market Softens
Even when the dust settles on the pandemic, we are likely to have some lingering effects that will hinder our ability to rent units. The aftermath of the virus will likely cause a small exodus of people and families from the Bay Area. It will be impossible for many to stay in the area, even as job recovery begins. This will soften the rental market. To add to the problem, the Bay Area has been adding thousands of housing units to curb the housing crisis that existed. Competition for rental units will soften, and we will likely see the resurgence of concessions and lower rents to attract tenants. Lower rents mean lower values. Period.
As the multi-family market begins to drop, it is not difficult to imagine a flood of properties coming to market. This would also be a negative scenario for values. Over the past several years, sellers have enjoyed a limited inventory of “For Sale” properties, which has helped push values in the Bay Area. A “rush to the market” would put the negotiating power firmly into the buyer’s hands.
Recession Ahead?
A recession will likely follow after the country moves past the COVID-19 hazard. The United States is printing money at an unprecedented rate to keep the economy afloat. The deficit will reach numbers never seen before. Lending will also begin to play into values as we exit the pandemic. Currently, interest rates are as low as they have ever been. The recent drop in the cost of lending dollars did nothing to insulate the market from dropping. If the country enters a recession after the pandemic, it is more than likely that interest rates will have to go up.
All these factors will assist in rental compression and softening values.
The Good News
The news isn’t all bad and there are still good alternatives. Owners willing to sell can still get up to 90% of the highest values ever achieved in the county. Many buyers are still active and trying to take advantage of low interest rates. There are several private buyers and acquisition companies that will still buy multi-family assets for 4.00% CAP Rates (based on 40% expense rate). Multi-family owners may find that changing products into Triple NET and Deferred Sales Trust (DST) programs may better suit their long term needs. For owners willing to exchange from apartments to apartments, values on the replacement property should be more discounted then their relinquished property. Owners may also benefit by trading into higher quality areas which will improve tenant stability and be more insulated during market downturns.
Please be safe out there and wash your hands.
Christian Losness is a broker and partner at the Losness Group which he co-founded with his two partners in 2005. Christian has been speaking on apartment topics for the last seven years to local apartment owners, keeping them up to date on the local apartment economy and opportunities. The Losness Group Apartment Brokerage focuses 100% in Silicon Valley apartment sales and acquisitions. For more information, call (408) 824-1111 or visit www.losnessgroup.com.