As the broader real estate industry grapples with the effect of Coronavirus, a difficult point must be disclosed up front: its impossible to predict with certainty what will happen.
However, looking back at history and the actions the government is taking gives us strong hints for what the future holds. Real estate investors that think ahead can take advantage of the situation.
Unlike the Great Recession of 2008-2009, where the extent of the damage to the economy during the peak of the Recession was unknown in the beginning, we already know how bad things can get – in fact, we are living through it – a complete shutdown of the economy outside of “essential businesses.”
This time around, it’s not a question of “what will happen” but rather “how long it will last?”
While there are various scientific models tracking the spread of the virus, the virus is new to the world and difficult to model. The exact mechanism for the spread is unknow, the prevalence is unknow (many don’t get tested), and whether it will cause another wave of sickness, or permanent immunity, is unknown as well.
But here’s the good news: we do know a lot.
- We know that the Federal Reserve has lowered the Fed Funds rate to 0% triggering a collapse in interest rates and creating historically low mortgage rates.
- We know that Congress approved injecting over $2 trillion into the economy (which is ~10% of the GDP).
- We know the that the Federal Reserve has also committed another $2.3 trillion in liquidity and various funding and purchase facilities to help companies, including mortgage lenders.
Here’s the bottom line: the government is doing everything they can, throwing the proverbial “kitchen sink” at the problem. In fact, it’s doing much more to help the economy than during the Great Recession.
Effectively, three scenarios are possible from the perspective of a real estate investor:
- Best case scenario: The government has overspent on helping the economy. This will cause inflation. Real estate prices are no exception and will appreciate as well, but importantly, the debt you owe as an investor, will become less expensive (a $300k house with a $200k mortgage will now be worth $500k, but you only still owe the $200k mortgage – that didn’t increase).
- Medium case scenario: the government has helped just enough to prop up the economy and avoid a major disaster while the virus is dealt with. This will cause an initial drop in prices, which should recover relatively quickly. This is a good time to work on projects such as fix and flip. There will be plenty of distressed opportunities which can be bought on the cheap now, rehabbed, and sold when the economy has recovered a year from now.
- Worst case scenario: The economic collapse is too great for the government to save. Those who have lost their jobs may have to sell their homes. Inventory will increase, as investor capital dries up – home prices will fall. The upside for investors is that more people will become renters. In this scenario, it will be better to be a buy and holder investor, rather than a flipper.
We assign a higher probability to scenario 1 (35%) or scenario 2 (50%), with a lower likelihood of scenario 3 (15%). In either scenario 1 or 2, real estate investors will benefit. One word of caution with respect to scenario 3: now more than ever, it is extremely important that you buy at the best possible value today so that even if prices experience a sustained drop, you will still have a profitable, cash flowing investment. Be diligent about your opportunities and don’t pay top dollar.