What would Warren Buffett do?

Many investors large and small find themselves musing about this today, drawing on the reputation billionaire Berkshire Hathaway CEO Warren Buffett has earned over the years for buying assets during periods of distress, holding them and reaping billions in profits as a result.

In today’s real estate landscape, there are plenty of people who think they know exactly what Buffet would do, and they are making plans to do it, too.

Blackstone, Brookfield Asset Management, CBRE and other giant real estate investment managers could not have known that the next downturn would arrive in the form of a novel coronavirus, but they knew a downturn was coming.

Blackstone, for instance, just last autumn finished raising the largest ever real estate fund, $25 billion, and is now poised to deploy that war chest into a market that looks likely to be rich in distressed assets. They were smart enough to hold back during what turned out to be the very top of the market in a very aged economic expansion.

“Real-estate investors—when you take the emotion out of it—many of them have been waiting for this for a decade,” David Schechtman, a broker at New York-based Meridian Capital Group, told the Wall Street Journal this week.

The Fire Sale Order of Battle

Schechtman’s right. Prequin, a leading alternative asset research firm, reported at the end of 2019 that funds specializing in distressed-asset had about $142 billion at their disposal. There’s not much out there yet, but it’s early days for this crisis. Hospitality – hotels, casinos, cruise ships and amusement parks – look to be the first up. Retail, hammered by the “stay-at-home” orders, isn’t far behind.

And commercial offices? My sense is that this is less of a Buffett moment for commercial office space than a brave new world. Corporations, who pay the lion’s share of commercial rents, will be watching closely for signs of how worker productivity fared in what is, effectively, the greatest gaming exercise in telecommuting a corporate beancounter could ever ask for.

Will corporations still pony up $75 or $85 per square foot for a Manhattan or San Francisco headquarters (or even the $19.50 it costs in Columbus?) And when the politicians finally say, “it’s safe to go back in the water,” will office workers trust them and eagerly rush in?

Ultimately, as leases come due, my sense is that:

  • the COVID-19 pandemic +
  • the blistering pace of office construction in the last decade
  • vast new data on telecommuting =
  • —————————————————-
  • a lot more empty downtown offices in the medium term.

Living with Density

So will these factors also tank commercial residential – what we colloquially refer to as multifamily real estate? I don’t think so, and here’s why.

Unlike commercial real estate, where the largest 20 US metros added some 682 million square feet of office space in the last decade, the pipeline for the kinds of properties Americans need – affordable, decent “B” and “C” class multifamily properties – has continued to lag demand since well before the 2008-2009 financial crisis.

Source: Yardi Systems

To put it brutally, whether or not folks want to live cheek-to-jowl in the post-COVID-19 era, US economic realities give them little choice. The single-family market remains out of reach for much of the middle and working class despite the current correction and historically low interest rates. The idea that this enormous “middle” of the US income quintile (roughly families making between $35K and $85K annually) will suddenly move to a tract home isn’t in the cards.

If anything, demand is likely to continue to grow due to demographic realities. Millennials, virus be damned, want to be close to urban cores, if not actually in them. For this demographic – now the largest in the US economy – there’s more to life than a lawnmower, little league and a barbeque grill. Central cities may lose corporate tenants, but the fact remains gig workers and blue collar service industry employees often cannot get a mortgage even if the picket fence life did appeal to them.

So What’s a Small Investor to Do?

Here’s what not to do: Jump into a run-of-the-mill deal right now. As I’ve written again and again, Multifamily Residential outperforms other asset classes for its investors even in the worst of times. Within the real estate sector, single family, retail, office and warehousing took a beating in 2008-2011, but Multifamily Residential held its own.

In part, this goes to my previous point. When push comes to shove, having a roof over your head tends to outweigh almost any other priority except for your health (and sometimes even that). In 2008-2011, occupancy rates in US Multifamily Residential never dipped below 94%, and the nature of the crisis – a mortgage market disaster – actually created a pipeline of new multifamily renters as banks ruthlessly foreclosed on their homes. As one large multifamily operator told me last year, “2009 was a non-event for me. My portfolio of storage units took a beating. But the rents from our apartment buildings kept rolling in.”

But the Buffett moment is coming, even for Multifamily Residential. The nature of this crisis is quite different from 2008-2009. During the last financial crisis, a restaurant worker or a liquor store owner endured pain and had to scramble, but restaurants and liquor stores still needed workers. By and large, the service economy weathered the storm.

This time, however, rent collection may experience a short and sharp downturn, forcing not only tenants to the wall but the operators of their apartment buildings too.

And this, as ugly as it is to write, will be the Buffett moment. The government checks and GoFundMe campaigns that will forestall the worst for the moment. But there will be blood, don’t fool yourself.

April’s rent collections don’t yet reflect the full impact of the global pandemic and already payments have dropped to below 69 percent, according to the latest data from the National Multifamily Housing Council (see chart at right); May will find people dipping into savings and borrowing to make rent, and maybe using some of the money appropriated to each family by Congress. It’s June, I believe, or at latest July, when the full impact of the crisis will hit the Multifamily Residential sector. And then, like Hospitality, Retail and Office Space, valuations will hit bottom.

And a once in a decade opportunity to invest in discounted properties will arrive – properties that will bounce back more quickly than commercial, industrial or single-family assets.

Risk Analysis Pays Off

There is no reason individual investors need to leave these opportunities to the Blackstones of the world. Above $50 million in value, any investor will be bidding against these giants, and good luck to you. That’s not our plan – it never was. Below $30 million, however, there will be mom-and-pops looking to exit and flying well below the radar of the big boys.

I’m happy to say our conservative, risk qualified approach has paid off. At PCRP Group, we all but stopped bidding on properties at the start Q3 2019. There were plenty of listings, of course, and a number of off market deals that came our way, too. But the fact is, they didn’t pencil out. Sure, we could have taken down a property in Colorado Springs or the Raleigh area for the sake of deal flow. But that is not in keeping with who we are.

We insist on resilience in every sense of the term – in term of climate risk, economic fundamentals and demographic trends. At the prices prevailing in late 2019 – which we now know was the top of the market – my partners and I simply could not ask our investors to expose themselves.

Sadly, the pandemic and subsequent government ordered shutdowns of the global economy have borne us out. All of us know someone afflicted, and many of us know people who have died. It’s a tragedy and a great challenge for us as individuals and as a nation. And it’s not a time to buy.

For now, we’re scanning the horizon and keeping our power dry. As is, I might add, Buffet himself. Buffett’s successes during downturns are legendary. In 2008, when many investors lost their way (along with their shirts), Buffett’s firm bought BNSF Railway, a move that some saw as retrograde at the time. He also took big stakes in Mars/Wrigley’s, Goldman Sachs, and later Dow Chemical, GE and Swiss Re, an insurance giant. All looked shaky at the time, and it’s quite possible some of them might not be around today without the $25 billion in shares and loans Buffett’s firm extended.

“You make your best buys when people are overwhelmingly fearful,” Buffett told the Wall Street Journal in 2013 after his profits from those moves during the crisis topped $10 billion. They’ve only risen since.

The “Oracle of Omaha,” as he’s known, may decide to save an airline or two, or perhaps take a multibillion-dollar stake in the drug firm who appears close to a COVID-19 vaccine. Billionaires have that luxury. And if they bet poorly, they’ll take the tax write off, thank you very much.

But PCRP Group investors know we approach any investment opportunity with a very disciplined, very transparent risk and resilience methodology. We do this precisely for times like these. “That which does not kill us, makes us stronger” the German philosopher Frederich Nietzche wrote.

Those are words to live by, my friends.  Be well and thrive ­– and know the PCRP Group team is watching closely for the true Buffett moment.

We love talking to people about out Multifamily investment strategies.  If you would like to hop on a call with us, please email us at inquiries@pcrpgroup.com, we’d be happy to talk with you.