I want to start off by saying that this is just an opinion piece. I am not a doctor nor an economist and am far more of a generalist than a specialist in many areas. It is also worth mentioning that this content is far from evergreen. It’s quite tied to the next 24 hours (today is March 16th, 2020), since the pace of change, i.e. changes in the data we receive, political responses and central bank policy, is currently unimaginably fast. 

The spread of COVID-19, along with the related panic and rapid economic contraction, has created an air of fear (and subsequent volatility) rarely seen in public markets. If you’re reading this though, you probably aren’t looking for advice or opinions on the stock market or math around how quickly an infectious disease could spread, i.e. what happens if you double a penny every day for 30 days.

I’m going to break this down into something succinct and tangible while trying to steer clear of the pandemic itself (including the health, supply-chain, and broader macro-economic repercussions) and instead just focus on the way it touches those in the multifamily sector.

The Pros

• 10 year treasury yields are unbelievably low.

• The Federal Reserve cut its benchmark interest rate to almost 0%.

• Debt in some cases is meaningfully cheaper than it was a month ago. 

• Sustained low rates may create downward pressure on cap rates.

The Cons 

• Tenants may fall behind on their rent. Employees of all types, particularly those touched by the trickle-down effect of travel restrictions are at risk of shouldering a substantial economic burden reflective of reduced hours, or worse, terminated employment. Lost wages coupled with the precipitous drop in equity values (a metric tightly correlated with consumer savings) creates a significant risk to multifamily property net operating income and therefore, from an income capitalization approach, value. A second order outcome could be a fracture in the implied security of what has historically been perceived as a recession-proof asset. This is not to say that multifamily, as an asset class, will not be incredibly resilient but the effects of declining occupancy and net operating income directly impact valuations and can easily snowball to affect capital markets, as less owners would qualify for conventional financing and the risk of defaults would loom.

• Agencies are pushing up floors and spreads to hedge against volatility and potentially fear of blowing through their caps because of the knee-jerk inundation of loan applications when 10-year treasury yields broke below 1.00%. Today, March 16th, 2020, Fannie® and Freddie® pushed up baseline spreads while Fannie® held its 90bp treasury floor and Freddie® remains at the greater of 75bps or -15 from the treasury at time of quote. Freddie® SBL increased coupons by 25bps across the board this morning as well. 

• Multifamily property buyers may get spooked, we’ve already seen this, which could create a widening between asking prices and bids and a (temporary) reduction in market liquidity and transaction velocity possibly leading to price reductions. 

The Unknown 

• The biggest issue in my opinion is the unknown. It is the element of uncertainty that is driving up the price of sovereign debt and driving down yield. It’s what’s causing a flight from equities. It’s what pushes out credit spreads and it's what keeps everyone on self- or government-imposed quarantine. As the great minds of our generation put their heads together and aggregate data, this uncertainty will inevitably pass. This is not to say that we will not have a big problem on our hands. It is to say that as we continue to aggregate and translate the data, we will know better what we are dealing with and have sufficient evidence to create an actionable plan. As we become more informed, panic will be replaced by prudent precaution. 

• What are the repercussions of continued QE (quantitative easing)? I floated this in a LinkedIn and email post recently: is this next round of QE sufficient to help us through this sudden, worldwide economic bottleneck? I can’t imagine it is. What are the long term impacts of the continued printing of money and throwing it at our problems? We don’t really have a reference point. This sovereign debt bubble is a new thing. The word bubble is quite intentionally chosen here. Again, I’m not an economist, but I feel like more than a few countries in South America have tried printing their way out of economic cycles… How did that go? I am not saying this is an apples to apples comparison, but it feels like oranges and tangerines? Botanists, forgive the crude metaphor. 

• The Fed is out of bullets. That 100BP drop was our last piece of likely meaningful ammunition in the face of a recession. Now what can the Fed and the US government do if we face a real, long term recession? I don’t necessarily fault them (or not fault them) for this QE and rate-cutting decision but I do wonder if it’s the use of a sledge hammer in lieu of a scalpel, or as I’ve mentioned in other posts and articles, pushing a string. Will we be forced to negative interest rates in the future? Negative interest rates did not have the desired effect in Japan.

What Now

Well, for starters, wash your hands and don’t sneeze on anyone, right? I don’t want to give any direct advice but I’d like to share some anecdotal notes. Markets run in cycles, irrational exuberance is often followed by similarly irrational panic. If you’re in equity markets, the bulk of us normal humans have this weird tenancy to buy tops and sell bottoms. Over time (and I certainly can’t say how long it will take) this too shall pass. If you’re thinking about refinancing multifamily or commercial real estate debt, rates may be higher than they were a month or two ago with agencies, and lower with FHA and banks. They may be static. The primary thing right now that is static though is the very non-static nature of credit markets. I’d probably be pulling the trigger on something if there is a looming maturity afoot. We don’t know how long this will last or the medium-term repercussions on capital markets. If you have a good deal and you’re waiting for the best rate ever, you may just want to go ahead with it because if tomorrow is unknowable, so is Q2… and Q3. Finally, be responsible but don’t panic. 

Was this helpful? If so, please share with colleagues. Do you have suggestions or comments? Email me at blake@janover.ventures and I’ll do my best to be as responsive as possible. Wishing everyone a safe and hand-sanitized Monday.