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I am an enthusiastic reader of Afford Anything, a blog by Paula Pant. In her latest blog post she said, “The greatest risk is assuming that we know the future. Beware of certainty. Those who pretend to know the future are clinging to security at the expense of honesty and accuracy. Don’t listen to any economic or market projections that are expressed with too much confidence. We don’t have a crystal ball. Nobody knows what the future holds. The wise ones recognize this and accept it.” Well said, don’t you think?
No one knows the future
No one knows what will happen moving forward. Some experts expect the economic reopening that’s beginning now to result in a second half recovery followed by the development of a vaccine that puts the coronavirus behind us. Others see a second wave of infections resulting from reopening too early, prolonging the recession and pushing the economic recovery out to 2021 or possibly longer.
It’s too early to determine which position (or something in between) will prevail. I make no predictions of my own. How foolish would that be if I did! No one knows what the future holds. Certainly not me.
What we do know
But this we do know. A world in an economic crisis creates investment opportunities. It’s obvious that there will be losers. Those of us who have invested in retail and office properties will likely be the big losers. Less obvious, but also true, there will be big winners in the months ahead.
Those sitting on the sidelines flush with cash, may not lose by doing nothing, but they certainly won’t be considered winners either when the dust settles and everything returns back to normal, whatever the new normal turns out to be. They will have missed the best buying opportunity since the Great Recession. They will look back two or three years from now and regret not taking advantage of the turmoil in the real estate market.
It’s time to be greedy
Real estate investors should be asking ourselves daily this one question: “What investment opportunity is staring me in the face that I need to take advantage of?” Warren Buffett said it best when he said, “I tell you how to become wealthy. Be fearful when others are greedy. Be greedy when others are fearful.” How true! And right now, this virus has made many of us fearful, and rightly so. Millions of people have lost their jobs or have experienced significant declines in their personal net worth. People have a right to be fearful. But fear need not prevent us from making sound investment decisions.
Don’t give in to fear
In 2009 I, along with a group of like-minded investors, purchased an apartment that had been recently foreclosed upon by the lender. The real estate market at that time was in a freefall. Everybody and their brother was trying to get out of real estate. Was I fearful? You bet I was! It was a scary time. But that acquisition turned out to be the best real estate investment I have ever made. The key was moving forward with the purchase regardless of my fear because it made sense to do so. And now we are again in that same type of environment. I urge you not to let fear get in the way of what you truly want in life.
Buy the “blue light specials”
In the months ahead, real estate investors who are cash buyers should purchase those “blue light specials” that become available in the market. The rest of us should consider pooling our money with other like minded investors when a promising real estate opportunity surfaces.
Be a cash buyer of real estate
But notice I said real estate investors should be cash buyers. Why shouldn’t they finance their acquisitions with debt? With the exception of Fannie Mae and Freddie Mac, most lenders are not lending at this time. And those that are, their rates and terms are significantly less competitive than they were 60 days ago. In addition, many lenders are requiring the borrower to fund at closing a 12 month reserve for mortgage payments, property taxes and insurance. And because of these mediocre rates and terms, this is not the time to seek out long term fixed rate financing.
That said, if you don’t have the means to buy a property all cash, then I suggest you finance the property with short term fixed rate debt that has a modest prepayment penalty. I suggest a fixed rate loan of no more than three years, shorter if you can find it.
Big winner strategy – buy now, refinance later
Why? Because I believe the big winners of this pandemic are going to be real estate investors who buy now and refinance their acquisitions in the next year or two. Regardless of which candidate wins the presidential election in November, the winner will put pressure on The Federal Reserve to implement another round of quantitative easing (QE) which will artificially lower long term interest rates as a strategy to stimulate the economy out of this COVID-19 recession.
Due to the effects of QE, I would not be at all surprised if a year or so from now, 10 year fixed rate loans for apartments and other property types are in the mid to high 2 percent range, possibly lower. If true, you want to have the ability to refinance your properties with debt that significantly reduces your property’s annual debt service. That means you don’t want to finance the purchase of these “blue light specials” with agency debt (Fannie Mae or Freddie Mac) as their prepayment penalty of choice is yield maintenance. Yield maintenance is so onerous that no sane borrower would ever pay off a loan that has a yield maintenance prepayment penalty.
Positive influences of QE
QE has two positive influences on rental properties:
- The lower interest rates will result in reducing annual debt service which will improve a property’s cash-on-cash return; and
- Over time, cap rates will compress to adjust for a property’s improved cash flow. Lower cap rates mean property values will increase, quite likely very significantly.
Must solve our dismal rent collections first
So it’s possible that in a couple of years, that one of the big unintended winners of the COVID-19 recession will be real estate investors. We’ll see. In the short term, we need to figure out how to overcome dismal rent collections. If that issue is not resolved favorably over the next few months, then all bets are off.
Those are my thoughts. I welcome yours. Who do you believe will be the big winners of the COVID-19 recession?
Doug Marshall is the award winning author of Mastering the Art of Commercial Real Estate Investing. Check it out on Amazon!