Real Estate During a Global Pandemic
We’ve spent years building our cities upwards.
Skyscrapers filled with thousands of workers tower over busy city streets. Apartment complexes with small rooms are costly yet typical. Retail stores line the streets with bright lights and big signs, convincing customers to peruse their selection and spend away. Life is busy this way, but it’s exciting.
Most people eventually move to the suburbs to slow down and start a family or retire. This model has served Americans well for decades. However, the very foundation of this lifestyle has been challenged and pushed to its limits amidst a global health pandemic. Many agree that the world will never look the same, often coining the term “new normal” when COVID-19 is properly controlled. Personal space is now seen as more of a necessity rather than a privilege or luxury. These changes in preferences and public health concerns will impact how we all use real estate in our lives.
Americans were not prepared for the wave of infections that overwhelmed densely populated areas. Physical distancing can be difficult when people share transportation, housing, and various services as an essential part of their lifestyle. The same goes for businesses that relied on customers coming to a physical location for a product or service. This has led to monumental shifts in the real estate market on both the commercial and residential fronts.
Interest rates are sitting at all-time lows. The 30-year fixed mortgage rate is hovering around, or below, 3.00%. This led to new mortgage applications spiking throughout most of June and July, and the largest spike in homeownership rates we’ve ever seen. Single-family homes and new developments are booming as a result.
As for commercial real estate, businesses are filing for bankruptcy and closing storefronts. The world shifted its attention online, and companies who were ill-prepared couldn’t afford the rent to keep the physical locations open. Office locations with cubicles and conference rooms are deemed unsanitary, pushing many companies to keep their employees home and reconsider what the office of the future looks like.
Given this information, what does this mean for an opportunity in the real estate sector? Will this pandemic lead to a permanent shift in American ideology? Will the public ever feel safe enough to share space the way we did before 2020? Experts have mixed opinions.
Newton’s third law states “For every action, there is an equal and opposite reaction.” Though commonly associated with physics, this rule can dictate movements in the real estate market as well. For example, retail locations are closing as Amazon, Walmart, Alibaba, and more dominated the online market throughout the pandemic. If this change is permanent or persists, industrial real estate will remain in high demand as warehouses and distribution centers struggle to keep up with the order flow. Offices may become larger to spread out employees. However, this is costly. Some companies have offered more positions for employees to work from home. This can create opportunities with data centers, internet infrastructure, and more to fill the void.
Is now the time to commit more capital to real estate? Is it better to enter the public or private sector?
It’s important to understand your current exposure to real estate. Including your home, your overall asset allocation may have a larger exposure to real estate than you may realize. Your exposure grows with vacation homes, commercial buildings, or other investment properties.
Public real estate is primarily comprised of real estate investment trusts (REITs). REITs gathered attention in the recent bull market due to low interest rates and suppressed bond yields. They offer a highly liquid medium to invest in real estate at a relatively low cost. Nearly all market-based funds offer exposure to REITs through the real estate sector. Because of its market liquidity, public real estate can seem more volatile than its private counterpart.
Private real estate is appealing due to its perceived stability. At times, both the stock and bond markets can feel unnervingly volatile. Private real estate can tempt investors as an alternative. However, it’s important to note that the private sector is illiquid and faces factors (high transaction costs, maintenance, insurance, etc.) that can adversely impact long-term returns.
When considering a new acquisition in real estate, an investor should consider two main factors: income and liquidity. Income, in both the public and private sectors, is almost entirely tied to rent payments. There are different risks depending on the asset class, so it’s crucial to understand the differences among various forms of real estate. For example, mortgage REITs, which typically employ leverage to buy mortgage-backed securities, are very different from a REIT that owns retail malls. The risks of data-center investments are different than those of hotel properties.
Liquidity is a risk in virtually every asset class, but it’s a substantial risk in real estate. The private real estate sector is tempting, often boasting high returns and perceived stability. However, if you need your money quickly, it will be nearly impossible to liquidate quickly or liquidate for fair value. Ensure that you can find liquidity elsewhere if needed. In many real estate investments, debt and leverage is part of the strategy, potentially intensifying the risk of holding hard-to-sell assets.
Real estate has its place in many portfolios. Before investing in any asset class, understand the implications this could have for your financial future. Understand the risk, determine what this means for the bigger picture, and ensure your success through a carefully crafted financial plan.
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