|
From investors and developers to lenders and the construction industry, we are seeing a huge stall in the market that is to be expected. What no one knows is the extent of the market correction we are headed for and when it will occur. Let us state the issues at hand and where the opportunities will be.
Inflation
Governments around the world pumped money into the economy trying to combat the effects of COVID. Economic 101 states that when there is too much money in the system, you will have inflation. Why everyone seems to be befuddled about this event is surprising. Much of the COVD money in the US system has not been spent and we are seeing some state agencies giving money to others because they don’t need it. More money now is being put into the economy under the Inflation Reduction Act. The irony of this is not lost on us.
Interest Rate Solution
The economy is running red hot. Unemployment is low, commodity prices are high (wages, housing and food). The Federal Reserve has made drastic increases in their Federal Funds rate to slow down the economy, hoping that people will stop spending money. The stock market has crashed and the cost of doing business has increased for everyone.
Commodity Pricing
Building materials and other durable goods that make the world go around have gone up in price. Construction is slowing because of this and to rent or buy homes has gone up on the debt side. It is pushing potential buyer out of ownership and making them turn to rental housing while increasing the price of rental housing for those who can least afford it.
Supply Chain
A long delay in work by many suppliers due to COVID created a backlog of needs that were unmet. When China and other major producers in the world are shut down, you can’t get basic products that the world relies on. Chips for cars, refrigerators for apartments, and other materials. The supply chain shortages are felt across many industries but it is improving. Economics 1010: when supply is short, prices increase.
The Effect on Real Estate
Developers are stuck trying to deliver projects on time. The cost to finance their build is more expensive so people may not be able to afford what they deliver. They are backed up getting materials to finish and at the end of two years of construction may have a project that will be more costly to own than their buyer or renters can afford. The debt that they underwrote is much higher….a pending storm in the making.
Investors are trying to refinance assets they purchased and may not get proceeds to pay off their old debt. Many apartment investors used short term variable debt and are caught trying to finish putting “lipstick on the pig” (analogy for buying cheap property and turning it around quickly after raising rents). Their interest rate alone in the last 30 days has increased by over 20%. Many are under water. The people they want to sell to now have higher costs to make their numbers work on the buy side so the price must come down. There is a huge disconnect between buyers and seller today and this will not turn out pretty.
Lenders would like to put out money. Those in dire straits can’t move fast enough but the majority of the market is sitting and waiting for the interest rate movement to stop and prices to adjust.
Action Steps to Prepare: it is likely that a recession is pending. The Federal Reserve would like to see the unemployment rate increase (job losses) to combat inflation. The cost for everything has gone up and there will need to be an adjustment.
From an investor’s point of view:
- Refinance all properties with long term debt as we did – many may be too late
- Increase Capital budgets for cost of construction and everyday operating expenses. Last year’s budget won’t come close to 2023 costs!! – (note we feel that the slowdown in construction industry will actually move material prices down)
- Set realistic housing rent expectation – apartment rents have increased so fast. Can it last? If a recession is coming, people will have a harder time making ends meet and rent is a key component of the monthly budget
| 
