As we enter in to the start of this new decade, there are seemingly more questions than answers. When will the current economic cycle, the longest in U.S. history, come to an end? Should we expect the next recession to be only a slight dip, a protracted slowdown, or a crash? How can property managers and investors prepare for what’s ahead, in 2020 and beyond? We’ve decided to focus on the biggest question on Americans’ minds: How will a potential recession impact me? Here are some of the topics we’ll be discussing:
When a recession is expected to hit, and what the likely triggers are
How a recession could affect housing prices
The impact a recession will have on rental demand
How regulations will impact rental owners and property managers in 2020
Where returns will be strongest for investors in the coming year
A recession is possible in 2020, and likely by the end of 2021, but it won’t be caused by the real estate market. As our economy’s record-breaking expansion continues, talk of an impending recession is to be expected. Experts are uncertain on exactly when we can expect a downturn to occur:
50% of real estate experts surveyed by Zillow foresee a recession in 2020, while 35% don’t think one will arrive until 2021.
41% of economists interviewed by Bankrate anticipate a recession to begin before the 2020 presidential election.
38% of members of the National Association for Business Economics anticipate a recession in 2020, while 25% expect one to start in 2021, as reported by SFGate.
A model developed by Bloomberg Economics puts the chances of a recession occurring within the next 12 months at 29%: higher than it was a year ago, but lower than it was before the last recession.
No two recessions unfold in exactly the same way, so in order to foresee what’s to come for the U.S. economy in 2020, it helps to forgo our memories of the 2008 market crash. Over the last decade, our economy has expanded in a steady, yet moderate way. So rather than a dramatic crisis like we experienced last time, the next recession will feel more like a gradual slowdown. With stricter regulations in place to prevent the kind of mistakes that sent the housing market running off a cliff 11 years ago, experts now anticipate that the next recession could instead be triggered by a stock market correction, trade war, or geopolitical crisis.
In the year to come, we should find a balance between staying on top of fluctuations in the economy and avoiding needless anxiety. As of now, we are seeing the economy begin to slowly move in an upward direction, after the downfall it took from the global COVID-19 outbreak. We are seeing the government put in as much quantitative easing (pumping money back into the economy usually through bonds) as they can in hopes to stabilize it. The yield curve is headed in the right direction, the stock market has plummeted in the last few weeks and has since began rising, & the government is scrambling for economic stabilization by attempting to implement a $1 trillion plan to pay every single American in order to help pay for necessary bills.
Anticipating a recession can be a self-fulfilling prophecy. When consumers, investors, and businesses pull back on their spending, the economy consequently slows down. Remember, that a recession is a natural part of the economic cycle, necessary for bringing overheated parts of the market back down to earth. Leverage it as motivation to continually ensure that your business will still be in a good place when double-digit growth of the last decade is no longer a guarantee.
A recession will worsen the conditions causing the housing shortage. Because the last recession was caused by the housing market crash, many have come to associate an economic downturn with falling home prices. However, in markets that have found themselves at a breaking point when it comes to the disparity between incomes and housing costs, a recession could make things even worse. We’ve all seen the headlines, there’s a gap between the housing that a majority of Americans need, and the type and amount of housing that’s actually being built. A growing number of Americans are reaching prime homebuying age and establishing homes, but for the last several years, they’ve faced a competitive housing market that’s pushing up prices on a limited supply of starter homes.
Over the last decade in the construction industry, tariffs on building materials have made it more expensive to build new housing, and a labor shortage has limited the number of homes that can be built. Because of this, builders have had to devote their resources to pricier homes in order to stay profitable. This has created a surplus of luxury housing and a severe shortage of low to middle-income housing, and a recession will likely worsen the situation.
Rising wages and low mortgage rates have increased Americans’ purchasing power in the second half of 2019. In fact, Millennials—for whom student loans, stagnant wages, and rising rents have made it hard to save for a down payment—made up nearly half of mortgage originations in September 2019. These gains have allowed the homeownership rate to rise by nearly 2% since it bottomed out in mid 2016, though they’ve also depleted the supply of available housing even further.
However, in the event of a recession, these gains could be erased. Construction could slow even further as fewer projects are initiated and projects that are kicked off will likely be the kind of luxury housing that’s profitable for developers. Slowing growth in the economy could prevent companies from increasing their number of employees and from raising wages at the current rate, which in effect, will lower consumers’ purchasing power. Current homeowners, who are already staying in their homes for longer than ever before, may decide not to list their homes as they wait for better economic conditions.
What’s unclear right now is the effect that this will have on property prices. On one hand, it appears to be a simple equation of supply and demand. The limited supply of low- to mid-priced homes in the face of strong demand will continue to drive prices higher. But on the other hand, demand may drop as a recession prevents even more Americans from being able to afford these rapidly rising prices. Home sales and price growth may flatten or fall, particularly in markets where home prices have far outran household incomes. If mortgage rates stay as low as they’ve become over the last few months, it could boost a faltering housing market. However, entering a recession with rates this low gives the Federal Reserve one less lever to pull in response to financial difficulties down the road. For real estate investors looking to grow their portfolios, the uncertain future of home price growth makes it hard to predict whether it’s better to buy now or wait it out. Low mortgage rates and years of price appreciation provide an incentive to buy sooner rather than later, but persistently low cap rates and the potential for a cooling market are causing some second guessing. Will price growth hit its limit in 2020, or will the continuing housing shortage—potentially worsened by a recession—drive prices through the roof? Will property managers’ investor clients pull back until prices cool off, or buy now to insulate themselves from further price growth in the future?
I know one things for sure, if the market crashes and we come into a recession, that’ll be the time when we are buying the most. With such low prices on multifamily assets, cap rates will be upwards of 8%, demand will be high for B & C class rentals due to low income, loss of jobs, and low supply; and returns-on-investment will be sky high due to an almost guaranteed backfilling of units after forcing appreciation through renovations. If a recession is to hit Americans in the near future then that is the time to buy, buy, buy!
Demand for low- and mid-priced rentals will see an increase due to the shortage of starter homes. A recession on the horizon raises a lot of anxiety for prospective homebuyers: Will they be able to afford their mortgage payments if their income decreases? If home value growth slows in their area, will their home gain sufficient value by the time they’re ready to put it on the market? This uncertainty leads many to put off buying a home during a recession, keeping younger residents in the rental market longer, and raising renting as a new possibility for families and older residents who might otherwise own their homes. Even without a recession straining Americans’ paychecks, buying a home remains out of reach for many thanks to factors like high home prices; the shortage of starter homes; tight credit standards to qualify for a home loan; stagnant wages; student loan debt; and high rents that make it difficult to save up for a down payment. The three most common occupations in 2018 (retail sales, food prep, and cashiers) each paid the average worker less than $30,000 per year; and in the near future, 3 in 4 newly created jobs will be considered low-wage. This makes renting a critical option for a larger portion of the population than ever before.
In addition, since the end of the last recession, a new demographic has formed in the market, renters by choice. These are renters who could afford to purchase a home, but choose to rent for the flexibility, lessened responsibility, and access to amenities and downtown neighborhoods it provides. In line with this trend, the largest gains in rentership in recent years have been among renter households with annual incomes of $75,000 or more, and those headed by someone age 55 or older, two groups who may be more likely to have the means to purchase homes. Lastly, social factors like young adults’ slower pace in forming households, having children, and buying their first homes, as well as older adults’ desire to downsize and age in place, make renting an appealing option for a more diverse array of Americans, and a recession is likely to fuel these trends. All in all, an estimated 1 million new rental households will form each year over the next decade. However, American cities are far from prepared to house all of these new residents: Insufficient construction of low- and middle-income rentals over the last 3 years has left us with a deficit of nearly 1 million new units.
There’s one segment of the rental market that is sure to see demand drop over time, particularly in the event of a recession: Class A rentals. Because of the rise of the ‘renters by choice’ demographic and the high cost of building new units, luxury rentals, which are more profitable for developers than workforce housing, have dominated multifamily construction in recent years. However, across U.S. cities, there’s an oversupply of Class A multifamily properties in proportion to the number of residents who are willing and able to afford these units. In New York City alone, more than a quarter of the 16,242 luxury condos constructed since 2013 are sitting empty. One-third of these condos are being rented out by their owners. We expect a recession to cause vacancy rates in Class A properties to rise even more. In response, developers and property managers will need to turn to concessions to attract new tenants, running the risk of renting to residents who won’t be able to afford to pay full-price for their units down the road. All of this to say that upon a recession, multi family real estate will remain a cash flow dominator due to such high demand. In the coming decade, you can expect profitability to be over 150% ROI in B & C class rentals over just a three year hold period. Now, that number is only an assumption, and every deal is different, but if there was ever a time to begin passively investing into real estate and begin creating that path to financial freedom, now is the time!
Regulations will continue to be raised for discussion in markets where rents have risen far faster than incomes.
Rent control has been a serious topic of debate within the rental market this year. With the housing shortage showing no signs of a halt, we believe that policies aimed at addressing rental affordability will be on the table in cities across the U.S. in 2020, as they have been in California, New York, and Oregon over the last year.
The potential for rent control policies to be implemented in major cities is a major source of anxiety for those in the rental sector. In a time of persistently low cap rates, rental owners worry that having their ability restricted to raise rents in conjunction with rising costs means they won’t be able to afford to maintain their properties’ profitability and finance capital improvement projects. The inflation hedge that rental real estate has always been could come to a stopping point if rent control enters every market. Property managers fear that these changes will damage the appeal of rental property investment. In addition, today’s property managers face the challenge of balancing the profitability of their clients’ investments with rent prices that keep units filled with qualified residents. The main reason that rent control is even up for discussion is because there’s a crisis-level shortage of housing that Americans can afford. 1 in 2 renter households spend more than 30% of their income on housing each month, significantly narrowing the pool of prospective residents who can afford rising rents. However, as a potential fix for this nationwide issue, rent control falls short by failing to address the need for more low-income and workforce housing to be built. We simply can’t solve the housing crisis without addressing the supply side of the equation.
Minneapolis took a different tack in 2019 by becoming the first city to ban single-family zoning. While many believe that increasing cities’ housing density is a key step in addressing the housing shortage, opponents worry that a majority of new construction will be at the high end of the market, failing to solve for affordability. It remains to be seen which cities and states will be next to pass regulations to address housing affordability. Areas where rent growth has far outran income growth in recent years (and that don’t have rent control preemptions in place) are most at risk; and as a result, investor interest in these markets may decrease. We’ll all be watching with great interest as local governments and 2020 candidates propose policies to address the various interconnected aspects of the housing crisis, from zoning restrictions to insufficient construction rates, particularly with the possibility of a recession. In all of this complexity, there lies a big opportunity for property managers: We believe that they’ll come to play a critical consultative role as regulations create an increasingly complex legal landscape for rental owners. By staying on top of changes in their local market, property managers can market their expertise as a crucial resource for their clients’ businesses.
Returns for real estate investors will be stronger in certain up-and-coming cities than in primary markets. Over the last several years, real estate investors hunting for higher cap rates and lower prices have focused their attention on fast-growing cities away from the coasts. Between July 2017 and July 2018, the U.S. cities that gained the most residents from domestic migration were Phoenix, Dallas, and Las Vegas; while New York City, Los Angeles, and Chicago actually shrank.
Why is this the case? Since 2016, population growth in certain mid-sized cities has outpaced growth in powerhouse cities long considered cornerstones of the U.S. real estate market. These secondary markets have certain characteristics in common: They have strong job growth that’s not restricted to a single industry, which helps cities to weather a recession; and often includes an emerging tech sector that attracts young, educated professionals. Though home and rent prices show robust growth, the cost of living stays affordable for the average resident because the supply of housing is less constrained than in primary markets. Workers, families, and businesses take notice of this growth and start moving in.
In addition to these fast-growing mid-sized cities, residents are also turning their attention toward mixed-use developments in the outer ring of major cities. Today’s residents want to live in places where they can easily walk to work, restaurants, stores, and local attractions like they could find in downtown neighborhoods, but at the more affordable prices of the suburbs. In 2020, these highly walkable suburban neighborhoods, particularly those within commuting distance of business districts, are expected to see faster rent growth than urban neighborhoods that are already nearing their ceilings for sustainable rent growth. Best of all, these neighborhoods appeal to Millennials and Baby Boomers alike as these groups balance their desire to be part of a community with appealing amenities with their need for housing that they can afford. Investors, residents, and businesses are gravitating away from primary markets and toward thriving secondary markets for the same reason: Prices have risen beyond a level that the average person can justify or afford. In cities like New York City and San Francisco, the cost of living has risen out of residents’ reach as the supply of affordable homes fails to keep up with the demand.
As the housing shortage continues into 2020, we expect that persistently high prices and low cap rates in traditionally popular cities will continue to drive real estate investors’ interest toward less-established markets. As we reach the end of the current real estate cycle, smart investment picks are constantly changing, as investors have rushed into thriving cities like Austin and Nashville, prices have ballooned and cap rates have rapidly compressed. This has investors more interested in safe bets like Mobile: which remains a good investment even as a recession looms due to its resilient job market, powered by its many universities, & large commercial sector of Aviation and Oil Refinery.