How to Profit in Uncertain Markets – Economists’ Real Estate Predictions for 2023

How to Profit in Uncertain Markets - Economists' Real Estate Predictions for 2023 

How to Profit in Uncertain Markets – Economists’ Real Estate Predictions for 2023

Tell me you have no clue without telling me you have no clue.

In December, Deloitte published its outlook for commercial real estate in 2023. Here’s a quote they included from Deloitte China Real Estate Industry Leader Philip Law:

Uneven growth trajectories could propel the industry in new directions over the next few years. Amid high uncertainty, commercial real estate companies should focus on strategic, asset-level decision-making to meet the evolving needs of investors, tenants, and regulators. Operating with a ‘business-as-usual’ approach should be long behind us.

Thank God you cleared that up, Phil. I was afraid we were going to be left scratching our heads.

In all seriousness, that’s a lot of big words to say “I have no idea what’s going to happen. You’re on your own.” Is there any credible economist or analyst willing to do more than avoid accountability while trying to sound smart? To say something we can hold them to, backed by data or at least common sense?

Let’s take a look at what’s out there …

Deloitte

I know I started this article by making fun of them, but London-based Deloitte is a bigger deal than I am, so let me dial it back.

Deloitte gathers interesting data, and they ask the same questions year after year so you can track trends. They also don’t have a building to sell you, so I trust what they have to say about commercial real estate — they don’t have a dog in the fight, so why would they lie?

So … Deloitte surveyed 450 CFOs of commercial real estate firms to find out what they were bracing for. They discovered that:

• Only 40% of those CFOs expected revenue growth in 2023. Compare that to the same survey they took last year, when 80% of survey respondents predicted revenue growth.

• 33% of those CFOs reported plans to cut costs in 2023, compared to only 6% in last year’s survey.

So CRE professionals responding to Deloitte aren’t optimistic about their financial performance in 2023 — at least, not compared to last year.

Let’s go back to that quote. If there’s a useful point to be extracted from that word salad, it’s the part about “strategic, asset-level decision-making.” With good decision-making, individual assets can do well, even if the market as a whole struggles.

JPMorgan-Chase

Banking giant JPMorgan-Chase understandably has its eye on residential and commercial real estate markets. Their giant status also puts in their field of vision macroeconomic factors that impact the global markets. For example …

• The war in Ukraine, with its accompanying price spikes and supply chain disruptions.

• Record-high inflation pricing smaller players out of the market.

• Rising interest rates, which puts upward pressure on cap rates but potentially helps multifamily by turning households into long-term renters.

(Deloitte cited many of these factors too. I smell consensus.)

The report pointed out that multifamily — a far more local industry, though not immune to macroeconomic factors — is the best-performing asset amidst all this upheaval and uncertainty, since rent increases with inflation and rents can be adjusted far more quickly. They quote Moody’s chief CRE egghead Victor Calanog as saying: “As of the third quarter of 2022, multifamily vacancies are at 4.4%—a five-year low.”

JPM also pointed out something else that you will hear more about later — the insatiable demand for affordable housing outstripping the supply. Moral of the story, investors who find creative ways to offer affordable housing could find opportunities even in an uncertain market.

CBRE

Coldwell Banker Richard Ellis (CBRE) has one of the most comprehensive 2023 forecasts out there, broken down by asset class.

CBRE predicts strong demand to insulate the multifamily sector of commercial real estate. Don’t expect the double-digit rent increases or sub-3% vacancy rates of 2021 and 2022 — that party is over. But they do expect strong rent growth of 4% and vacancy below 5%. Any multifamily syndicator would be happy with those numbers.

CBRE also points out that the skyrocketing cost of homeownership puts wind at the back of the rental industry. Before the pandemic, the average monthly housing payment exceeded average rent by 8.5%. In Q3 2022, that number shot up to 57%.

Now … I don’t like to take the word of CBRE as gospel. Know why? See the problem? Remember I said Deloitte doesn’t have a building to sell you? CBRE definitely does. When a company is in the business of buying and selling real estate, they tend to be rah rah about real estate. It’s always a good time to sell and it’s always a good time to buy. Um … which is it?

National Association of Realtors

The National Association of Realtors was one of several sources to predict the most uncertain future for offices, still struggling from the pandemic-era exodus to work-from-home.

Like CBRE and JPMorgan-Chase, they also remain bullish on multifamily — or at least less bearish — due to strong employment numbers.

Nevertheless, they expect slight price contraction across the board — but perhaps less contraction than the inflation and interest rate environment might predict. According to chief NAR economist Lawrence Yun: “Cap rates simply cannot match up with higher borrowing costs, especially among people who need to refinance their properties. However, strong job growth is supporting prices in many markets.”

The takeaway? Slightly bad time to sell, decent time to buy. Isn’t it nice to use less words?

Business Insider

Let’s take a break from the stuffed shirts for a minute. Business Insider took an interesting survey — twenty young real estate leaders. Let’s see what some un-jaded people have to say about real estate in 2023.

Here are some of the opinions they had to offer:

• Maya Abood, a housing planning analyst for the City of Los Angeles, echoed JPMorgan-Chase about the dearth of affordable housing. No kidding — she’s in LA — but under recession conditions this is a national problem, even if it’s particularly pronounced in California.

• Matt Barnett, a senior associate architect for national architecture firm LS3P, dusted off his crystal ball and predicted the strongest growth forces for the southeastern US. He specifically namechecked the states of Georgia, North Carolina, and South Carolina. (Hmmm … where is the Investor Boardroom portfolio, again?)

• Open House Austin co-founder Stephanie Douglas predicted that markets that saw explosive growth, like Austin and Raleigh, might see a drawback of maybe 5-8% in their housing market. Easy to believe — they went up so much so quickly, where do they have to go but down? Redfin chief economist also predicted a “weak year for home sales.” But remember — problems for home sales could be a boon to multifamily, as households become or remain renters.

• Era Ventures partner Raja Ghawi echoed Deloitte in predicting a rough 2023 for the real estate industry, but that the pain would sort the wheat from the chaff: “Whoever survives will have a strong business model that will be primed for success. It’s like when you put pressure on coal — on the other end, we will get diamonds.”

Takeaway Messages

• The industry expects contraction, or at least uncertainty. Players will need sound strategies and resilience to make it to the other side.

• Interest rates put upward pressure on cap rates. Some asset classes and markets will be more affected than others. Expect more pain in the office sector, less in the multifamily sector.

• Affordable housing will boom. Developers that find creative ways to offer high-quality affordable housing options will have the ability to make the most of this recession.

• Look to the southeast for the strongest growth. Expected continued growth trends in states like Georgia and the Carolinas.

How to Profit in Uncertain Markets

So what is a company like Investor Boardroom to do under conditions like this? What is the average retail investor to do?

We will still be buying. Not only do we feel good about our target markets, we have the relationships to get access to good deals and the credibility to close and finance them.

As for high interest rates, we don’t care (well…it’s not that we don’t care, it’s that we can account for that in our analysis). Worry about interest rates is for homeowners — and their worry actually helps us in multifamily. As long as the price is right and the cash flow is there, it doesn’t really matter to us whether interest rates are up, down, or sideways.

So, assume we are looking at a recession. How do you make money in real estate in a down market?

Underwrite Conservatively

Conservative underwriting is never a bad policy. If you expect the worst in your analysis, you’re ready for anything. Everything good that happens is a pleasant surprise. An overperformance of expectations.

Investor Boardroom will be merciless in our underwriting in 2023. Fortunately, this will mean few changes. We were underwriting 2-3% rent increases even when some markets were experiencing 8%, 10%, even 20%.

The Fed might dial back interest rate increases, but we’re underwriting like interest rates are going to stay high or go even higher. If we’re wrong, it means more cash flow. Good for us!

We’re also realistic about our exit cap rates. We will be underwriting based on current cap rates or even higher. It will rule out a lot of marginal deals, but we don’t want to take chances with investor capital.

Focus On Local

One of the good things about real estate as an asset class is how responsive it is to local economies. The country could be going through a depression; the whole world could be in the throes of an economic downturn. But if job growth and in-migration are strong in one city out of hundreds, the real estate in that city will experience growth.

So, choose your markets carefully. Texas, Florida, and Alabama have been strong for years. Georgia and the Carolinas too, and we expect them to stay strong. If you choose your markets correctly, you can prosper in even the worst recession.

Prioritize Cash Flow

With interest rates high, it’s tempting to focus less on positive cash flow. There’s less of it, and it’s harder to achieve anyway. So why bother? Why not bank on appreciation?

Because without positive cash flow, appreciation tends to be hard to achieve — especially in a down market. Cash flow might not be high enough to retire Mom, but it’s at least an indicator of the financial health of the asset as a whole.

Whether it’s cutting costs or finding value-adds to increase the rent, positive cash flow is Number One. Positive cash flow reduces risk. Positive cash flow gives you options.

Reevaluate Exit Strategies

If the value of your asset has dropped a little, bury your head in the sand and pretend it didn’t happen. Or sell in a panic to cut your losses.

Just kidding. This is the game, and this can happen. Don’t worry — if you picked your market well, the fundamentals are strong. If you planned to sell, it might be time to consider a different exit strategy.

For example, it might be time to refinance. Yes, interest rates are high, but it’s a non-taxable option to recoup some or all of investors’ capital so they can free up dry powder to use price corrections as a buying opportunity.

If you’re up against the loan term, it might be time to refinance anyway. Considering the recent double-digit rent growth, you may have more equity to pull out than you think, even with a slight drawdown on prices.

Pick Your Asset Class Carefully

A recession is a time to think carefully about which asset classes you want to be in. For example, we still like multifamily; we don’t like offices unless we can reposition them to be something different, something more in-demand. We definitely like senior housing, self-storage and affordable housing.

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The only guarantee when it comes to listening to economists and other “experts” is that when the dust settles, half of them will look like idiots and the other half will think they’re geniuses — in other words, ripe to look like idiots in the future. Real estate markets contain clues to the future, but they can also surprise you. The blue ribbon goes to investors who are careful and flexible.

Investor Boardroom will keep buying, even amidst all this uncertainty. Our strategy is built for it. Downturns are the time to buy because assets are cheap. Reach out to us if you want to join in!