How will Covid-19/Coronavirus Affect my Alternative Investment Portfolio? Part 15: June 6th
Updated: 3 days ago
U.S. progress against the virus suddenly stalls; Sweden's roller coaster week; Georgia's mixed reopening; 1.88 million more unemployed, but bottom appears to be coming into sight; Government data suggests astounding one third of unemployed have been stranded without benefits; Business bankruptcies skyrocket 48% to 11 year high; Non-political Congressional Budget Office releases a dark 10-year economic forecast; Heavily criticized paycheck protection program (PPP) is revamped; Anti-malaria drug hydroxychloroquine is miraculously resurrected from grave, only to stumble back in again; Real estate investment rundown; Hotel and retail commercial mortgage delinquencies soar; Brutal 42% of top retail chains didn't pay their rent; Formerly "safe" trophy properties hit the skids; Self-storage rents fall across 97% of the country; Nursing home occupancy plunges a painful 10-18%; Is your office investment really ready for a post-lockdown world?; A tale of two (multifamily) classes; Pandemic will probably deal deathblow to many movie theaters; Crowdfunding platform Crowdstreet experiences the best and worst of times; Update on my investment strategy.
(Usual disclaimer: I'm just an investor expressing my personal opinion and not a registered financial advisor, attorney or accountant. Consult your own financial professionals before making any financial decisions. Code of Ethics: I/we do not accept any money from any sponsor or platform for anything, including postings, reviews, referring investors, affiliate leads or advertising. Nor do we negotiate special terms for ourselves in the club above what we negotiate for the benefit of members.).
Many things happened this week that affect investors. And for the 2nd week in a row, the river of information about the virus itself slowed down. So our discussion will again be tilted toward news and analysis of the economic repercussions of the crisis (as well as real-estate). Before jumping in, here's a quick summary of the series so far:
U.S. Progress Against the Virus Suddenly Stalls
The U.S. continued its months-long battle against the coronavirus. And as of Saturday afternoon, the death toll had climbed to 111,627 (from 105,353 the previous week).
However, the national death doubling rate (the time it takes for deaths to double) was unchanged, maintaining the same slightly inclined slope as last week, doubling over an eight week period (56 days).
This was unusual because the country had improved each and every week for the past 7 weeks (since it first started to have success bending the curve back on April 11, as discussed in part 7).
A look at the daily death chart shows why:
In the last week, there was a bit of a death surge. It ultimately settled back down to about the same plateau as the last two weeks. But little to no progress was made in bending the curve.
Some epidemiologists fear an increase in deaths in the next week or so, due to the two to three week lag from increased social activity on Memorial Day. An example is the "Zero Ducks Given" pool-party in Missouri where hundreds crammed together without masks or social distancing (see part 13). And this week, hundreds of thousands of people gathered in cities across the country on multiple days to protest the racial injustices that led to George Floyd's and others' deaths. Since speaking loudly is known to spread the virus, and there's typically a lot of shouting at protests, this also has some epidemiologists concerned.
We'll see what the data shows over the coming weeks.
Meanwhile, South Korea continued to lead most of the world for another week in minimizing deaths (one of the lowest per million) while also minimizing economic damage (projected to barely shrink this year, and without needing to borrow trillions of dollars for stimulus):
As we talked about in part six, South Korea uses an aggressive mixture of the Three T's of disease control (testing, tracing and treatment).
Japan has gone with a similar strategy, and this week continued to experience similar success:
Sweden's Roller Coaster Week
Meanwhile, Sweden has opted with a Lockdown-Lite strategy (see part 8). The hope has been that if this works well, it might provide another workable model for other countries looking to deal with the virus.
This week, the country had an up-and-down experience. On one hand, they made progress and appear to have beaten back the troubling third wave of the virus that hit them last week:
On the other hand, Sweden's death rate continues to be three to seven times higher than their Scandinavian neighbors (see part 12). And Lockdown-Lite seems to have failed its main economic objective. The country is still expected to plunge into a severe recession (GDP projected to be -5.6% in 2020 versus -5.9% for the U.S.). This is a bit better than the average -8.1% projected for the Euro Zone, but isn't the large benefit many hoped to see.
And this week, things got a little unexpectedly crazy. Sweden’s state epidemiologist and architect of its unconventional plan, Anders Tegnell, has previously been an unconditional defender of the policy. Now, he made a surprising confession to a local broadcaster and said the country "clearly" could have done better fighting Covid-19.
"If we were to run into the same disease, knowing exactly what we know about it today, I think we would end up doing something in between what Sweden did and what the rest of the world has done,”
Until Tegnell spoke, the Swedish had broadly supported the strategy. But after the broadcast, public support plunged 18 points (from 63% to 45%). And Prime Minister Steve Lofven promised an inquiry into the government's response.
At a later press conference, Tegnell then said he still stands by the overall strategy and believes that in the long run all countries will end up having about the same success or lack thereof. He claims Sweden could have done a better job protecting care facilities and should have "tested a bit more." He also believes that closing primary schools was unnecessary and does not believe facemasks to be effective.
Recent antibody tests in the country have also shown disappointing results. The number of people who have caught the disease has been fewer than the Public Health Agency’s models predicted and suggests that herd immunity is further off than they were counting on.
Meanwhile, some E.U. countries (like the Czech Republic) are restricting travel from Sweden as they have deemed it a "high risk Covid zone."
Georgia's Mixed Reopening
One of the most important questions for investments (as well as the health of the country) is "what will the shape and speed of the recovery be?" If it's V-shaped and quick, then many investments will be just fine. On the other hand, if it's one of the other shapes (U-shaped, swoosh, etc.), then some or many investments might run into problems. (See part 14 for more information on the possible shapes and their ramifications)
To monitor the evolving situation, we've been watching Georgia very closely. It was one of the first states to reopen. So this makes it one of the most useful early indicators of what may be in store for the rest of the nation.
On April 24th, Governor Brian Kemp reopened nail salons, hairdressers, bowling alleys and gyms (as long as they followed state protocols). Then, restaurants and theaters were allowed to open three days later on April 27th. So they've effectively been open for a little more than a month.
How are they doing? There's no state agency that publishes weekly data on this kind of statistic. But, fortunately, we can get the info from other places. For example, Placer.ai tracks mobile phone usage to different types of businesses to measure foot traffic.
In the past, we've looked at McDonald's, Applebee's, and the Cheesecake Factory. And progress has been slow. This week, let's start by looking at a different type of business: Costco. Here are the results:
This is a pretty good-looking graph. Foot traffic at Costco has recovered from a bottom of -26% eight weeks ago to -4.47%. So this is great to see for them.
On the other hand, grocery and supply stores have generally done very well throughout the entire downturn. So this chart probably isn't reflecting an increase in economic activity, but rather a shift from online traffic to in person. Either way, it's unlikely to contribute much to the state's recovery.
So let's take a look at a business in a category that would be more likely to be affected by the downturn: gyms. Here is Gold's Gym:
Unfortunately, Gold's Gym's graph isn't looking so hot. For some reason, they backtracked since last week, which is disappointing. And they are currently at -45% foot traffic versus the same time last year. Since gyms are not high profit-margin businesses, this particular Gold's Gym is probably unprofitable. The silver lining is that it has improved from the absolute bottom several weeks ago. But the overall speed of the increase looks more slow and swoosh-shaped than V-shaped.
Let's look at another business category that was affected by the downturn: retail. Here is Kohl's:
On on hand. they are at -17%, which is unlikely to be very profitable. But the trend is clearly greatly improved from the peak only four weeks ago. And, the speed of the recovery has been a lot faster than Gold's Gym (almost V-shaped). So this is potentially a promising sign for their near future. We'll continue to monitor them.
Here's another retailer: Bed Bath and Beyond:
They look more similar to Gold's Gym. While they have improved from their bottom six weeks ago, they are still at an unsustainable -41% versus a year ago, and unlikely to be profitable. Their recovery has been shaped more like a swoosh, although this week there was an acceleration. It would be nice if that were to continue next week. Again, we'll see.
Here's the Cheesecake Factory this week:
This is similar to Bed Bath & Beyond: a slow, swoosh U-shaped recovery, and currently at a very unprofitable -48.5% year on year.
Here's one more: IHOP:
IHOP is similar to Bed Bath & Beyond at a very unprofitable -46% year on year and a slow, swooshed-shaped recovery.
Overall it looks like the positive progress on shutdown-battered businesses is mixed. On one hand, Kohl's could be recovering in a quick V-shape. On the other hand, Gold's Gym, Bed Bath & Beyond, Cheesecake Factory and IHOP appear to be more of a slower swoosh recovery.
A statewide V-shaped recovery would almost certainly require wide participation by the majority of businesses. So far that doesn't seem to be the case. We'll continue to monitor to see how this evolves.
Meanwhile, one immediate X factor to consider is a second wave of the virus. If that hits and a shutdown is necessary, all the economic progress to date could be lost.
Here's how that's looking right now:
Georgia's daily data is noisy but the state appears to be stuck in the same plateau it's been in for the last three weeks. As mentioned above, some epidemiologists are concerned that we may see a spike next week due to the delay factor from increased activity on Memorial Day. We'll continue to monitor.
1.88 Million More Unemployed, But Bottom Appears To Be Coming Clearer Into Sight
For the 10th week in a row, more than a million Americans reported that they lost their jobs. This week it was 1.88 million, which is down a little from 2.13 million last week.
However, this jobless claims statistic tells us only who has lost jobs, and not whether some have been rehired. So for that, we need to go to the "continuing claims" number.
Last week, this number went down for the first time since the pandemic started, which was very welcome relief. And it suggested we might be near the bottom. But, as we also mentioned, the biweekly nature of the states' reporting, and the fact that hard-hit states (like California and Florida) are not included, mean the continuing claims statistic still probably overstated the recovery.
This week confirmed that theory. Continuing claims actually rose again from 21.1 million to 21.5 million (surprising some analysts, but not readers of this series). Even with the backsliding, this is still lower than the 25.1 million peak two weeks ago. And despite the move in the wrong direction, the trend currently still looks like a bottom. The next two weeks will tell us for sure.
Meanwhile, the May nonfarm payroll report also brought some very welcome news. After going into freefall in April (-20.7 million on payrolls), this week's payrolls clawed about 12% of that back, by increasing 2.5 million.
The fact that the nonfarm payroll even went up at all was a surprise to virtually all economists, who were expecting another drop. So the reversal was good news. On the other hand, some pointed out that the bounce may have been only temporary. The rules in the Paycheck Protection Program (PPP) originally required many companies to rehire at about this time, to avoid having to repay the money. So if the economy is not fully recovered when that one-time stimulus money runs out, the newly rehired employees may go back out the door just as quickly. But there's no way to know for sure at this point. And for now, good news is better than bad news. Again, this may indicate that we're close to or at the bottom. A few claimed this data point was proof of an imminent, quick, "better than V-shaped recovery." (See part 14 on the different recovery "shape" possibilities). Others claimed the growth looks too anemic and at best is looking like a slower, swoosh-shape. Time will tell who's right. Meanwhile, the headline unemployment rate fell also, from 14.7% to 13.3%. However, as we discussed in part 11, this is a potentially misleading statistic in today's environment. Similar to last month, a large number of workers were improperly recorded as "absent," when they were actually unemployed. Correcting for this, the Labor Department said the real number was 16.3%. Still that was lower than the same correction a month ago (which was +5% or 19.7%). And in theory, this was good to see.
But even that number does not take into account the fact that the headline rate doesn't include all of the unemployed. It omits people who have given up looking for work, which which makes sense in normal times but not now (when many people who want work, can't even try because the jobs aren't available yet). So to get the full picture, we need to look at the U-6 rate, which was 21.2%. Unfortunately, this was not much different from the 22.8% last month. And it would mean that a brutal one in five Americans were still unemployed.
And unfortunately, even the U-6 rate ignores factors needed to accurately count the out-of-work. For this reason, the Chicago Federal Reserve came out with a new statistic called the U-COV that does. As we discussed last month, this previously showed the actual unemployment rate for April was a mind-blowing 30.7%. That meant almost one in three Americans was out of work.
We will have to wait for them to crunch the numbers for May to see what U-COV comes out to be next.
Government Data Suggests Astounding One Third of Unemployed Have Been Stranded Without Benefits
Studies have shown that when significant numbers of workers lose jobs and have no income, the damage to the economy can last a long time. So one of the key U.S. strategies to delivering a quick, V-shaped recovery, has been to provide a strong unemployment safety net. The idea is to provide unemployment income to keep the jobless spending money (which supports the economy). And it also helps them to keep their housing, continue to eat and be able to look for a job when things rebound. And as part of the CARES stimulus bill, the U.S. government provided additional unemployment payments on top of the typical state payments to do this.
However, as we discussed in previous weeks, millions of the unemployed have been left high and dry and not able to access their funds. This has been caused by antiquated and overloaded state computer systems and bureaucratic snafus. And if this happens to enough people, the odds of a quick recovery become very low.
Unfortunately, the government doesn't release any official data to measure the number of people still unpaid under CARES. So back in part 12, a senior fellow at the Century Foundation used indirect means to try to estimate it. He concluded that about 40% of people had not been paid at that point.
This week, Bloomberg economists attacked the problem in a more direct way. They compared the claims made by the states versus the actual payments recorded by the U.S. Treasury over the course of the pandemic. And from March to May, an astounding one third of the unemployed have not received their money.
If accurate, it suggests that there may be significant amounts of lasting damage. If so this could be problematic for a quick recovery.
The silver lining is that May was the lowest shortfall at about 20% (versus about 55% in April). So while still not acceptable, it has also improved a lot in just a month. And so it's possible that next month will continue to improve and look better. We'll see when they update the analysis next time.
Business Bankruptcies Skyrocket 48% To 11 Year High
U.S. courts reported that business bankruptcies skyrocketed 48% in May (versus last year). This number was up from a 28% increase in April (year on year). And year to date, the numbers are the worst since the Great Recession (in 2009).
The pain was widespread, and large companies were not spared either. Prominent companies who filed bankruptcy included JCPenney, Neiman Marcus, J.Crew, Gold's Gym, Lasix Vision Institute, Le Pain Quotidien bakery chain and generic drug maker Akron. This drove up the bankruptcy rate for major companies (having $50 million in liabilities or more) to 37%. This was also the worst month for this since the depths of the Great Recession in 2009.
Bankruptcy lawyer James Conlan, with Faegre Drinker Biddle & Reath LLP’s restructuring group, said May was a "busy month" and that pain was wide-spread. Sectors included energy, airlines, aircraft lessors, real estate, top automotive suppliers, hospitality and retail. And he claimed that while the pandemic downturn caused the situation for many, some companies had actually gotten themselves into trouble beforehand by borrowing too heavily.
Few expect this to be the end. Amy Quackenboss is executive director of the American Bankruptcy Institute and represents more than 12,000 bankruptcy professionals. She said, "The Cares Act and other swift government measures have been successful in keeping consumers afloat during the crisis. As this relief runs its course, however, mounting financial challenges may result in more households and companies seeking the shelter of bankruptcy.”
Conlan also concurred.“I think we’re going to see an extraordinary number of large corporate bankruptcies, not just in the U.S. but across the globe,” he concluded.
Non-Political Congressional Budget Office Releases a Dark 10 Year Economic Forecast
Meanwhile, the nonpolitical, nonpartisan Congressional Budget Office (CBO) released its 10 year forecast.
Surveys from purchasing managers were negative and indicated a recession (a 43.1 on the U.S. Institute of Supply Management Manufacturing Index). This was a bit better than 41.5 reading in April, but well below the 50 that marks an expansion.
And the analysis showed that the slow pace of recovery, despite the removal of lockdowns, suggests that the recovery in the months ahead could be tentative. They also found that the $3.3 trillion stimulus program will only "partially mitigate the deterioration in economic conditions".
As a result they revised their previous estimate of 2020 growth from 2.2% (pre-covid) to a painful -5.6%. They expect unemployment to still be above 10% at the end of the year. And while they project continued slow growth, it will not come fast enough to make up for the ground that's been lost so quickly. As such they are forecasting a depressing 10 years before the country returns to its pre-Covid-19 economic health:
If this ends up being accurate, this would be a combo-shaped recovery (see the different recovery "shape" possibilities in part 14). The recovery would start quickly (v-shaped) but eventually peter out into a long "swoosh-shaped" recovery.
On the positive side, the forecast is based only on what we know today. And they acknowledged that certain things might drastically change the results. One of these was the possibility of the government passing significant additional stimulus.
Last week, we talked about how a chamber of the U.S. Congress (controlled by one political party) had passed a $3 trillion stimulus bill.
Initially, the other chamber (controlled by the other party) had pronounced it dead on arrival. But then some very poor economic data came out, and the President and his administration announced support for more stimilus. And then the leaders in the blocking chamber also agreed. As of last week, negotiations were ongoing.
This week, little progress was reported. However, the President further proposed a $1 trillion package, and the leader of the balking chamber has agreed to this in principal.
At the same time, several leaders of that chamber say they aren't in a rush to pass stimulus. And, the earliest they will even look at it is late July. If this continues, then those waiting for a stimulus calvary to charge over the hill, might be waiting for a while.
Heavily Criticized Paycheck Protection Program (PPP) Is Revamped
In late March, the U.S. government passed the first part of a huge stimulus package ($2.2 trillion) to offset the economic pain of the lock-downs. A large part of that ($660 billion) was allocated for the small businesses hit hardest by the shutdowns, like restaurants, shops and salons. The idea was to give them free money to tide them and their employees through the shutdown. This would allow the businesses to reopen quickly afterwards and prevent the employees from falling through the bottom and permanently damaging themselves and the economy. This program was called the Paycheck Protection Program (PPP) and was designed to facilitate a V-shaped recovery.
However, in part 7, we talked about how many companies haven't been able to receive the aid intended for them, due to a string of problems. These have been caused by government bureaucracy, snafus and questionable decisions by the Small Business Administration, the Treasury Department and others.
And in part 11, the SBA and Treasury were dressed down by both parties in Congress for leaving tens of thousands of businesses out in the cold with overly strict rules (that were also against the intention of the law). Despite this criticism and despite lobbying by business advocates, the agencies did not back down.
So this week, Congress explicitly passed a revision bill to deal with this, and it was signed into law by the President on Friday. It makes the following changes:
It reduces the controversial requirement to spend 75% on payroll to 60% (effectively increasing the amount available for other things, like rent, from 25% to 40%). The previous restriction made it impossible for many retail businesses in high rent area to use the program. Although the reduction was less than the 50/50 split that business advocates had recommended, it's still expected to be a big step in the right direction.
It increases the time frame in which businesses must spend the money from 8 weeks to 24 weeks. The eight week period ended up being impractical for many businesses, as they had no chance of opening during shutdowns and thus would have a better chance of surviving if they could use it for payroll when actually open. So this change is expected to help those businesses.
It pushes back the deadline for rehiring workers from June 30 to December 31. The majority of businesses have no hope of fully rehiring all workers by the end of this month. So this change makes the requirements more realistic and should encourage more businesses to participate.
Tom Sullivan, of the U.S. Chamber of Commerce and Vice President for Small Business Policy claimed the changes would, "help Main Street's efforts to reopen."
He also pointed to the Chamber's latest Small Business Coronavirus Impact Poll, which found that while 8 in 10 businesses are in the process of reopening, 55 percent of owners believe it will take six months or more to be fully operational. This number is up from 50% in April, which itself was up from 46% in March.
Some were concerned that both the SBA and Treasury Department will still have to provide significant additional guidance on the above. And time is of the essence since the first PPP deadline has already passed (May 29). But guidance from both departments has previously been heavily criticized as slow, incomplete and sometimes contradictory. Karen Kerrigan, president of the Small Business & Entrepreneurship Council (a nonpartisan advocacy group) said, "We ask that it be clear and speedy".
Anti-Malaria Drug Hydroxychloroquine Is Miraculously Resurrected From Grave, Only To Stumble Back in Again
Many had hoped that the anti-malaria drug hydroxychloroquine could be repurposed into an effective Covid-19 treatment. And early on, studies looked promising. The potential catch was that none of these studies were scientifically sound, because they were too small or didn't follow proper scientific protocols.
In mid-April, the first big scientifically rigorous study came out (150 patients) and was disappointing. It showed no benefit from taking the drug at all. Still, there was a faint hope that perhaps another larger study would show something different.
Then in late May, a study of 96,000 people came out. It also found no positive effect for taking hydroxychloroquine against the virus, nor for combining it with the antibiotics azithromycin or clarithromycin. And worse, it showed taking the drug dramatically increased the chance of death (34%) and serious heart arrhythmia (137%).
This appeared to be the nail in the coffin. And these health concerns also caused the World Health Organization (WHO) to cancel their own study of hydroxychloroquine.
However, early this week, the researchers who published the study made a surprise announcement. The company that provided the data, Surgisphere Corp., had originally claimed that they would allow an independent review as part of the peer review process. But ultimately, they reneged, claiming it would violate the confidentiality agreements they had signed with the different hospitals. And since the reviewers could not conduct an independent and private peer review, they researchers retracted the entire study.
This was a remarkable turnaround for a drug that seemed at death's door only the day before. And once again, it raised hopes that perhaps a larger study could find some positive benefits. After the announcement, the WHO announced that they would resume their own study of the drug.
However, the roller coaster ride wasn't over. On Friday, Oxford University revealed the results of their own large study. This was conducted on 11,000 patients across 175 NHS hospitals in the U.K. And unlike the previous study, they gathered their data directly. So there was no third party to potentially muck up the results.
Unfortunately, the results agreed with the mid-April study. The researchers claimed that the drug produced "no beneficial effect" and further they said they "decided to stop enrolling participants... with immediate effect". Preliminary results were released with full results expected shortly.
If this holds up, it unfortunately may indeed be the last nail in the coffin for hydroxychloroquine.
Hydroxychloroquine isn't alone in disappointing. So far, none of the repurposed drugs have been found to have any significant effect on stopping the virus. The closest has been Remdesivir which showed slight improvement on very preliminary results for the most seriously ill people. But so far, it's shown no success in treating anyone else with the disease.
However, trials are continuing on these repurposed drugs, and some continue to hope for better results.
Real Estate Investment Rundown
How are real estate investments during this crisis? Now that we're two and a half months in to this pandemic, we're starting to get more clarity.
The ultimate fate of most investments will still depend on a big unknown: the shape and speed of the recovery. As we discussed in part 14, a quick, V-shaped recovery would mean that the majority of investments will end up being perfectly fine. On the other hand, some of the other shapes (like U-shaped, swoosh or L-shaped) would mean longer recoveries. And if that happens and the pain lasts long enough, many asset classes would take significant (and perhaps even catastrophic) losses.
Also there are a lot of X factors that are still in play that may change the end result dramatically. Will we get help from science with an effective treatment or cure? Will we get a second wave of the virus either from premature reopenings or from cooler weather in the winter? Will the virus end up being impervious to a vaccine, and mutating so quickly that we have to live with it for years? At this point, we don't know yet.
So, bottom line: I feel it's important for every investor to come up with their own opinion on the recovery and continue to refine it as the situation evolves. And if you're interested in my own opinion on what will happen, it's at the bottom of this article.
Finally, it's important to understand that there's not a lot of sales data right now in most commerical real estate classes, because so much of the market is frozen. Sellers still remember the pre-Covid 19 price and are hoping for a quick recovery to justify demanding that price even now. Buyers see a lot more risk than a few months ago and are not willing to go forward without a substantial discount. So as a result, deals don't close and volume is way down.
Ultimately, this will get resolved in one of two ways. Either we'll have a quick recovery and sellers will start getting their full price. Or we won't and sellers will start capitulating and dropping prices. If this happens, it will probably take time because sellers will try to hold out as long as possible. In the end, we'll see how it plays out.
With those caveats, here's what we're seeing so far:
Hotel and Retail Commercial Mortgage Delinquencies Soar
Many loans on commercial real estate are held by investors in structures called commercial mortgage-backed securities (CMBS). The nice thing about CMBS's is that they generally have an obligation to regularly report to investors how they're doing. So while they may not be representative of the entire market, they still are a great way to monitor how that particular segment is doing.
Trepp Analytics reported this week that the number of CMBS mortgages that are seriously delinquent (30+ days) soared in May to 7.15% (from 2.29% in April).
If a property can't afford to make the payments on its loan, this can result in default. And generally, this means a large or complete loss of the investment for all equity investors.
Trepp also reported that an additional 7.6% of loans missed their May payments for the first time. So, if a significant number of these remain delinquent next month, the "30+ days" delinquent properties will hike up even higher next month.
Taking a closer look at the data, the CMBS pain is being mostly felt by hotels and retail:
These soared to a distressing 19.13% and 10.14% respectively.
On the other hand, while multifamily delinquencies more than doubled (from May's 1.75% to 3.75%), this still was a relatively low level of problem properties. And office and industrial also saw small increases, but were relatively unchanged.
Brutal 42% of Top Retail Chains Didn't Pay their Rent
As mentioned above, the CMBS data doesn't necessarily paint a complete picture. The $550 billion CMBS market is significant but still only 13.5% of the market.
So there are other ways to get a wider look. For example, real estate analytical firm Datex produced an analysis of the top national retail chains. Before Covid-19, many of these were considered some of the safest investments. What they found was alarming.
Overall, landlords collected only 58% of the rent in May (versus 96% a year ago). This means that 42% didn't pay. As expected, gyms, movie theaters and hair salons were among the worst nonpayers. But they were not the only ones. Other rent skippers included well-known household names like Supercuts, Barnes & Noble, Red Robin, General Nutrition Centers, Gap, H&M, Foot Locker and Men’s Wearhouse.
On the positive side, the 58% collection metric was slightly improved from 54.1% in April, although not by a lot.
If things fail to improve relatively quickly, then this could potentially be bad news for investors. As mentioned above, a default can mean a large or even complete loss of the investment for the equity holder. But it also could be difficult for the debtholders as well. These have extra protection against default, because the investor can then foreclose, take ownership of the property and then resell it to recoup losses. But, if the property cannot generate income, they would be unlikely to recover their money.
Ironically, some of the top retail chains were sold to investors before the pandemic at top dollar, under the assumption that they would be unlikely to ever miss payments.
Starbucks, for example, commanded a premium price, and was considered to be one of the more reliable triple net lease investments. Two weeks ago, the company revealed they had lost $915 million in sales in the second quarter and demanded rent concessions from landlords for the next 12 months. Unsurprisingly, this got a chilly reception from many.
Formerly "Safe" Trophy Properties Hit the Skids
If you're a business that's been hammered by the virus and have a real estate loan, it matters who owns your debt. If it's a bank, you're probably in luck. Many of these have been relatively lenient, and allowed borrowers to reduce and even defer payments. According to a survey by American Hotel and Lodging Association, 91% of owners who borrowed from banks have been able to adjust their terms.
On the other hand, if the loan is in a CMBS and owned by Wall Street, then it's probably a different story. Typically, investors are unwilling to tolerate concessions. So only 20% of those with CMBS loans have been able to get the same treatment described above. And the remaining 80% have been stuck in a very painful position and many investors claim they are at risk of losing everything.
Single asset CMBS's (where only a single property is in the structure rather than many) have been hit unusually hard. Typically, these are trophy properties, and before the pandemic, were marketed as top-of-the-line, safe, gold-plated debt. They were so popular that they grew to almost 40% of the $120 billion commercial mortgage market in 2019 (a 21% increase from 2012).
But the pandemic caused occupancy and revenues to plunge to almost nothing, and so far recovery has been slow. And many formerly high-profile properties are finding themselves unable to pay their debt and investors fear losing everything to the lenders.
Adding to their woes, trophy property CMBS's were also left out of some of the recent government stimulus intended to help real estate. Previously, the U.S. created a program called the Term Asset-Backed Securities Loan Facility (TALF) which would lend $100 billion of cash to investors. The key is that the loans would be allowed to be secured with real estate bonds. So, since investors know the Fed will take them as collateral for lending, it makes these real estate loans a much more attractive offering to them. And this keeps prices from falling, increases liquidity, and keeps the market running smoothly.
But, the Fed has specifically omitted single asset CMBS' from TALF (along with, incidentally, collateralized loan obligations or CLO's). As a result, single asset CMBS debt is a lot less desirable to investors than debt that is backed by TALF.
An example is the famous Fontainebleau Hotel in South Beach Miami. The property is an icon that has played host to celebrities from Frank Sinatra to Elvis and has appeared in movies like the James Bond series. It also features numerous high-end restaurants and bars where a single main course can go for as much as $198.
Unfortunately, the hotel owes $975 million in debt, and needs to make millions of dollars of interest payments to stay afloat. Revenues have dropped to almost nothing. So it's asking investors for forbearance, but doesn't know if it will get it.
Meanwhile, the investors are also in a tight squeeze. The debt was underwritten based on a steady 75% occupancy rate and a steady stream of customers dining in those restaurants and bars. If investors have to foreclose, and own the property, it's currently uncertain when those optimum conditions could be expected to recur.
Self Storage Rents Fall Across 97% of the Country
Self storage analytics firm Yardi Matrix reported that self storage unit rents have dropped in 97% of the markets that they track. The average climate control unit dropped 6% and the average non-climate controlled dropped 2.6%.
Metros with the highest concentration of at-risk employment have seen the largest declines. For example, Orlando is highly tourism-dependent and experienced a 10.1% drop in climate controlled rent (and 6.7% for non-climate controlled). On the other hand, Phoenix was the single top market without a loss with storage rates unchanged from last year.
Many self-storage markets have been coping with oversupply, which has caused problems for some investments in hitting pro formas. And unfortunately, so far, the pandemic has not helped. Yardi reports that currently construction is still continuing at the same pace as before. However, they also project that this won't last. And they expect that by the end of the year, construction will have slowed down by about 10%, and by 40% over the next five years. If accurate, this would provide some welcome relief (especially to oversupplied markets).
Nursing Home Occupancy Plunges a Brutal 10-18%
Meanwhile, nursing homes have taken a crushing blow from Covid-19, losing almost 10% of their residents in the last six months (almost 100,000). This has been caused by the high virus-caused death rate in nursing homes (over 32,000 so far) and a decrease in new customers coming in.
The biggest nursing home chain, Genesis Healthcare Inc. has been hit even worse and AHS taken a 15% drop across its 335 nursing homes.
Life Care Centers of America, Inc., is another chain which operates the infamous nursing home in Kirkland, Washington, that saw a huge outbreak in February. It's experienced an 18% drop.
Is Your Office Investment Really Ready For A Post-Lockdown World?
Many office investors have been encouraged by the fact that lockdowns have ended. And some have pictured a quick return to business normalcy.
However, this week, the CDC released its new guidelines for offices. And in the post-lockdown world (at least without a vaccine), office life looks like it'll be very different from anything we've seen before:
All employees must take daily temperature screenings and system checks before entering.
Facemasks are required in all areas, and workstations have to be placed at least 6 feet apart.
Markings must also be put on the floor to facilitate social distancing, and transparent shields installed where that isn't possible.
Employees must be given disposable wipes to wipe down frequently used surfaces.
Cleaning crews must clean frequently.
Ventilation also has to be improved by opening windows as much as possible and increasing air filtration.
Handshakes, hugs and fist bumps are prohibited.
Coffee pots, water coolers and snack bins should be removed and replaced with prepackaged single-serving items.
With all the restrictions, many companies are wondering if reopening is even worth it. Capitol One said employees can stay at home at least through September. Amazon and Microsoft said telecommuting will continue until at least October. And both Zillow and Google have extended it until the end of the year. Shopify announced it will keep its office closed until at least 2021.
Other companies are going even further. Many claim they've found that working from home is not as bad as expected. So even after the pandemic is over, they expect to re-examine their permanent use of office space. Twitter, Facebook, and Upwork are all encouraging workers to stay at home and are offering all employees the option to work remotely forever.
Many financial firms, which have been a staple of commercial real estate, are also considering serious downsizing. For example, Barclays, JPMorgan Chase and Morgan Stanley are three of New York City's largest commercial tenants. And together they employ tens of thousands of workers who occupy more than 10 million square feet of Manhattan skyrises. And all three say it's highly unlikely that all the workers will return.
James Gorman, the CEO of Morgan Stanley, said the crisis has “proven we can operate with no footprint. That tells you an enormous amount about where people need to be physically.”
Nielsen has 3000 workers in the city and says that they will no longer be in the office full-time and instead can work from home most of the week.
Investors are watching these developments very carefully. The concern is that if these changes become more prevalent, it could have significant long-term effects on office occupancy, rents and prices.
A Tale of Two (Multifamily) Classes
The first day of each month is now a much more nervous time for some landlords than it use to be. With record unemployment, many are holding their breath to see how collections go. Many tenants are relying on one-time stimulus checks and credit cards to pay rent. And without more stimulus or a quick recovery, many aren't in a sustainable situation.
However, so far, things have gone pretty well for some. For example, the National Multifamily Housing Councils (NMHC) reported that 90.8% of rents were collected in May versus 93% a year ago. This was welcome news.
But, not every property has been so lucky. The NMHC skews to more expensive buildings (sometimes called Class A). And their high income clientele has been relatively unaffected by the virus. For example, more than 45.3% of those making over $200,000 per year have been working at home through the pandemic. In comparison, less than 13.3% of those making less than $100,000 can say the same.
This is because many working-class jobs require in-person contact (hospitality, warehouses, retail, etc.). Many of these positions were furloughed or laid off.
This has caused some surprises. Before the pandemic, some sponsors touted workforce housing (class B- to C) as recession proof. The theory was that even if workers lost their jobs, they would be quickly replaced by people from higher class apartments losing theirs and being forced to downsize. But, so far in this recession, the higher-income workers have been spared and lower income workers have taken the brunt. So this has not panned out as expected.
On the other hand, this could change as things evolve. Some are projecting that the next wave of layoffs will start hitting white-collar workers more. For example, a Bloomberg analysis found that as many as 6 million jobs (ranging from supervisors of front-line workers within hotels and restaurants, to professional services, finance and real estate) are potentially at risk:
If significant numbers of those jobs are lost, then the trend could reverse.
Also, so far, most tenants have been reluctant or unable to move out due to lockdowns. This has kept occupancy levels up. If the country continues to reopen, this dynamic will change and occupancy levels could start to drop. We'll see what happens.
Either way, lots of landlords are currently feeling the heat from missed payments. Apartment List is a rental listing service that covers the spectrum of classes. And they found that in May, 31% of tenants did not make a full on-time payment. And this was an increase from 25% the month before.
Many landlords may be granting leniency in the hope that the tenant can get a job sometime soon. If that happens, then everyone will probably end up very happy. If not, some may later look down on this technique as a second act of the "extend and pretend" techniques that banks used on delinquent borrowers during the Great Recession.
Meanwhile, tenant advocacy groups from New York to Los Angeles are encouraging millions of renters to deliberately withhold rent. Using the hashtag #CancelRent, they are trying to create pressure for an expansion of affordable housing and tenant-friendly legislation.
Much of the general public incorrectly believes that rental real estate is a high-margin business. They don't understand that landlords have significant financial obligations including bills and mortgages. And few understand that if even just a relatively small number of renters withhold rent, the vast majority of landlords would be in danger of going out of business.
However, so far, these campaigns have generated more noise than action. And understandably, multifamily owners continue to watch the situation closely.
Pandemic Will Probably Be Deathblow to Many Movie Theaters
Many movie theaters were already in poor financial shape before the virus hit. In the 1990's, the megaplex was invented and cheap credit fueled a huge construction boom. But over time, American viewing habits changed. By 2019, many started preferring at-home options. But theaters were stuck in a pinch with high fixed costs and mounting debt payments. By the end of last year, 23% of theaters had closed (with only about 5500 still open out of 7200 theaters).
Then the virus hit, and revenues dropped to nothing with lockdowns. And now, even with reopenings, many theaters aren't allowed to run at full capacity. Even if they were, many Americans currently say they're uncomfortable visiting one. So, many theaters are confronted with the possibility of months with little revenue.
Obviously, this would be a potentially catastrophic outcome for an equity investor. And even a debt investor (who has the increased protection of being able to foreclose and take control of the property) may still be in hot water.
The problem is that theaters can't easily be repurposed with a new tenant. They have a very specialized design with sloped floors and unusually large rooms. So there's practically zero chance that a new, non-cinema tenant would accept the design. This usually means taking a bulldozer and knocking everything down and starting from scratch. This could make the retenanting process especially long and painful.
Crowdfunding Platform CrowdStreet Experiences the Best and Worst of Times
On one hand, CrowdStreet seems to be not just thriving in a Covid-19 world, but doing better than ever. Over the last several years, a typical successful crowdfunding deal on the platform might take anywhere from a day to several weeks to fully subscribe. But recently, the timeline seems to be accelerating on certain deals. For example, on May 4th, 255 investors fully subscribed to a CrowdStreet deal in a stunning two hours and six minutes. This was the same day that the Dow had its worst one-day point drop in history and the S&P had gone down 12%.
On the other hand, on Tuesday, CrowdStreet CEO Tore Steen announced it was laying off more than 1/5 of its workforce (24 of its 110 employees).
Steen claimed: “Prior to the pandemic, the company was on track to double its business, as it had in recent years, and hired aggressively to support those growth projections. Given the impact COVID-19 has had, CrowdStreet made necessary cutbacks across divisions and made the difficult decision to lay off 24 members of its staff.”
According to CrunchBase, the company had taken in about $24.9 million in venture capital, including $12 million in late 2019. Since the firm doesn't release financial information, it's unclear if it's expected to be profitable after the layoffs or if it would still be operating at a loss (like many VC-funded companies do ).
Update on My Investment Strategy
Every week I take a look at the latest developments and data and reevaluate my personal outlook on the possible economic scenarios and my personal investment strategy. This week I've changed my shape forecast from a two stage combo to a three stage. I've also added more tweaks and additions. But many of my fundamental views are essentially the same as last week.
Treatment: I believe chances are good we'll have an effective treatment for Covid 19 (i.e. antibody treatment, vaccine, etc.) by fall or winter of this year. And with some luck we could even have more than one. Unfortunately, it's also unlikely it can be manufactured and distributed in large enough quantities to immediately treat everyone who wants and needs it. If that happens then it will not be enough to super-charge the economy right away. And there may be potentially huge quality-of-life difference between the treatment-haves and treatment have-nots. This will be divisive and exacerbate already strong tensions in our society and between rich and poor countries.
Recession? We've already had one quarter of negative growth in Q1 (-4.8%) and Q2 will be record-breakingly bad. So a technical recession (2 consecutive quarters of negative GDP growth) is inevitable.
Shape of the recovery: In part 14, we talked about how the shape of the recovery (V-shaped, U-shaped, swoosh-shaped, W-shaped, L-shaped, combo-shaped etc.) will have a huge effect on the ultimate outcome of many different investments. So far, pretty much everything that's happened has been much worse than the consensus expected. Pretty much no one saw the lock-downs coming back in February. More people have been killed than originally projected. Many more than expected have lost jobs. The stimulus and unemployment aid was enormous but has too many unexpected holes and isn't getting to millions who need it the most. States are starting to reopen but most individuals are still choosing to stay at home anyway. So unfortunately, I don't think a quick, V-shaped recovery is going to happen. I would love to be wrong. But if I'm right then I'm also concerned about a very damaging "W", which could come from a second wave of the virus and a second lock-down. So I continue to monitor the state reopening data very closely. At this point, thankfully, there aren't any definitive signs of a second wave. So until I see that, I believe we will have a 3 stage combo-shaped recovery that starts off quick as the first "easy" industries and companies come back online (i.e. v-shaped). But this will peter out as the more difficult ones are unable to and a slow swoosh will become apparent (stage 2). Then in fall/winter, I believe we will probably see a treatment and/or vaccine. And if we do, then that would be the trigger for the 3rd stage and an accelerated recovery. Most likely, though it will take time to ramp up production and delivery to enough Americans to get herd immunity. And that would mean a slower boost. But we could get a little lucky (for example, if the successful vaccine treatment is of a newer type that can be scaled up more quickly). If so the 3rd stage boost will be faster. If I'm wrong, and we don't get a treatment or vaccine this year, then the economic damage caused by long-term job loss and wage cuts will most likely be severe and further exacerbate (and slow down) whatever type of recovery we do get. That would probably be ugly for the majority of all investments. So let's hope we don't have to find out how that scenario would play out.
Investments: If the above is roughly correct then it will unfortunately be painful for many individuals and some investors. And some subsectors of alternative investing (like certain real estate classes) will come under heavy stress. Many may fold in the coming months. At the same time, I think there will also be an opportunity to purchase dislocated and distressed assets at very favorable pricing and significant discounts. And I believe that patient, discerning investors may be able to take advantage of once in a decade or once in a generation opportunities.
Strategy: 1) Invest in assets that are corona-virus resistant (and uncorrelated with the business cycle). That includes: - 1a) Music royalties (which can actually do better in lock-downs due to increased streaming). 1b) Life settlements (which actually perform better when people are dying faster and in any event isn't directly tied to the business cycle) 1c) Litigation finance (which performs based on winning or losing cases and also isn't directly tied to the business cycle). 2) Continue to hold cash and be patient for dislocated and distressed opportunities. The worse the economic damage, the more chance there will be for once-in-a-generation or once-in-a-lifetime opportunities.
My opinions and strategy will change if we get some better or worse news on the science side or some of the other X factors. For example, the stimulus bill being debated in Congress is one that could shift things in a more positive direction. And, as I mentioned above, the virus getting out of control again in large areas and forcing large lock-downs a second time, could make things worse. In the meantime, that's the review for this week. And I hope you and your loved ones are staying safe and healthy.
Next Article Part 16:
U.S. makes mixed progress against the virus; Georgia's muted reopening appears to stall; "Houston We Have a Problem": Signs of second virus wave begins to swell; Economy pinned to the mat by yet more massive unemployment; Almost $1.5 trillion of crucially needed stimulus funds are sitting idle due to bureaucracy; OECD expects US recovery will lag the top countries; The stock market's triumph of optimism over experience; Type O blood may be protective against the virus; More unexpectedly fast progress in the race for a covid-19 treatment; Update on my investment strategy. Click here to view next article.