Written by: Samira Fatehyar
Synopsis
First off, I’d like to issue an apology for missing out on my last blog post. Due to personal reasons, I decided to go dark. During these past few weeks, I have revamped the blog as well as added a podcast called, Bad Bad News, that runs in parallel with these blog posts. For those who don’t have the time to read, I highly encourage you to check on the podcast! I’m also adding a permanent section in these blog posts that pertain to the European economy and real estate market.
To listen to the podcast version:
So what has gone on in the past few weeks? A lot of economic data has been released signaling a recovery is near. But is that really the case? There’s been a lot of talk about the rental housing market and I thought it would be a great topic to explore, so we look at two major cities, NYC and SF to see what is going on. We’ll then dive into the European market and see how they are fairing through the COVID-19 pandemic economically. Specifically, we look at what the city of Lisbon, Portugal has created.
Economic Update
A side note: I’ve learned that looking at data in the middle of a crisis, can tell you a lot of things in that moment in time. It’s extremely hard to predict what will happen next. So, please take each data set that I share, with a grain of salt. Though, I’m a firm believer that our fundamentals are still wrong and we will have a long recovery ahead of us, I can be proven wrong; in fact I hope I am wrong and we recover from this rapidly.
In the last several weeks a lot of economic data has come out, most have been positive, but is it too soon to tell if the recovery has begun? I believe so, especially since we are currently seeing a resurgence in COVID-19 cases across the country. I’ve said this in the past and I will stress it once again, a recovery cannot begin until we can substantially mitigate the risks associated with the virus; this means that the best bet is a vaccine. Another element is that of consumer psychology, if someone doesn’t feel safe to go out and spend, they won’t. How do we make them feel safe? Again, I think a vaccine is going to be the key. Though I will mention that we still don’t know how effective a vaccine is and if this will come back every year like the seasonal flu. There is still a number of questions we don’t have the answers to and that is definitely making consumers fearful.
Looking at the recent PMI (Purchasing Managers Index) for the manufacturing and service sector numbers, it looks like the worst is over and we are on our way towards a rapid recovery.
Graph 1
PMI Data from January 2019 to July 2020
https://tradingeconomics.com/united-states/manufacturing-pmi
In Graph 1, above, it’s clear we’ve experienced a V-shaped recovery. But does this really tell the whole story? What it tells us is that purchasing managers feel that things are recovering and we are moving ahead. Can this all be dropped down again if a major resurgence of COVID-19 cases arise, as we might be witnessing currently? Yes. But this is telling us that at this moment in time, these managers don’t expect a detrimental economic shutdown in the near future.
Let’s now look at consumer confidence data.
Graph 2
Consumer Confidence Index from January 2019 to July 2020
https://tradingeconomics.com/united-states/consumer-confidence
Looking at Graph 2, above, we notice that consumer confidence has not recovered the way PMI numbers have. This is quite an interesting contrast because purchasing managers are confident that their supply chain is going back towards pre-COVID-19 levels, but if consumers don’t yet feel comfortable to spend, will this in the end affect the economic recovery? Yes. No matter how socially distant and how many precautions are taken by businesses, if the consumer doesn’t feel ready, they won’t spend their money. As stated previously, our best bet is a vaccine.
There was another statistic that came out showing that the number of people collecting state unemployment was decreasing while those obtaining federal benefits were increasing. Graph 3, below, illustrates the numbers.
Graph 3
Comparison of those receiving state unemployment vs federal unemployment benefits
https://www.marketwatch.com/story/soaring-demand-for-federal-jobless-benefits-points-to-fresh-fissures-in-the-us-economy-2020-07-09?mod=economic-report
How could these numbers be so far off from what is being officially reported? Many blame a lag time from when they were first filed to now when its being reported. In any case, it’s raising eyebrows because having this happen does not make sense. This is suggesting that either the unemployment numbers or the unemployment benefit numbers are wrong. What ever the case is, it is something that I think everyone should be aware of.
Another interesting phenomenon we are witnessing is the rise in businesses filing for Chapter 11 bankruptcy. I thought it would be helpful to first define what Chapter 11 bankruptcy is and how it works.
Chapter 11 is a type of bankruptcy that focuses on reorganization the company’s debts and assets. In the majority of cases, the companies do not go out of business during this process. It’s a very lengthy process and if the reorganization doesn’t work correctly, the company will go out of business. It’s like a last ditch effort companies make to keep their business alive.
Below is a list of medium to large sized US companies that have filed Chapter 11 bankruptcy in 2020, so far:
24 Hour Fitness
Akorn
Art Van Furniture
Bakers Square
Bar Louie Restaurants
Borden Dairy
Boy Scouts of America
Brooks Brothers
Chesapeake Energy
Chuck E. Cheese
Clean Energy Collective
Cosi
CraftWorks Holding
Dean & DeLuca
Diamond Offshore Drilling, Inc.
Earth Fare
Exide Technologies
Fairway Market
Fingerhut
FoodFirst Global Restaurants
Frontier Communications
GNC
Gold’s Gym
Goodrich Quality Theaters
The Hertz Corporation
HopCat
Hornbeck Offshore Services
Intelsat
J.C. Penny
J. Crew
John Varvatos
Krystal
Libbey, Inc.
LSC Communications
Lucky Brand Jeans
Lucky’s Market
McClatchy
Modell’s Sporting Goods
Neiman Marcus
Peter Piper Pizza
Pier 1
Roman Catholic Diocese of Harrisburg
Stage Stores
Sur La Table, Inc.
True Religion Brand Jeans
Tuesday Morning
USA Rugby
Village Inn
Vivus
Whiting Petroleum Corporation
XFL
To put this in perspective, in 2019 alone, there were a total of 49 medium to large size companies that filed for Chapter 11 bankruptcy. Granted, declaration of Chapter 11 bankruptcy does not necessarily mean you go out of business, but for a number of these businesses it does. In 2020, we’ve had a total of 51 so far and we still have 5 more months left in the year.
It should be noted that many firms are still announcing furloughs. Just this week, United Airlines announced that they would furlough 36,000 in October. This is just one example of a multitude of companies that are following the same route.
Rental Housing Market: A Case Study
I’ve been getting a lot of questions about housing especially as it relates to the rental market. I thought it would be best to look at two major cities, NYC and SF to use as a case study. With all the COVID-19 economic implications, it should be obvious that a lot of renters are having trouble paying their rent, which in turn ends up hurting the landlord’s ability to pay for their mortgage payment (if they have one), insurance, and property taxes. It’s a ripple affect that I think is important for everyone to understand. The economic impacts we are seeing from the pandemic is not hurting one specific population. It affects all of us in some way. When we hear the words, “We are in this together,” it really is true.
New York city
We all know that NYC is famous for its pricey housing units. So, when an economic downturn happens like what we are currently witnessing, it makes sense that rent prices would also be decreasing. But it’s happening at a rate that has not been seen at least in the last 3 decades. Before I get into the specific numbers, I think it’s especially important to first point out the unemployment numbers. Below lists out the unemployment numbers seen in May 2020 for, among other areas, NYC.
Table 1
Unemployment Rates in the US, NY state, NYC, and the suburbs of NYC as of May 2020
https://labor.ny.gov/stats/pressreleases/pruistat.shtm
Unemployment increased to 18.3% in May 2020 for NYC. This is an incredibly high number seeing that the official unemployment rate for the US in the same time period was only 13.3%. NYC was 5 percentage points higher than the US as a whole. So, if NYC is known for its rent being about twice the national average and having its unemployment rate higher than the national average, it should signal a red flag to everyone. I’d encourage everyone to click on the graph and explore the table that shows the sectors most heavily impacted in New York.
Two-thirds of the NYC population rents housing units. Many of these renters have numerous roommates. According to CHIP (Community Housing Improvement Program), 1/4 of renters haven’t been able to pay since March; that means 4 months of rent has not been paid, thus far. Evictions are currently on hold, but it’s only a matter of time before the state can no longer help these renters. It’s a sad reality, but one that we seem to be kicking down the road, hoping for some miracle to occur. This impact could potentially inflict generational levels of poverty for these families that will have to be evicted and move to a more affordable area. Even the word “affordable” creates an image in the minds of many Americans as the “ghetto.” The majority of people that end up in the ghetto never leave and neither do many of their descendants. What I’m trying to stress here is the potential for major negative impacts, if this situation isn’t handled right.
As a real estate consultant, I believe it’s also important to understand the landlord’s side in these turbulent times. Many of these smaller landlords have mortgage payments to make. If their tenants are unable to pay rent, landlords subsequently cannot pay their mortgage. Thankfully, the government has urged landlords to work with their debt service providers But let’s look at a worse case scenario happening. Imagine these landlords evict their current and in order to find new tenants they have to substantially decrease the rent price, which then affects the asset price and before you know it, many of these landlords could be underwater on their mortgage. This means that the value of their property could be worth less than their mortgage; exactly like what we saw during the housing market crash of 2008. Do I know that this will definitely happen? No. But this is a scenario that should be in the back of everyone’s minds.
Now, let’s look at the institutional landlords, the ones that most likely don’t have a mortgage payment to make. Property taxes in most major cities in the US, including NYC, is extremely high. Let’s explore another possible scenario that could arise. Tenants become evicted and many of these properties have not had any rent paid for several months. Property taxes and insurance become due. These institutional landlords won’t be able to pay their property taxes or insurance payments. This in turn hurts both the city as well as the insurance companies. The city could lose a substantial amount of revenue and will have to cut many programs to deal with the shortfall. Many of these programs could be ones that deal with those who end up losing their homes. Insurance companies would in term end up raising their premiums to offset their revenue loss. This is not a scenario I hope happens, but again it’s possible to envision especially when a lot of the data sets are showing a grim reality.
Miller Samuel, a real estate appraisal and consultancy agency, creates market reports for the Manhattan, Brooklyn, and Queens areas. In their latest report they showed a number of areas where the market is lagging.
Table 2
Manhattan Key Rental Metrics
https://www.millersamuel.com/files/2020/07/rental-06_2020-pdf.pdf
Looking at Table 2, above, we can see that rental prices haven’t lagged very much; yes prices have gone done a bit but nothing drastic. This could be for a number of reasons. Because prices don’t change until a unit is on the market and able to find a tenant willing to lease it at that rate. With everything that we know about the unemployment rate and many tenants not paying their rent but also not leaving their apartments, this could certainly skew the data. Another important variable in this is the fact that in NYC there is still a lot of new inventory that is coming on the market now and in the short-term future. Many of these prices are based on the new inventory and the tenants that are able to afford those prices at this time. The number of leases increased from May to June and I would certainly attribute that to new inventory, but it is still down -35.6% from June 2019.
Another interesting metric on this table is that of listing discount. In an expensive market like Manhattan, you’d usually have people outbidding one another to get the property. Listing discount is now at 2% according to Miller Samuel. According to RealPage, a real estate property management company, they have seen an average of 8% off asking price on average. Taking either of those numbers signals the urgency and desperation landlords are facing in these turbulent times.
Vacancy rate is another important metric to look at. At first glance, 3.67% isn’t necessarily high, but since evictions are on hold for now, I don’t anticipate to see that figure increase until the eviction moratorium is lifted. Though, it is important to see that vacancies have increased over time since last June.
Chart 1
Net Move-Outs in major cities across the US
https://www.realpage.com/analytics/u-s-apartment-demand-falters-2q/
Chart 1, above, shows the net move-outs in a number of major cities across the US. NYC, Los Angeles, and San Francisco were the top three in this chart. This is important to point out because NYC was seen as one of the strongest residential rental markets not too long ago and to see it fall this fast only shows how vulnerable it already was. Granted, the COVID-19 pandemic wasn’t something anyone could easily prepare for, but it shows how many jobs were impacted in a city where rent was twice the national average. Maybe the prices were a bit overinflated?
San Francisco
On the other side of the country, we are seeing something similar happen as well. Chart 1, as we saw, showed San Francisco suffering a large number of move-outs as well. San Francisco is a bit of a different animal though, since many job are tied to the Silicon Valley. It’s extremely interesting to point out that many of these large Silicon Valley corporations’ stocks are skyrocketing at this time but so many people are leaving the San Francisco area. There are a few reasons I believe this is happening.
Much of Northern California was under a stay-at-home order for about 2-3 months. Many of these tech firms had no choice but to transition their employees to remote work. With no end in sight for the COVID-19 pandemic, many companies have extended their employee’s remote work until the end of the year or further, with some, like Twitter, saying workers will now have the choice to work from home forever. Many of these employees have realized that they no longer have to live in the same city they work or even near it, if they work remotely. So there is an influx of people moving out of San Francisco at the moment, which easily accounts for such a high number seen in Chart 1, above.
Table 3
Unemployment Rate for San Francisco-Oakland-Fremont Area (Dec 2019 to May 2020)
https://www.bls.gov/eag/eag.ca_sanfrancisco_msa.htm
Let’s compare unemployment data, as we did above with NYC. Above, in Table 3, shows the unemployment rates for San Francisco, Oakland, and Fremont area. The unemployment rate actually decreased from April (13.2%) to May (12.7%). Again, I attribute this to the tech companies being able to thrive in these times of uncertainty in the market. They have been carrying an extreme weight in the NASDAQ and S&P 500 indices, so I don’t see unemployment being a big problem in this sector.
Now, all the potential worst case scenario implications I described above in NYC can also happen in San Francisco. Though, I expect San Francisco could experience it faster. With so many tenants already re-locating to other places, we’re able to see a more drastic price decrease. This is happening because these units are able to come to market faster and landlords are having to reduce their prices to entice new tenants to move in. According to Zumper, an apartment finding app, they have recorded a record 11.8% price drop (year-over-year) for one bedroom apartments in San Francisco.
Chart 2
Changes to Rental Prices Year over Year in the San Francisco/Bay Area
https://www.zumper.com/blog/san-francisco-bay-area-metro-report/
Looking at Chart 2, above, we see that San Francisco isn’t even the worst area in the Bay Area in terms of price decreases. Cupertino saw a whooping 16% decrease, followed by Mountain View at 15%, and then Emeryville at 14%. This should underscore just how much the Bay Area has become affected by the COVID-19 pandemic. It’s interesting to see that the Bay Area is having larger drops than NYC. I believe this is because so many people are willingly leaving these cities on their own, instead of waiting for the eviction moratorium to be lifted.
Granted there are areas that have seen growth. Livermore at 15%, Campbell at 5%, and Concord at 2% is extremely interesting because this shows that there is definitely demand for these more suburban areas as opposed to the bigger urban areas. I am surprised to see that both Oakland and Daly City are seeing increases of 5% and 4%, respectively. They are both pretty urban areas. PG&E did announce that they would be re-locating from San Francisco to Oakland, so it’s not only tenants moving to Oakland but also companies not wanting to rent higher priced spaces in San Francisco.
Another important metric to look at is vacancy rate, which in San Francisco is at 6.2%, according to RealPage. This is a large number and like I stated before, I believe this is attributed to many tech employees relocating to more affordable areas to continue their remote work.
European View
This will be a permanent segment in this blog. I think that with everything going on around the world, it would be beneficial to understand what is happening in other countries to give a comparison. I’ve chosen Europe since I believe they are most similar to our country’s economic system as opposed to Asia. This week we are diving into Lisbon, Portugal.
Lisbon, Portugal
A few years ago, I came across a video on Vimeo, called You’ll Soon Be Here. It was an incredible documentary about the life of the locals in Lisbon and how many of them were being forced out to live outside of Lisbon due to the influx of foreigners buying housing and renting it out to Airbnb to make more money than they would if they rent to locals. The unemployment number in Portugal has always been high. This statement is true for many countries in the European Union. The European Debt Crisis of 2012, took a big toll on the youth population in these countries. Let’s take a look at the graphs below.
Graph 4
Portugal Youth Unemployment Rate over the past 25 years
https://tradingeconomics.com/portugal/youth-unemployment-rate
Graph 5
EU Youth Unemployment Rate over the past 25 years
https://tradingeconomics.com/european-union/youth-unemployment-rate
Looking at Graphs 4 and 5, above, we can see that Portugal’s youth unemployment rate is still about 6 percentage points higher than that of the whole EU. At its peak, Portugal’s youth unemployment rate hit about 42% whereas the EU as a whole only saw a high of 24%. During the debt crisis, Portugal as well as Greece, Spain, and Italy suffered from high amounts of fiscal debt. The EU came together and bailed the countries out, but with criteria that they needed to meet. One of the lasting effects of the bailout is that there is still high youth unemployment rates in these countries.
Given that the youth unemployment is high, many of these young adults have been having a hard time finding a place to live. In Portugal, the government gave out incentives to foreigner investors to buy housing. These foreign investors then went and starting renting them on Airbnb. This in turn started increasing the prices on these residential properties, making it impossible for Lisbon’s locals to own or rent anything.
On a tangent note, I have been been extremely vocal about investors investing in foreign countries. Not only are there many tax and legal implications that you need to know; the local economy is extremely important to understand. I say this because I truly believe the rent caps in place in many large cities around Germany wouldn’t have been needed had the foreign investors learned basic German economics. What I mean by German economics is that German wage growth is extremely slow due to their inflation rate being extremely low. That means yearly rent increases would not only be unsustainable in that market but would prove to be detrimental. The German economy prides itself on stability, meaning you may not get a wage increase or a rent increase but you will get paid the agreed upon amount for a number of years. Even during the Global Financial Crisis, Germans didn’t layoff their workers because they understood the major cost of having to re-train people when things started picking up again. Instead, they cut worker’s hours and kept things moving at a slower pace. When you have foreign investors come in to these kinds of economy, without any knowledge of the local economy, it becomes a disaster for both sides. I will forever be an advocate of educating investors, foreign or domestic, about the economy as that is a major variable in determining the viability of an investment product.
Back to Lisbon’s real estate market. I was very happy to come across news that the Portuguese government is starting to address the housing affordability crisis. The government has created a program (called Renda Segura) where the City becomes the tenant of many of these residential units. The City then finds its own tenants to live in those residential units. By becoming the middle man, the City is able to provide landlords a steady income (albeit lower than what they would normally get off of Airbnb) and address the affordability crisis by making these residential units affordable to the average local Lisboan.
Compared to the united states
To many Americans, the thought of a government entity becoming a middle man to a rental transaction sounds scary. How will I know the tenants will care for the apartment? Will I be able to get rid of them if they end up destroying my unit? These are valid questions and ones I don’t have an answer for, but I would assume that the government would provide some kind of deposit in the event that things are damaged. But, I would like Americans to understand that there is a similar program here called Section 8 housing. I’m sure you already have a bad taste in your mouth. Section 8 housing? Sounds terrible. The US government basically pays for up to 75% of the rent while those who qualify (those who earn a very low income, elderly, or disabled) are required to pay the remaining 25%. It sounds like a pretty safe investment, right? I’d say yes for the most part. But I am a big picture person and see a systematic problem that arises from this program.
In large cities in the US, rent tends to be many folds higher than the average rental price in the US. Let’s look at an example of someone who makes $15,000 a year and obtains Section 8 housing in Los Angeles. Great, they only have to pay 25% of the full rent amount and are able to save money. They suddenly start making more money and suddenly lose the assistance from the government and now have to fork over 100% of the rent due. In this case, there is no incentive for them to move forward and find a higher paying job since rent is fairly unaffordable in the Los Angeles area. Unfortunately, many of these people that use Section 8 housing are African American and other minorities. How can we expect to raise them up if there is a systematic cycle that creates an incentive to not get a higher paying job? How do we control the landlords from asking too much of their tenants? It all comes down to inflated asset prices, our inflation rate, extremely slow wage growth, increased costs of living, and the expectation from landlords to receive yearly escalations of 2-3%. After years and years of this, you arrive at the point where we currently are out, a real estate market that cannot be sustained.
Concluding Remarks
I think there are a lot of lessons that the American economy can learn from its European counterparts. By no means am I saying Europe is perfect, but at least there is a sense of collectiveness in those countries. By leaving a population segment behind you end up leaving everyone behind in a sense. I am hopeful that these experiences we are all going through will make us more collective than not. We need to continue to be vigilant and keep our eyes on the data of both the health statistics of the pandemic as well as the economic metrics. They both relate and as I have said before, an economic recovery cannot begin until either people feel safe to go back to pre-COVID-19 behaviors or a vaccine comes out.
Please check out my podcast and share it with people who may be interested! Please stay safe and healthy everyone! I’ll write you again in 2 weeks!