COVID-19: The Unintended Consequences of “Wait and See” to the Apartment Market

In times of uncertainty, common sense is to “Wait and See.”

Individuals not under quarantine will stay at home as much as possible while they “Wait and See” until they feel safe returning to restaurants and retail stores.

Businesses (Amazon excluded) will “Wait and See” before hiring new workers or investing in growth drivers.

Schools will “Wait and See” before re-opening, keeping working parents at home with kids.

The same is true in the multifamily market.

Prospective renters will “Wait and See” before signing a long-term lease.

Current renters may choose to renew or go month-to-month while they “Wait and See” what happens next.

Investors will “Wait and See” before inking deals to buy or sell apartment properties.

After all, “Wait and See” is a sensible approach. It’s conventional wisdom. It’s safe.

Why would prospective renters sign a long-term lease if they are worried about their income stream or if they believe rental rates will drop?

Why would current renters leave if they aren’t sure what the future holds – particularly in markets where local governments have banned property owners from evicting delinquent renters?

Why would investors buy now at current pricing if they believe there’s a good possibility of acquiring similar properties at better prices in the near future?

In the COVID-19 era we now live in, “Wait and See” seems like common sense. But what are the costs of “Wait and See”? The potential downstream consequences are enormous – the difference between a short-lived crisis and an extended all-out recession.

Individuals staying at home hurt local restaurants and retail stores and other businesses. A dramatic drop-off in business leads to closures and layoffs. Shuttered schools put more working parents at home, and some will be forced to take unpaid leave or quit their jobs if they can’t work from home. Corporate jobs may appear less impacted for now as remote working skyrockets. But what happens when businesses pause new investments and growth slows? Layoffs could be looming.

What about the apartment market?

As individuals pause apartment hunting, that means less traffic coming in. Less traffic means fewer applications, which translates into one of two undesirable outcomes. One: Apartment operators bring in fewer new leases, which means vacancies increase. Two: Apartment operators reduce screening standards and accept riskier renters, which means increased odds of delinquencies. (This scenario will prove even more troublesome in markets like New York and Miami and parts of California where operators will be unable to evict delinquent renters.) Either way, apartment revenue drops. And if layoffs do occur, the slowdown extends to long after COVID-19 goes away.

As investors slow roll acquisitions, that leaves a substantial amount of capital sitting on the sidelines. Talking to investors, “Wait and See” is very much the rule of thumb. The problem isn’t their appetite for apartments. Investors still like this sector. Even if returns diminish, multifamily assets project more favorably compared to other options. Green Street noted on a webinar this week that apartments are more likely to hold their value versus other sectors right now. But investors also want to play it smart. If they think pricing will drop, they’ll wait.

We saw this happen in Houston a few years ago after oil prices plummeted. Most investors didn’t redline Houston. Instead, they were sitting on the sidelines ready to pounce once apartment pricing dropped. But pricing never really dropped off. Sellers didn’t want – or need – to sell at low-ball prices. The net outcome was a freeze in deal flow. Could the same happen now nationally? It’s possible. As has been frequently noted, this crisis is not tied to real estate or the financial markets. Prices may drop, but the plunge is unlikely to match what happened in 2008-2009 due to stronger underwriting standards and better safety nets.

So, what does all this mean?

For apartment owners and managers: If you can stomach lower occupancy, take that route over a surge in riskier renters – whose impact will linger on the rent roll for a long time (especially with the possibility of extended eviction moratoriums), and potentially limit your ability to benefit quickly once conditions improve. Don’t slash your rents too drastically. In a low-demand market, pricing isn’t the issue. It’s tempting to slash rents, but you won’t meaningful increase the flow of qualified traffic – and you might be just giving away needless discounts for those who do sign. (For more on pricing strategy in this environment, register for our upcoming webcast.) And don’t go crazy dialing up your marketing budget when potential leads are hard to come by; instead, get smarter and ramp up very targeted marketing via direct lead channels (SEO, SEM, property websites) that cost less and convert at higher rates.

For apartment investors: Look around and note most of your peers have the same strategy. If you aren’t selling your properties for a deep discount, don’t expect a flood of your peers do it either. Look for the right deal (as you always would) and when possible, structure for longer hold periods on investments that should be relative winners. Be skeptical of the big Gateway Markets that institutions favored in this past cycle. These are the same cities that are adding enormous risk on apartment owners through rent controls and limited evictions. Follow the data to the Sun Belt’s most mature markets (PREA subscription required).

Where do we go from here? Well, we’ll have to “Wait and See.”