In my last blog post, What the Coronavirus Could Mean for Commercial Real Estate, I stated that this virus has become a black swan market event. I went onto explain that a black swan in economic terms is an event that has not happened in the past, making it impossible to predict.
I also went onto explain that most economic experts are now in agreement that regardless of how severe this virus turns out to be, the damage to the world economy has already resulted in tipping it into recession. It is too late to stuff the genie back in the bottle. The damage has already been done.
A Silver Lining to this Economic Storm
But there is a silver lining to this economic storm. Not everyone is going to feel equally the adverse impact of the world economy going into recession. As we all know, stock market investors are taking it on the chin and there is no end in sight. I shudder to think how long before the stock market begins to rebound. But those of us who own commercial real estate, especially those of us who own B and C quality apartments, should weather the economic storm. It is possible we might even prosper. Why?
As I mentioned in my last blog post, there are two reasons why CRE investors might actually prosper going forward:
Reason #1 – Increased demand for CRE
I believe that some stock market investors fleeing the equity markets will choose to start investing in real estate. Why wouldn’t they invest in CRE? After taking the drubbing they’ve taken the last few weeks it only seems logical that some of them would say enough is enough I’m going to pull my money out of the stock market and invest it in some other less risky type of investment.
Reason #2 – Treasury rates at historic lows
Treasury rates have plummeted to historic lows. On March 9th, the ten year treasury bottomed out at 0.569%! Yikes. It closed on Friday substantially higher at 0.981%. A year ago, the ten year treasury closed at 2.592% so the decline has been dramatic. Those of us who have debt, whether it is a home loan or loans on our rental properties, are going to benefit by refinancing debt with significantly lower interest rates.
Those are the two reasons why we CRE investors could benefit from the current economic crisis.
Skewering a Commonly Held Belief
Before I move on, I feel compelled to skewer a commonly held belief about The Federal Reserve’s ability to lower interest rates. On March 3rd, The Federal Reserve lowered the federal funds rate by ½ of one percent. It was met with applause and much ballyhoo by the talking heads. Who cares! It’s irrelevant. The federal funds rate refers to the interest rate that banks charge other banks for lending them money from their reserve balances on an overnight basis. Let me make this perfectly clear: The federal funds rate has no impact on ten year treasury yields. None.
Treasury yields are impacted solely by the law of supply and demand. When stock markets plummet worldwide, stock market investors sell their equities and invest them in less risky assets. What is their asset of choice? Most believe there is nothing less risky than U.S. Treasury bonds. So when there is a huge increase in demand for treasuries (as there has been the last couple of weeks) and the supply of treasuries remains the same, it takes less and less of a yield to sell the bonds on the market. And that is why treasury rates have plummeted these past weeks. They will continue to do so until stock markets around the world begin to stabilize.
In the meantime, those of us that own assets with debt have the opportunity to benefit by the lower interest rates. But even if we do not refinance we will likely benefit by the value of our real estate rising. Why you ask?
Further Cap Rate Compression
If there is increased demand for CRE and interest rates remain low, the logical result will be that capitalization rates will continue to compress even further than they are right now. This means that even if a real estate investor doesn’t refinance his rental properties, the value of his real estate will still go up as cap rates continue to compress. So bottom line is that those of us who have invested in commercial real estate will inadvertently benefit from this black swan event.
I wouldn’t wish a worldwide recession on my worst enemies. A lot of people throughout the globe are going to suffer economically from the coming economic storm. But let’s keep this upcoming recession in perspective. This isn’t our first rodeo. We’ve done this before (think Great Recession) and we were able to come out on the other side. We’ll do so again.
Are you more concerned you will:
- Catch the Coronavirus, or
- Be affected economically by the Coronavirus?
I welcome your comments.
Doug Marshall is the award winning author of Mastering the Art of Commercial Real Estate Investing. Check it out on Amazon!