This is the first part of a two part series on 2021. The two most likely questions on the minds of real estate professionals and real estate investors are:
- What is going to happen to the US economy in 2021?
- And as a result of the health of the US economy, what’s going to happen to the real estate market in 2021?
Good questions, aren’t they? Today I attempt to answer the first question. To do so, we should begin by reviewing what’s happened with the US economy in 2020, beginning with the general economic trends prior to COVID-19 and then as a result of how the virus has impacted the US economy.
Here are some recent economic data:
As we all know, the unemployment rate soared to 14.7% in April. But less well known is the steady improvement in the unemployment rate in recent months to 8.4% in August.
Lost income skewed to lower income earners
Those whose jobs are in the service industries, e.g., hospitality, restaurants, retail, etc. are fairing much worse than those in higher wage earning professions.
Consumer spending plummeted 32% in March, but has rebounded to about 10% below pre-COVID-19 levels.
US Corporate Debt
US corporate debt was at a record high prior to COVID-19 and has soared in the 2nd quarter of this year.
Firms whose debt servicing costs are more than their profits are vividly described as “zombie companies.” They are continuing to stay in business by borrowing more hoping that their earnings before debt service will eventually exceed their mortgage payments. The number of zombie firms has tripled since 2008 and is approaching 20%, exacerbated in part by COVID-19.
With four months remaining in 2020, U.S bankruptcies have soared to 84, the most since 2008. Some of the more well-known companies are:
- 24 Hour Fitness
- Borden Dairy
- Brooks Brothers
- Dollar Thrifty Automotive Group
- Gold’s Gym
- The Hertz Corporation
- J.C. Penny
- J. Crew
- Jos. A. Bank
- Lord & Taylor
- Neiman Marcus
- Pier 1
COVID-19 has had a negative effect on 83% of small businesses. Those in retail or in the restaurant business who rely on in-store traffic have had to find new ways to get their product to their customers or go out of business.
Government Response to COVID-19
Since March, federal and state governments have responded in a variety of ways to the COVID-19 induced economic crisis.
- Paycheck Protection Plan – a loan designed to provide a direct incentive for small businesses to keep their workers on the payroll
- Stimulus Plan – checks of $1,200 for individuals and $2,400 for married couples
- Unemployment Benefits – varies by state
- Student Loan Deferment and Forbearance – with either of these options you can temporarily suspend your payments
- Rent Forbearance – Eviction ban for nonpayment of rent extended through December 31, 2020
- Mortgage Forbearance – federally back mortgage borrowers can have 180 days of forbearance, and are allowed another 180-day extension
At the present time, Congress and President Trump are at an impasse about the next round of stimulus, how much it will be and what form it will take. My guess is that they will come to some agreement before the November election.
Prior to COVID-19, the historically high US corporate debt and the record high number of “Zombie” companies indicated that all was not well with the US economy. Most of the 84 companies that filed for bankruptcy this year had nothing to do with the economic fallout from the virus.
Then came the devastating economic impact from COVID-19 and the government’s response to soften its adverse impact on the economy. The Federal Reserve and the US Treasury Department deserve our praise for their quick action in implementing these six different economic stimulus measures since early March. But doing so has created an artificial economy which is not sustainable.
I am not criticizing these institutions for doing this. It was sorely needed and without these programs the economy could possibly have collapsed to the level of the Great Depression. Thank goodness someone had the courage to lead in these unprecedented times.
2021 Economic Forecast
But the downside to all this economic stimulus is that the real economy, the one that existed before COVID-19, is presently in limbo and will continue to be so until the artificial economy begins to wane. At some point money available for economic stimulus will come to an end. It has to. The government does not have an endless supply of money to throw at the problem. And when that day happens, we’ll then see what the real economy can do to pull us out of this recession.
There has been much speculation as to when a viable COVID-19 vaccine will come to market. But even if it was rolled out today, many economists are predicting it will be two, possibly three years before the economy fully recovers and unemployment dips down to pre-COVID-19 levels.
And if we do have a slow economic recovery, it will likely push some of the “Zombie” companies over the edge. They are living on borrowed time. Once they are no longer artificially propped up, bankruptcy is inevitable for many of them making economic recovery that much more difficult.
Action Steps to Take
Not a rosy picture is it? So let’s assume this dire economic outlook is on the mark. What does that mean for real estate investors? In my next article I will discuss the outlook for each major property type but today, let’s talk in general terms. How should we prepare ourselves for what’s coming? There are three things you should do:
- Sell baby sell. Now is the time to sell that rental property that you don’t want to be stuck with during an economic downturn. You know the property. It’s the one that is currently limping along. It’s not doing badly but it never seems to perform like you had hoped it would. The good news is that it is still a sellers’ market. I believe in the Greater Fool Theory. Sell that property to a greater fool than you were when you purchased it. Let them work out the issues that have kept this property underperforming your expectations. Unload it while there’s still time to do so. In another few months it may be too late. The sellers’ market may be coming to an end and you want to sell that underperforming property while the market is still strong.
- Hoard cash. I know, I know. The kneejerk reaction to selling a property is to do a 1031 exchange to avoid paying the capital gains tax. I get it and I will say that every property I’ve ever sold, I’ve done exactly that. But this time may be different. I believe in a year or two there will be bargains galore to purchase for those who have the courage to buy when everyone else is selling. You should seriously consider paying the tax and waiting patiently for the market to turn to a buyers’ market. Because it will, and you will want to have cash in hand when that happens.
- Refinance. Interest rates are at an all-time low and going lower. For those properties you want to keep through the economic downturn and also have a modest prepayment penalty, now will be the time to refinance. One of the last arrows The Federal Reserve has in its economic stimulus quiver is low interest rates. They can and will play that card. In fact they are already doing so. But I suspect that after the election is over, regardless of who wins, we will see treasury rates dip even further than they are now. Imagine refinancing your property with interest rates in the low two percent range! That day is coming. And you will want to take advantage of it when it comes.
With every change in the economy, there are winners and there are losers. There is no reason why you can’t be one of the winners. But it requires careful planning, doing these three things I’ve suggested and then having the courage to follow through on your plan. Good luck.
Sources: Unemployment Rate, U.S. Bureau of Labor Statistics, https://www.bls.gov/charts/employment-situation/civilian-unemployment-rate.htm; 2020-21 State of the Union for RE Investors & Private Lenders by David Stech of Access; Total U.S. debt surges to $55.9 trillion amid big increases in corporate and government borrowing, Jeff Cox, CNBC.com, June 11, 2020; “Zombie” companies my soon represent 20% of U.S. firms, Dion Rabouin, Axios, June 15, 2020; Companies that filed for Chapter 11 bankruptcy in 2020, Wikipedia; Paycheck Protection Program, U.S. Small Business Administration.