Don’t Read Too Much Into The Housing Headlines
Warren Buffett and his buddy and investing partner, Charlie Munger, made headlines recently when they expressed their worry over the commercial real estate sector. They believe a storm is brewing in the sector that could engulf the banks and impact the broader market. “The buildings don’t go away,” Buffett said at the May 2023 Berkshire Hathaway shareholders meeting.
“But the owners do,” Munger chimed in. “I think that the hollowing out of the downtowns, in the United States and elsewhere in the world, is going to be significant and quite unpleasant,” adding that he believes that the U.S. economy will weather the storm eventually but that commercial real estate will eventually “involve a different set of owners.” What he means is that he sees foreclosures in commercial real estate ramping up and ownership changing hands as a result.
Buffett and Munger are likely basing their fears on the performance of two particular segments of commercial real estate that don’t necessarily correlate to other segments.
According to a recent report by the consulting firm McKinsey, traffic near stores in metropolitan areas is 10% to 20% below pre-pandemic levels, while office attendance is 30% lower than before COVID. The report predicts that, because of these trends and other factors, demand for office space could still be almost 20% lower in 2030 than it was in 2019.
That’s bad news for commercial landlords. It’s worse news for their lenders. Munger said in an April interview with the Financial Times that the U.S. banking sector was “full of… bad loans” in the commercial real estate sector. Eventually, higher interest rates, lower rental income, and resulting lower property values could send some of these loans underwater, meaning that the outstanding balance will be greater than the value of the underlying properties.
Don’t read too much into the headlines…
The media and the public have a tendency to lump all real estate sectors (residential and commercial) and all commercial real estate segments into one group so that when dire predictions are made about one sector or segment, everyone assumes that all sectors or segments will follow.
For example, pessimism about the housing sector carries over into the commercial sector. In this case, statements about commercial real estate that are targeted towards office and retail get twisted to include all sectors, including multifamily, industrial, hospitality, and special purpose.
If COVID taught us anything about commercial real estate, it’s that it’s foolish to generalize. If you were a commercial real estate investor who shied away because of the declines in office and retail, you would have missed out on the robust performance of multifamily, especially in the affordable and mobile home communities subsegments.
While nearly every commercial real estate sector took a hit in the early days of COVID in 2020, two segments – industrial and multifamily – outperformed. Industries benefited from the increased e-commerce activity due to state-mandated shutdowns and social distancing. And while hospitality, office, and retail all suffered significant downturns in 2020, multifamily had already staged a comeback and made a full recovery by early 2021. In fact, it came back stronger than ever.
According to CBRE’s 2022 U.S. Real Estate Market Outlook, multifamily rebounded quickly from COVID and even managed to finish 2021 with overall occupancy and net effective rents above pre-pandemic levels. And within the multifamily segment, affordable housing and mobile home communities are in the highest demand, with supply at crisis levels across the country as incomes remain stagnant while rents climb and home ownership becomes more and more out of reach.
Demand for mobile home communities has been so robust over the past couple of years that even institutional investors have been drawn to them.
Smart investors have always gravitated toward multifamily for its resilience and ability to insulate cash flow and appreciation from both recession and inflation. These investors know better than to be spooked by headlines chirping about the sky falling in the real estate market. They know the facts, and the facts favor multifamily and affordable housing. They can separate the hype from reality, and the reality is that demand for multifamily has outpaced supply since the financial crisis, and the gap is only widening.
Don’t read too much into the headlines about a downturn in the commercial real estate sector. Dig a little deeper, and you’ll find that multifamily – affordable housing and mobile home communities in particular – is still a safe bet.