July 2020 – Page 2

How the COVID-19 Crisis Continues to Impact Real Estate Investors

by Tom Olson
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The economy is open, but that doesn’t mean we’re “back to normal.” Things have changed dramatically for real estate investors since the start of 2020. In January, real estate investors were still shaking hands with everyone at seminars, slapping each other’s backs at networking events and doing everything they could to “get out there” in competitive housing markets around the country. Now, just six months later, investors are bumping elbows or simply nodding a greeting from six feet (or more) away from each other. The seminars and masterminds have come to a screeching halt, for the most part, although the economy is beginning to reopen. The term “reopened economy” is pervasive these days. But what does it really mean? As with so many things in both real estate and the world right now, the nomenclature changes wildly from state to state, market to market and speaker to speaker. For real estate investors, the reopened economy means some major shifts in historical norms are heading our way. For investors who are watching for these changes, accept there is a “new normal” headed our way and are prepared to act, the second half of 2020 could be one of unprecedented opportunity. Contrarian Movements Aren’t Just Political Anymore We all know “that guy” on social media who says the opposite of what everyone else says just for the likes, comments and outrage it creates. These contrarians are particularly prevalent in the political arena, and objective investors tend to ignore them because they are usually almost all bark with very little bite. In the wake of the COVID-19 shutdowns, a physical contrarian movement is gaining steam. These days, you need to watch the actual movement that accompanies surprising consumer preferences to see whether people are simply “talking the talk” about making major life changes that will affect housing in their markets, or whether they are listing their houses and “walking the walk,” so to speak. For example, for the past 10 years, the general population has had a distinct preference for urban housing markets. We have seen strong demand for walkable neighborhoods, multiuse developments and more affordable urban living options. Young professionals have been overwhelmingly willing to delay homeownership, marriage and children in favor of renting with roommates in centralized locations with access to jobs, entertainment and public transportation. Now, however, those preferences have reversed. Entrenched populations in New York City, San Francisco and many other coastal cities are moving toward the outer edges of city suburbs or toward the Midwest and Southeast. This movement is a result of many factors. Among the biggest are: Remote working Health concerns Safety concerns Housing affordability When the coronavirus sent all of us into remote-working mode, it did more than give parents a new appreciation of their children’ teachers. It helped employees and companies realize that remote working on a large scale is truly an option. Although many homeowners and renters might not be willing to commute 90 minutes to work each day, the idea of making that drive once a week or a couple of times a month is not nearly so terrible. Further, since housing prices have not slumped in the way many analysts predicted they would this spring, housing affordability in the Southeast, Midwest and more rural areas of the country creates a compelling case to move for individuals no longer interested in the amenities and advantages of living in the city center. Rental Preferences Are Shifting One of the biggest short-term results many investors are seeing from this movement away from big cities is that rental preferences are shifting. Single-family rental owners are finding their product, always a strong asset as a long-term cash-flowing strategy, are in higher demand than they have been in about a decade. The outflow of residents in metropolitan multifamily units looking for suburban or even rural single-family options is driving the demand. Multifamily investors at the extreme high and low ends of the spectrum, on the other hand, are struggling, as luxury tenants literally move to greener pastures, and vulnerable renters find themselves unable to pay rent and unlikely to be evicted, at least at the present time. This shift in renter preferences is creating strong opportunities for real estate investors in both single- and multifamily residential real estate.If you have been wishing you could get involved on the multifamily fix-and-hold side via a syndication or other group project, now is likely a great time to do so at lower entry levels. On the other hand, if you already hold single-family rentals in your portfolio or want to add more of them, then now is the time to acquire properties in those trending areas where residents have started looking. Pay Attention and Optimize Everything With residential preferences changing so quickly, it’s important for real estate investors to remain actively engaged in tracking these trends and, furthermore, in optimizing their portfolios. Investors must watch market rent rates because they are not, as the “talking heads” might have you believe, falling. In fact, in most B Class and C Class neighborhoods, home values and market rents are rising. It is important not to let the COVID-19 pandemic convince you that nothing is going on and you should just be happy if you are collecting anything. The reality is that this is a time of growth in many areas and sectors of the country. Do not let that growth leave you and your real estate portfolio behind.

How Resident Satisfaction Impacts Net Operating Income

by Ray Hespen
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Have you considered the role your maintenance process plays? Of the various approaches to maximizing net operating income (NOI) for a rental property, improving resident satisfaction is often overlooked. This is largely because it feels like a qualitative measure when compared to other more historically quantifiable expenses that directly impact the bottom line. This is also precisely why improving resident satisfaction may be the key to improving your NOI. First, let’s talk key performance indicators. More specifically, let’s talkleading versus lagging indicators. Leading indicators tell us what will happen; lagging indicators tell us what has already happened. Both are essential in managing any investment. Most of us tend to focus on lagging indicators, often because they’re more readily identifiable and available. However, both leading and lagging indicators are essential in predicting and verifying quality of outcomes. Another important distinction to consider is that an indicator can be both a leading indicator in one context, and a lagging indicator in another. Such is the case with resident satisfaction. One way to maximize NOI is to minimize resident turnover. The reason has as much to do with transaction cost, as anything. Put simply, regardless of length of residency, when a resident decides not to renew a lease, a number of tasks must be completed before the next renter moves in: move-out inspections, deposit disputes, turnover repairs and cleaning, marketing the property, showing and leasing the property, move-in inspection and others. These tasks create costs for the property’s owner and to the property manager. One key factor in minimizing turnover is resident satisfaction. It stands to reason that residents who are satisfied with the quality of their home are less likely to move. Controlling the Controllable A variety of factors affect leasing churn. Property managers have control over some of them (e.g., rent price and overall experience). Other factors, such as job loss or transfer, are outside the property manager’s scope of influence. In any business, the higher the cost of customer acquisition, the greater the impact on the bottom line. Any business owner will tell you it costs far less to retain an existing customer than to acquire a new one. A resident’s maintenance experience can have a meaningful impact on their decision to renew their lease—nearly a third of nonrenewals list lackluster maintenance as one of the primary drivers for not signing a renewal. Data Helps Residents’ maintenance experience comes down to two core needs: speed and transparency (in that order). Data is available to help identify some of the common elements of a happy resident. One of those is the speed of a repair. When you ask someone in the industry what defines an excellent maintenance experience, you might hear phrases like “personal touch” or a “human experience.” Data tells a different story. Residents weigh speed heavily on the repair, and the data confirms just that. Here is some broad guidance based on statistical information: HVAC repairs should be completed in less than three days. Plumbing repairs should be completed in less than 4.5 days. Electrical repairs should be completed in less than five days. If your repair times start stretching beyond that, the statistical likelihood of a happy resident falls drastically. How to Control the Outcome Property management is seeing some of the most impressive growth of any industry and demonstrating incredible resiliency. Much like other rapidly growing sectors, there are learning opportunities. Among these is clarifying the most relevant key performance indicators (KPIs), specifically those that correlate with lease renewals. Among these are two that, at a minimum, you should monitor closely: Speed of repair measures the time from the submission of the repair request to the time the repair is complete. Some firms track the entire length of time a work order is open (to include time waiting on an invoice). This muddies the waters a bit and makes the indicator less useful for gauging resident satisfaction. Practically speaking, there are reasons to also measure the time a work order is submitted until it is closed at receipt of an invoice. This is a different KPI and more useful in gauging the cashflow cycle impact and process flow with the billing department. It will not predict resident satisfaction. Tracking time to completion from a resident perspective can help the property manager better understand its impact on resident satisfaction. Standardizing the methodology to exclusively measure time of repair will also help you benchmark your operation against others more effectively. Resident satisfaction is the average satisfaction score residents provide, based on maintenance activities. Once again, measurement methodology is critical. If you allow this KPI to become a marketing exercise, wherein the system is gamed to ensure the highest score, you’ve already lost. You want to understand your actual resident satisfaction, not your opinion of your resident satisfaction. A good KPI sets the standard. The goal is not to adjust the KPI to meet your standards. The goal is to adjust your processes and thereby raise your standards to meet those set by the KPI. Resident satisfaction should be checked within 24 hours of the repair completion and must be requested for all repairs. If you pollute your measurements with subjectivity, omitting repairs that may mess up your data, the KPI is meaningless. Automating this process prevents subjectivity from creeping into the process. Automating this process gives you consistency. Consistency gives you an honest score. Both metrics are critical for creating a measurement process that includes both leading and lagging indicators. In terms of the repair itself, speed of repair is the leading indicator, and is verified by resident satisfaction as the lagging indicator (note that resident satisfaction also acts as a leading indicator in predicting resident turnover). If your team has visibility into repairs lasting more than five days, they have an opportunity to improve processes (control their controllables) to reduce these repair times, which improves the likelihood of a renewed lease. Viewed through this lens, maintenance is much less the “set it and forget it” process of

Real Estate’s Short, Hot Summer

by Amie McCarthy
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With any luck, demand will heat up the housing market this summer. Spring is a home-buying season. However, the 2020 season had a false start. 2020 started with new and existing home sales at a 12-year high. In late February to early March, mortgage applications were up, and the market looked optimistic. Then COVID-19 hit, and the U.S. sheltered in place. Open houses were canceled, and future homebuyers were suddenly unemployed. Homeowners who intended to list homes waited. Now homebuyers are proceeding with caution, easing into home searching, uncertain of the future. With any luck, the market will pick up this summer. Short Housing Supply, Pent-up Demand There is pent-up demand, and it is a seller’s market. With the shift to digitally enabled purchases and financing transactions, somemhomeowners rely on virtual searches, tours and secure financing online. According to the Mortgage Bankers Association, purchase applications increased 18% year over year. It is going to be a short, hot summer for real estate. Housing supply is constrained, and the pace of new construction is sluggish. The National Association of Builders/Wells Fargo Market Index (HMI), which measures confidence in the single-family market, was 37/100 in April, a five-year low. Housing statistics dropped to 30.2%, the lowest since 2015, according to the Commerce Department. On a positive note, the S&P CoreLogic Case-Shiller National Home Price Index showed prices increasing by 4.4% in March, the highest annual growth since December 2018. Sales dropped 8.5%, according to the National Association of Realtors, for the same period. After working and schooling from home, buyers are starting to look for their first or next home. States are beginning to open up, and so is the housing market in parts of the country. ‘Bright Spot’ COVID-19 has wreaked havoc on the economy and instilled a level of fear in consumers and businesses. The CARES Act provides temporary relief, but expanded unemployment benefits expire July 31. An extension by Congress of this benefit, which adds $600 to standard weekly employment, may incent workers to stay out of the labor force. Unemployment declined to 13.3% or 21 million people at the end of May, down from 14.7% in April. Many economists believe it will continue to climb to historic levels. It will be difficult to track those who have finished collecting unemployment and do not find a new job, which is not counted in official unemployment statistics. The actual unemployment rate is likely closer to 20%. The U.S. economy faces an uncertain and rough remainder of the year. Historically low-interest rates are a bright spot in the current environment. The 30-year fixed rate dropped to 3.15% at the end of May, a 50-year low, according to the Freddie Mac Primary Mortgage Market Survey (PMMS). Rates ticked up by 0.03 to 3.18% in the PMMS rate survey reported June 4. Low rates and affordability will hopefully induce the lagging purchase market. The lack of inventory will be a challenge for homebuyers, but signs show that the housing market is gaining momentum. Currently, 50% of mortgage debt is at a rate higher than 4%, and 24% is above 4.5%, which will continue to fuel refinance activity. Borrowers with positive equity are obtaining home equity lines of credit instead of a cash-out refinancing. Government-backed mortgage products will continue to dominate the lending activity. The housing market is a leading indicator of the country’s economic health, and real estate’s short, hot summer will contribute to the nation’s slow economic recovery, and likely extend until fall. With lower borrowing costs for builders and homebuyers, purchases of durable consumer goods should rise and drive gross domestic product (GDP). Consumers may choose to buy and remodel, and builders will likely increase activity to meet demandin both single and multifamily markets. The Federal Open Markets Committee meets June 9 and 10, and Jerome Powell is likely to leave the federal funds rate unchanged. The U.S. economy is still in crisis, and the Fed is unlikely to raise rates any time soon. Powell has a strong stance on negative interest rates, and the Fed will continue to employ other measures to push rates lower, such as quantitative easing (QE). The central bank is purchasing mortgage-backed securities, which is contributing to declining mortgage rates. Rates will remain at historic lows and may float lower due to monetary policy, investor confidence and exogenous forces. Mortgage Situation Non-qualified mortgage originators are adversely impacted by COVID-19, as holders of warehouse lines issued margin calls. Some lenders are waiting on the sidelines, holding off on lending, fearful of originating assets they cannot sell. The pandemic has negatively affected consumers of non-qualified mortgages, who are often business owners, self-employed or independent contractors. Private-label mortgage-backed securities issuers will need to collaborate and align to provide relief to borrowers impacted by the pandemic. Despite all these challenges, several private-label residential mortgage-backed securities (RMBS) were issued between April and the publication of this article, indicating there is still an appetite for higher yield RMBS. According to the Mortgage Bankers Association, from a single-family mortgage performance perspective, 4.2 million homeowners in May requested forbearance due to COVID-19, or 8.46% of all mortgages. On a positive note, data from Black Knight shows forbearances had the first decline since the beginning of the crisis. Whether this decline continues remains to be seen, as current political and social unrest will likely exacerbate economic conditions. From a rental perspective, 12 million renters have stopped making payments, which influences the multifamily mortgage market. Renters have also expressed apprehension about renewing leases, due to uncertainty. According to Datex Property Solutions, 58.6% of commercial renters paid their rent in May, making a significant impact on the commercial mortgage market. Bankruptcies and closures of some major retailers will also continue to pull down the CMBS market. Early in the crisis, HUD, Fannie Mae and Freddie Mac provided guidance for consumers facing impacts and are continuing to refine homeownership preservation programs. Forbearance and repayment options after forbearance are being rolled out in rapid succession. Other debt markets,