Are we in a recession or not?
That's the first question on everyone's minds, whether they're invested in real estate, the stock market, and even if they're not investing at all. It's something that people are concerned about, thinking about and talking about.
So, are we in a recession? On one hand, US GDP contracted by 1.6% in Q1 this year and 0.9% during Q2. Technically speaking, two consecutive contractions in GDP means that we are in a recession. That’s the common definition and one many economists consider when trying to determine whether or not we are in a recession.
However, the US National Bureau of Economic Research, the body that can officially declare a recession, thinks otherwise.
While the traditional definition is: “a significant decline in economic activity that is spread across the economy and that lasts more than a few months”, an official declaration from the NBER is much more complex and relies on a number of factors, particularly unemployment rates and real personal income.
Let's take a look at unemployment. At the beginning of Covid, in April of 2020, the unemployment rate spiked to 14.7%. Fast forward to September, 2022 and it currently sits at 3.5%, slightly below where we were pre-Covid. It’s been very slow to move despite the best efforts of the Fed.
Additionally, personal income has increased since Covid and has continued its climb even while rates have been rising rapidly.
Interestingly, on each of these charts, you can see that the NBER had previously determined that the US was in a recession back in April, 2020. Two months where economy shut down during Covid, and we all felt that.
The bottom line is that, despite shrinking GDP, other factors have outweighed that and the NBER has determined that we are not in a recession even though many feel that we are.
What would a recession mean for real estate?
First of all, when there's perception or belief (real or not) that there's a recession, behaviors change, and that can affect everything, including real estate.
Consider the impact of inflation, for instance. When costs rise, things get tough. When people feel the impact and believe that we're in or entering a recessionary environment, they tighten their belts. They cut costs. A recent Fed survey showed projected household spending growth of 6% for the next year, a sharp drop vs August results.
In multifamily, many people believe tenants will react by moving to cheaper apartments or finding other living arrangements. That’s a big step; most people will start with cutting discretionary spending, things like unnecessary purchases or big trips. They want make sure that they have more money to pay for the basics like food and rent.
Overall, we're still seeing strong demand, it really depends on the type of asset that you own. For instance, if you own Class C properties in areas when people are struggling and they don't have enough to pay for their day to day expenses, you can expect more vacancies and bad debt.
This is why we focus on the tenant base and investing in areas that have strong growth where tenants are willing and able to support rents.
In terms of dealing with vendors, those that are hired for renovations and CapEx projects like tree treatment and parking lot resurfacing, right now they're struggling to hire people and they're struggling with rising costs as well. While you might think “okay, it's a recessionary environment, we can save some costs and renegotiate”, it’s very hard to do these days.
While this has been a challenging period, you need to remember that, since 1980, the average recession length had, has been a little over 9 months on average, typically followed by a period of growth. My point is this: to some degree it doesn't really matter if we're in a recession or not in terms of how it impacts real estate, as long as you're disciplined.
What's happening with real estate prices?
We haven’t discussed prices yet but it's on everyone’s mind.
We all know the Fed has been extremely hawkish and focused on inflation; they aren’t concerned about what it's doing to the markets. As you can see, rates in the US have been rising at the fastest pace in recent history:
This has caused emotional and behavioral stress. When people believe that we're in a recession they behave differently. When it comes to real estate prices, we now see some prices being renegotiated if they're under contract and prices are coming down in other areas.
It definitely impacts the valuation of properties. When you underwrite a deal now you need to be more conservative and assume that you're going have a bigger portion of debt. You project that it's going to be more expensive to run those properties because of the recession and because the income could be a bit lower than what you may have felt comfortable with before the recession. It’s the same for expenses, we assume they’re going be higher in our business plan.
In terms of multifamily, it’s still very popular. We still some assets being sold higher than the anticipated price (also known as the whisper price) because there are groups out there that have to deeply capital and are willing to pay a premium for the right assets. That’s becoming less frequent however, and we’re starting to see pricing going down a bit.
Ultimately, sellers are seeing that buyers aren’t willing or able to pay as much as they were before the rate hikes and it impacts the price.
To some degree, it doesn't really matter if we're in a recession or not in terms of how it impacts real estate as long as you're disciplined.
The way to handle the uncertainty is to stay disciplined.
Stick to the investment principles that have gotten you this far, that you've had for months and years. If you can do that and adjust your models for current conditions you can weather this market.
There’s also a lot of money on the sidelines, people waiting for fire sales. They may come, but you have to remember the debt is not what it used to be, you have to stay smart and adjust your models.
At the end of the day, I still believe that this is a great time to invest in multifamily real estate; we’re still keeping our deal flow active at Blue Lake Capital and we're still looking for deals that make sense for us and for our investors.
Stay safe out there. Be bold, be great and keep pushing forward!
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About the Author
Ellie Perlman is the founder of Blue Lake Capital, a commercial real estate investment firm specializing in multifamily investing throughout the United States. At Blue Lake Capital, Ellie partners with both institutional and individual investors to grow their wealth by achieving double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.
A defining factor of Blue Lake Capital’s strategy is founded in utilizing machine learning/artificial intelligence throughout the course of all acquisitions and asset management. This advanced technology enables the company to produce accurate and data-driven forecasting for all assets on a market, property, and even tenant basis. In doing so, Blue Lake is able to lead commercial investments with the full capabilities of today’s technology.
Ellie is the host of REady2Scale, a podcast that highlights the assets, processes, and strategies for the multiple approaches to successful real estate investing.
She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.
Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.
You can read more about Blue Lake Capital and Ellie Perlman at www.bluelake-capital.com.