Recent forecasts by Goldman Sachs and Moody are predicting that the current housing downturn, our first of the post-Great Financial Crisis era, will worsen as we close out 2022 and carry well into 2023.
In a paper titled, “The Housing Downturn: Further to Fall,” released on August 30, researchers at Goldman Sachs predicted sharp declines across the board to close out this year, including new home sales (22% drop), existing home sales (17% drop), and overall housing GDP (8.9% drop). They don’t project any relief either - they predict new home sales to fall a further 8%, existing home sales to fall a further 14%, and GDP to fall a further 9.2%.
Furthering that, Moody’s believes home prices are likely to rise 0% next year. We’ve seen home prices rise 19.4% over the past 12 months, so this represents a dramatic change in the tailwinds. If a recession does come, Moody's Analytics predicts significantly "overvalued" housing markets are likely to see home prices decline between 15% to 20% over the next two years.
The forecasted market presents numerous challenges that residential real estate entrepreneurs will need to navigate in the coming 12-18 months.
As we discussed in our previous blog about the impact of federal interest rate hikes on residential real estate entrepreneurs, these market conditions impose a variety of capital-related obstacles. Both the cost of debt capital and the entrepreneur’s capital contribution requirement tend to increase in the face of market uncertainty as lenders seek to balance their risk profile and become more conservative with their underwriting. Existing equity partners may become more risk-averse in the downturn. Capital overall is likely to become harder to come by as those with it choose to keep dry powder on hand for when the market finally turns a corner.
On an individual project level, these market conditions create uncertainty when projecting what kind of environment will exist when the project completes and moves into its disposition phase. These environmental changes will occur to varying degrees, on both a regional and local level, placing an outsized emphasis on the entrepreneur’s market expertise and knowledge of the ongoing trends affecting their markets.
Perhaps the most nebulous impact, and the one entrepreneurs may have the hardest time projecting and accounting for, are how post-pandemic trends may couple with the looming recession to influence migration patterns. How will return-to-office mandates impact where people choose to live? Will those that left certain states during the pandemic realize the pastures weren’t greener and return? How will the real estate environment hinted above by Goldman and Moodys affect the greenness of those pastures? These are all questions that may have a not-insignificant impact on the real estate investing landscape.
After a post-2008 real estate landscape where real estate investors could almost do no wrong, success in the next 12-18 months is going to hinge on adherence to the same core tenets of real estate investing that enable entrepreneurs to find opportunities regardless of the winds of the market. We’ve identified four core things entrepreneurs can do:
#1 - Underwrite Conservatively
While realistic underwriting should be a cornerstone of successful real estate investing, entrepreneurs will benefit from becoming even more conservative in the face of market uncertainty or a downturn. Entrepreneurs should factor in a cushion - we recommend as much as 10-15% - to account for the potential of the market to drop or to sustain holding costs if the entrepreneur needs to hold onto the property for a longer period of time.
Additionally, entrepreneurs should seek to take advantage of periods within the downturn of low demand and high supply to drive down acquisition prices as much as possible, while simultaneously being willing to walk away from a deal if the margins are too tight.
#2 - Stick To The Wheelhouse
Entrepreneurs should stick primarily to the types of projects they have extensive experience and expertise performing. Predictability is the enemy of risk - if an entrepreneur better understands the market fundamentals, costs, supply chain management, and overall flow of the project, the less likely the project scope is to expand in a manner that threatens the profitability of the project.
#3 - Be Prepared with Other Disposition Strategies
A sale is the simplest, most straightforward exit - but entrepreneurs should be prepared to pivot their exit strategy if necessary, especially on tighter projects. The same market conditions which produce the challenges above often lead to an increase of rental demand. Entrepreneurs and their partners should be ready and willing to potentially pivot to holding their property as a rental, understanding the rental market in the area of their project, and familiarizing themselves with the potential debt service coverage ratio presented by the project. For entrepreneurs that specialize in new construction, this may mean being willing to exit earlier, ie. at the point of receiving plans and permits, rather than needing to hold for longer. Understanding all the possibilities increases the likelihood of maximizing the return on a given project and reducing overall stress and risk.
#4 - Get Capital in Order
Capital is the lifeblood of real estate entrepreneurship, and entrepreneurs need to stay on top of their access to capable via both debt and equity partners. Entrepreneurs should be constantly engaging with their lenders to determine the products available to them and the accompanying terms. For variable rate debt, entrepreneurs should underwrite their projects to the highest potential interest rate foreseeable during the project term.
Entrepreneurs also need to know who they can turn to for equity capital. Every equity partner in their network is going to have a different level of risk tolerance and view on the market. Understanding who is willing to invest, how much they’re willing to invest, and what kinds of projects they’re willing to invest in is critical knowledge as the entrepreneur seeks to identify and act on opportunities they uncover.
While it’s still uncertain as to the extent to which the broader economy will move - many are pointing to a broader recession as we close out 2022 and head into 2023. Fannie Mae, in a release at the end of July, projected that we’d head into a broader recession in the first quarter of 2023. Steve Hanke, professor of applied economics at Johns Hopkins University, even went so far as to say we’re “going to have one whopper of a recession” in 2023. Overall, ⅔ of economists believe we’re heading into a significant recession in 2023.
Continuing along with the discussion above about equity partnership, joint-venture can be an excellent option for entrepreneurs to balance risk by lowering the amount of cash they tie up on a per-deal basis and increasing their leverage.
At Fund.me, we’ve taken equity capital and turned it into a platform that entrepreneurs can use to increase their leverage and lower their capital contribution on a per-project basis. We don’t just stop there, however - we will also secure debt, perform the bulk of the administrative workload, and entrepreneurs can leverage our market expertise and underwriting to support their own efforts. With Fund.me, entrepreneurs gain access to equity they can count on, even in a market downturn.
Are you interested in learning more about Fund.me’s offering? Send us an email at email@example.com to get the conversation started.
Already have a deal in mind? We’ve streamlined the process by providing an online application, which you can complete here and our real estate team will reach out to discuss the opportunity.