Soft Landing in Real Estate?

It depends? Doesn’t it always? The mainstream financial news and many of the metrics like unemployment (low), wages (increasing), and inflation (low-ish?) suggest that we might actually get an economic soft landing after all. It all depends on how you measure it and what counts. In the macro sense we may actually have one at least compared to expectations much to many marketers surprise because that is a less gloomy headline.

However it always depends on what you are looking at. While the macro picture looks like we may do alright, we still have a few holes that I think are worth looking at.

Affordability Gap

The median household income in the US is about $75,000. That is roughly $6,300/mo which leaves about $2,100 for rent or mortgage. I am using ballpark 3X rules here that most lenders and landlords use to determine eligibility for a lease or a loan. The median house price in the US is a little above $400,000. With 20% down and the best rate you can get as of this writing (around 7.5%) your $320,000 mortgage (on a 30 year term) will be about $2,200 per month. This would be pretty close if it weren’t for taxes and insurance which will vary by market, but here in Austin that will add another $900. That $1,000 monthly gap means you need a household income of about $115,000 to hit that number, and thus the affordability gap. To get into a less stressful market, that gap would close at least somewhat. It can happen by lowering rates, increasing wages, lowering home prices, or more likely a combination of all three. So the home owner’s soft landing depends on how big that gap is and whether they can close it by increasing their income since the other two are out of their control. Your landing may vary. YLMV? Probably not a meme we will see anytime soon.

Commercial Debt

The business world is facing a gap of their own. Many businesses that go bankrupt don’t end up there because of a bad business or shrinking sales, it is often a refinance of debt that can cause the tipping point to be crossed. Lots of commercial debt is going to be refinanced over the next few years (at least $1.5 Trillion) from very low rates to very high rates comparatively speaking because rates went up so fast.

We are on the down slope but the key difference is rates are now substantially higher and the cost of that debt is going to make many businesses under water in terms of cash flow, not just real estate ones. So unless they have a cash stash they can afford to burn until they refinance (not likely), then many folks are going to go out or get bought by someone with a bigger balance sheet.

This is a bigger problem for office space than multi-family because obviously COVID has permanently reduced the need for office space. If everyone went back to the office, much of this problem would be mitigated because the leases would be in place to keep paying those notes. Building owners would take a haircut but not give their assets to the bank like we are seeing now. Commercial property owners in the office category are not going to have a soft landing.

Because COVID did not remove the need for humans to sleep in a home multi-family has been spared this existential threat. Those assets still face debt restructuring, but they still have tenants. Warehouse space is likely to continue to do well due to growth in e-commerce and the last mile shipping issue. Industrial space will likely grow as the US re-shores a lot of its manufacturing in the wake of increased tensions with China.

So where do I invest?

Invest in what you know. Personally, I never got into commercial office space, it hasn’t been something I’ve been an expert in. In that regard I dodged a bullet by never investing in that asset class. No one could have predicted that the nature of office work would change so rapidly. I still believe in multi-family and residential housing because in this age of disruption and AI, I don’t have the imagination to see how we can outsource or digitize the need for humans to sleep in a room for around eight hours a day. I can invest with a long term mindset in housing so any project I am in is not as subject to changes in the debt markets. I may not make the highest returns in an expansion cycle, but I will live through the contraction cycle which we are certainly in.

If you didn’t get out over your skis with leverage and you can afford your refinances where they fall then you will have a soft landing. If you maxed out your leverage and planned for low rates forever then you will have a hard landing. May yours be soft.

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