In Picketty and the decline of dirty mansions, Dylan Reid reminds of the debt-driven economic boom that built large single-family mansions in the early twentieth century. Many were converted to more efficient and affordable multiple-unit dwellings in the bust years that followed. In the process, working people who had been priced out of many areas could move into affordable housing in nice neighbourhoods with good access to transportation, services and schools. Social and economic strength improved as they did.
Another debt boom worked to reverse the trend over the last 15 years, as many of the same buildings were remodelled back to large single-family dwellings and nice rentals became scarce and prohibitively expensive.
Condo buildings, institutional dwellings for students and seniors, and office and commercial space became ‘no-brainers’ since they could be purpose-built in scale by yield-starved investors willing to buy with thin and even negative cash flow prospects.
Then came the pandemic and an exodus of workers and businesses out of high population areas. Similar migration patterns marked previous pandemics like the Spanish Flu of 1918-20 and the London plague of 1665-66, where those who were able left for less populated, larger, greener spaces.
As then, some of these moves will be generational, and the numbers are worthy of attention.
As A. Gary Shilling details in his October 2020 Insight (subscription only), apartment/condo and commercial vacancies are leaping. Rents are down 15 to 20% in hard-hit areas like New York and San Fransisco. Canada’s Rentalsdotca reports that Vancouver condo rental prices fell 17% Y/Y in Q3, and Toronto condo rents dropped 16%.
According to Realosophy’s John Pasalis, there were nearly 12,000 condo apartments listed for lease on Toronto’s MLS system compared to just 3,332 last year in September.
The surge in supply is starting to show up in prices. Redfin reports that the median US condo sale price fell 14% in June from a year earlier. In New York City, high-end condo sale prices have fallen more than 40%, while Manhattan home sales in the second quarter were 56% lower than a year earlier.
British Land, which owns a portfolio of central London properties and some shopping malls, reports that just 18% of its office tenants’ workers are back at their desks. This is higher than the 10% of Manhattan office workers who had returned as of September 8th and 15% in San Francisco. Toronto’s downtown business quarter is a ghost town. Technology and finance firms became dominant commercial tenants in the last decade. They are also some of the ablest to shift employees to remote work and have now announced plans for a permanent move in this direction over the next decade.
Individual behaviours are changing too as adult kids educate on-line in their parents’ homes, and seniors rethink retirement living plans. A recent survey by the National Institute of Ageing at Toronto’s Ryerson University found that sixty percent of respondents said the Covid-19 pandemic had changed their opinions on whether they’d arrange for themselves or an older loved one live in a nursing or retirement home. The number climbed to 70% for respondents aged 65 and older.
Years of low-interest rates and speculation over-built retail, commercial, institutional living and hospitality space well before the pandemic. Now most hotels and resorts are empty, and more than half of mall-based U.S department stores are forecast to close by the end of 2021 (Green Street Realty Advisors). Most borrowed aggressively to fund expansion.
No doubt, much of the space can be repurposed for warehousing and other uses; however, this takes time, and rents are likely to be a fraction of what the restaurants and retailers were paying.
Many private equity firms and investment products have concentrated on realty assets and related debt in recent years and will absorb losses as defaults compound. Just one case in point, Empire Realty Trust, which owns the Empire State Building, has seen its profits from rentals collapse to negative 19.6 million in 2020, and its share price has fallen 57% year over year. Real estate investment trusts are in the process of downside work. The Canadian real estate investment Trust (XRE) is already 32% below its February high, with another 20%+ downside likely coming. As the price falls, the income yield will keep rising–an attractive prospect for value investors who wait.
Even before the pandemic hit, there was evidence that rental/lease income projections were overshooting actual receipts considerably and that the securities into which these cash flows were bundled were likely to disappoint. Many individuals, institutions and pensions piled in any way.
A world of high leverage, shrinking cash flows and mounting supply are likely to keep eroding rent and property prices. This will be helpful for those looking to rent and buy even as present owners, investors, and lenders foot the bill. A much-needed wealth redistribution phase is once more underway.
