Over the last few months, the novel coronavirus has spread to all corners of the globe. The health, social and economic impacts have been swift and pervasive. While the unprecedented social distancing measures have been necessary to slow the spread of COVID-19 and reduce the health impact, they have caused economic activity to grind to a halt.
Before COVID-19, the US economy was continuing to grow and extend the longest economic expansion in its history. 2019 US GDP grew 2.3%, slightly outpacing expectations. The 3.5% unemployment rate at year-end 2019 stood at a 50-year low. While the outlook for 2020 was widely expected to be less robust than 2019, the current economic environment is unparalleled.
To control the spread of the virus and mitigate the public health crisis, most states and many local governments have banned large event gatherings and closed schools and non-essential businesses, including restaurants, bars, and retail. The impact of the economic standstill has been significant and abrupt, causing over 26 million workers to file for unemployment over the last five weeks. In response, Congress and the Federal Reserve have acted quickly to enact massive fiscal and monetary policies to cushion the fallout.
On March 15, the Federal Reserve (the “Fed”) dropped its benchmark interest rate to zero and committed to keeping rates low until the economy recovered. The Fed also launched a new round of quantitative easing, initially setting a $700 billion cap on asset purchases, only to remove the cap a week later making the asset purchases open-ended “in the amounts needed to support the smooth functioning of markets”. The Fed also expanded its emergency toolkit announcing up to $2.3 trillion in new lending programs directly to corporations, small and medium-sized businesses, and state and local governments to generate liquidity.
Congress also moved quickly to pass the $2 trillion Coronavirus Aid Relief and Economy Security (“CARES”) Act. The CARES Act is the largest economic stimulus package in US history and is aimed at providing financial support to individuals, businesses, and state governments. It also provides mortgage forbearance and foreclosure suspensions for federally backed loans. Despite the historic size of the CARES Act, the $349 billion Paycheck Protection Program (“PPP”) that was designed to help small businesses was depleted in under two weeks. Congress subsequently passed an additional $484 billion stimulus to replenish the PPP and provide more funding for hospitals.
Although Congress has moved swiftly to provide economic relief and the Fed has expanded its playbook to keep liquidity flowing, the speed and magnitude of one stimulus program after another is a clear indication that the impact of COVID-19 is much larger than anything we have experienced in recent history. Ultimately, the timing and speed of the economic recovery will depend on our ability to get the health crisis under control.
Commercial real estate, like all other aspects of the economy, has been impacted by non-essential business closures and social distancing measures. As we continue to monitor the impact of COVID-19 on each asset in our portfolio, our priorities are the safety of residents and employees at our properties and the preservation of our investor capital.
Over the past couple of quarters, we have been deliberate and disciplined in our acquisition strategy, as we believed we were in late stages of a market cycle. We have continued to work with a select group of experienced sponsor partners, targeting need-based asset classes we view as being more recession resilient, placing significant emphasis on downside protection. While there is a lot of uncertainty in the current environment, we believe we are well-positioned to navigate through the challenges.
Impact on CRE and Our Portfolio
COVID-19’s initial impact was concentrated on hospitality assets as conferences and corporate travel were cancelled. As policies were enacted to close non-essential businesses, activities, and services to maintain social distancing, the economic impact spread to other asset types. Many businesses have limited to no means of generating revenue when closed, but still face ongoing expenses. This has led to employee furloughs, staffing reductions and suspended rent payments, which in turn has impacted individuals and asset performance.
Multifamily is a need-based asset, but the magnitude of disruption from COVID-19 has impacted millions of households. Through April, multifamily performance has held up well. In the National Multifamily Housing Council’s (“NMHC”) survey of 11.5 million multifamily units across the country, 89% of apartment households made a full or partial rent payment through April 19. That compares to 93% in both the previous month of March and April a year prior. The 89% payment rate includes partial payments, so the actual rent collection rate is lower. Across the 15 multifamily properties Alpha Investing’s network is invested in, April’s rent collection rate of 90% was slightly ahead of the national average.
Most of our multifamily properties are Class B, where tenants tend to be “renters by necessity”. Demand tends to be stickier than Class A, as renters have fewer housing alternatives, and more durable than Class C, which often serves lower-income residents who were already financially stressed before the crisis. Under the current circumstances however, it is likely additional renters will become impacted the longer the economy remains shutdown.
Our sponsor partners are continuing to work with tenants on a case-by-case basis, prioritizing tenant retention and relations. Furthermore, properties with floating rate financing are benefiting from reductions in interest rates. Six out of our 15 multifamily properties have floating rate financing with no Libor floor. 1-month Libor stands at 0.44% as of April 24, which is 1.2% lower than February’s average of 1.64% and over 2% lower than April 2019’s average of 2.48%. Interest rates are likely to stay low for the near to medium term, which should provide those properties with additional cushion to absorb unforeseen shocks.
Senior housing is also a need-based asset, particularly for higher levels of acuity like assisted living and memory care. It is also an operationally intensive asset class. COVID-19 has presented a new set of challenges for senior housing operators as seniors are among the highest risk groups affected by the virus. We and our sponsor partner remain committed to the health and safety of residents and staff at our properties.
All our senior housing investments are with the same sponsor who owns and operates 19 communities with over 1,500 residents and 600 employees. The sponsor implemented early protocols to protect its communities. These measures included limiting non-essential visitors, restricting or eliminating common dining and group activities within communities, monitoring residents and staff exhibiting signs of illness, and increasing sanitation efforts.
As of April 24, there have not been any reported cases of COVID-19 at our communities. Across the portfolio, operations have been minimally affected thus far. Occupancy levels are slightly lower compared to prior 30 days, revenue is generally stable with no significant change in collections, and operating expenses are slightly higher due to preventative measures and protocols enacted to combat COVID-19. While we cannot guarantee our communities will remain COVID-19 free, we are confident our sponsor partner taking all necessary measures to limit the possibility.
Our belief had been that student housing would be more resilient in a downturn, given historical trends where college enrollment typically increased during recessionary periods as people looked towards higher education to improve their employability and earning power. We did not envision a down market caused by a global pandemic resulting in nationwide college campus closures. As there is risk of student housing properties becoming largely or fully vacant during the current shutdown and uncertainty surrounding when and how colleges will reopen, student housing is currently the most impacted segment among our preferred asset classes.
In rent trends provided by Entrata that tracks over a million student housing units, as of April 20, 91.6% of student housing units made a full or partial rent payment and 93.6% of rent was collected. This compares to 94.1% of student housing units that made a full or partial rent payment a month prior, as of March 20, where 96.0% of rent was collected. Alpha Investing’s two student housing properties averaged an 89.4% collection rate in April.
Alpha Investing Strategy
Over the last several quarters, we have continually referenced our belief that we were in late stages of a market cycle and asset pricing was high driven by a prolonged low interest rate environment. On the acquisition front, we have maintained a focus on disciplined underwriting and sound asset fundamentals and an emphasis on downside protection, all while continuing to partner with a select group of seasoned and experienced sponsors. On existing investments, we have capitalized on asset appreciation by selling assets ahead of underwritten timing to lock in returns, and refinanced debt at lower interest rates to reduce interest expense and return significant amounts of investor equity to de-risk the investments.
In the face of the current uncertain operating environment, many of our sponsor partners are prudently holding back distributions to increase cash reserves to protect against potential unforeseen costs or capital needs. We will continue to monitor the impact of COVID-19 on all assets in our portfolio, keeping in frequent contact with our sponsor partners and investors.
On the acquisition front, commercial real estate transaction volume has fallen sharply. Over the past three years, there were over 2,100 unique buyers of commercial properties in the US every month. In March, that figure dropped over 60% to just 790. The high level of uncertainty has made price discovery extremely challenging. While we continue to speak with sponsors and evaluate new investment opportunities, we recognize that we are first and foremost facing a public health crisis. While we are vigilant in monitoring new developments, many unknowns remain. In the face of this uncertainty, we believe the best approach is to remain patient and allow the crisis to evolve to a point where we feel we have enough information to make prudent and informed decisions to be responsible stewards of our investors’ capital.
The Alpha Investing Portfolio
To date, Alpha Investing has invested in 43 properties across the United States, as well as a commercial real estate debt fund. The total capitalization of the 43 properties in our portfolio is over $1.43 billion.
- At the end of March, refinanced a 120-unit multifamily property in Bremerton, WA with a seven-year, $18.5 million loan at Libor+1.97% with two years of interest only payments
- Returned over 76% of investor equity through refinancing proceeds
- Total investor distributions to date from the March refinancing, a prior refinancing in 2018, and property cash flow have returned ~135% of investor equity
- The property appraised for ~$25 million as part of the refinance process, which compares to an acquisition price of $13.25 million, resulting in significant remaining equity upside
- For the trailing 12-month period ending February 2020, property NOI was up 39% over the prior year and occupancy averaged 94%. As of year-end 2019, 73% of units had been renovated
- In mid-April, refinanced a 151-unit multifamily property in Hayward, CA with a ten-year, $35.6 million agency loan
- The new loan carries a 2.94% fixed interest rate with five years of interest only payments, which is a significant reduction in interest rate from the previous debt fund loan that carried a floating rate of Libor+2.75% with a floor rate of 4.25%
- Proceeds from the new loan were used to pay off the previous loan and set up an interest reserve, given the uncertainty of the current economic environment
- The property appraised for just under $53 million as part of the refinance process, which is a 20% increase over the acquisition price in just 15 months of ownership
- For the trailing 12-month period ending February 2020, the property averaged 93% occupancy
As always, we appreciate your interest in Alpha Investing. Please feel free to reach out to us at any time.