COVID-19 and the Downtown Savannah Rental Market
Updated: May 30, 2020
Edi, May 28th, 2020: Now that this post is about two months old I'd like to comment on how my predictions turned out. It seems that my models were more pessimistic than what actually ended up happening, and that's probably because I'm naturally a very conservative investor. Based off anecdotal evidence and conversations with other local investors + my own experience, it seems that rents definitely DID NOT go down 25% in April - but it was harder to fill vacancies. Many landlords lowered standards for what kind of tenants they would accept (in terms of credit and income.) Some landlords also reported price drops, but not extreme ones. Most landlords that I talk to do still agree on the overall assessment that rents are on track to remain flat this year or possibly slightly decrease. AirBnBs are still getting crushed, but the top 25% of units are not profitable again. Some SCAD students did end up breaking leases, but not to the extent that I modeled. And with that, on to the article as I wrote it two months ago:
We work with a lot of investors here at Trophy Point Realty Group, and they're all asking us the same thing: "What do you think the impact of the corona virus will be? Do you think real estate will go on sale like it did after the 2007-08 financial crisis?"
Our short answer is this: "We think the impact will be short lived and we don't foresee a great drop in real estate prices, but we can't know for sure just yet."
So what's the long answer? That depends on two things: how well Federal, State, and local authorities handle the medical crisis, and how well the Federal government and the Federal Reserve handle the financial crisis that could result from the medical crisis.
First let's talk about what we already have experienced.
Savannah started to feel the economic impact about a week before St. Patrick's day. The first industry to be hit was the hospitality industry, who saw a wave of cancellations the day that it was announced the parade would not happen. Occupancy for the city's AirBNBs and hotels is near 10%. Salons and barbershops are closed, as is almost every single downtown retailer. It seems about 50% of the downtown restaurants are closed, with the rest doing takeout only. SCAD pushed the spring quarter to online-only and closed the dorms, and it seems about 50% of students have left Savannah - some of them breaking leases in the process.
The downtown rental market has taken a hit, and we'll get into that with some detailed analysis later, but one thing that seems strange to me is that the market for buying and selling real estate in Savannah hasn't collapsed in the way that many suspected it would. Many investors are sitting on the sidelines, but most would-be homeowners are still buying. Savannah has been a sellers' market for a while, and things do seem to have shifted in favor of buyers a bit but not to a great extent just yet. It does seem, however, that listings over $300k and multi family listings are not doing as well as the 100k-160k starter home market. I believe that is because supply is still very low in that market relative to demand, which has not dropped off enough to motivate sellers to compromise. In fact, one of my cheap listings went to multiple offers over ask the same weekend I put it on the market.
How might this continue to play out?
Best Case: Efforts by local government to mitigate the spread are largely effective and social distancing measures can be lifted by the middle of April. Local hospitals quickly gain capacity to conduct mass testing (500-700/day in the Savannah metro area). This ramp-up in testing is necessary to lift social distancing measures, because mass testing will allow authorities to enact targeted quarantines where outbreaks crop up, leaving the majority of people free to conduct business as normal. SCAD begins in-person classes again by the Summer quarter, and travelers begin coming to Savannah again by the summer, bringing occupancy up to 50% by July and steadily increasing toward normal levels over the next few months. Federal government stimulus is timely, aggressive, and effective and results in almost all local small businesses making it through to the other side.
Most Likely: Efforts by local government to mitigate spread are somewhat effective, but can not be lifted until early May. Testing capacity does not meet demand until May. SCAD does not resume in-person classes until Fall and travelers do not come back until about the same time. Federal government stimulus is aggressive, but not timely enough to save the weakest businesses and landlords, and 5% are either forced to sell their assets or enter bankruptcy before August. Demand is also reduced for the rest of the year as scared people stay home more, causing another 5% of local businesses and landlords to fail. Note: That 5% number is really just a guess, I don't have anything other than my intuition to back that number up. Point is, 1 out of 20 downtown restaurants will go out of business in this scenario.
Worst Case: Almost no mitigation of spread. Local hospitals are overloaded like we saw in northern Italy and are currently seeing in NYC. Social distancing measures are not well enforced and community spread continues, forcing social distancing to continue until June or July. Stimulus is neither timely or aggressive, causing 25-33% of local small businesses and landlords to fail by December. Some hotels are forced into bankruptcy, and port traffic slows as U.S. and global demand falls off, forcing further layoffs. A second wave of infections in the fall/winter further deteriorates the economic situation. Note: the key point here is "stimulus is neither timely or aggressive." There's a very good chance there is a second wave in the fall, but if the federal government continues aggressive stimulus I think we will stay in recession territory and out of something akin to the great depression.
What's going to happen to the downtown rental market?
Anyone involved in real estate kind of knows intuitively what the effects of any of those three scenarios would be. Scenario one barely shows up as a blip on the radar, it would almost be like hitting the pause button on the market until May/June. The most likely scenario is a slightly longer pause, with a little more pain after the pause, but still not a major event -- more likely to stagnate prices for a year than result in a 2008-style crisis where prices drop 30% or more. The worst case scenario is truly scary to think about and would basically result in a depression.
I could just end the article there and leave you with my speculation, but I want to put a little more thought into my predictions. I spent the last couple days gathering data and building a model that I could use to predict changes in the market price and supply of downtown rental properties based on a few different variables. This model was built to tell us the average price per unit in the downtown Savannah area (basically 31401 and parts of 31404).
I would like to give you two words of caution about the charts above. One, it's almost impossible to predict how this virus will affect our community and how well our authorities will respond. Two, the model that I developed was devised using historic data over the past ten years, and this data is nothing like what we're seeing right now. Do I think average market rent will really be $780 in April? No, I think that there will simply be no new leases signed because we'll all be on lock down!
Also, a note on the term "excess rental supply": this is not a measure of vacant units, this is just a metric to illustrate the shifts in supply vs demand. In the case of these models, we will see both extra supply and reduced demand, which will have an effect on market price. In my worst case scenario I model an excess supply of about 5,800 units (out of about 10,000 total rental units in the studied area.) This doesn't mean there will be a 50% vacancy rate, it just means that landlords will have to slash prices to fill vacancies. Please reach out to me here if you'd like to discuss how I built this model!
It's almost impossible to predict what the market will look like while we're operating with shelter in place orders, because there basically won't be a market. I think where the model will be most helpful will be in showing us how the market will look in fall/winter after the situation has stabilized. In the best case scenario, stabilized average market rents will be about $30 (2%) lower, in the most likely case they'll be about $90 (5.8%) lower, and in the worst case about $220 (14%) lower. I think it is fair to expect the high end rentals to be hit the hardest, with cheap rentals staying relatively consistent, as is often the case during recessions.
If you're already a downtown landlord the key takeaway is this -- the next few months are going to hurt. You might have to ask your lender for forbearance, tap a line of credit, or apply for a SBA loan - and we'll put out a blog on that issue in the next few days. If you can keep it together until September I think that is when market rents will stabilize, but don't expect to bump rents like you normally might during SCAD move-in time. If one of my downtown properties goes vacant in April or May I'll probably just leave it vacant until June instead of dropping rent to find a tenant - not like anyone is going to be moving during that time anyway. I think most of us will be able to weather this storm unless we spend the majority of 2020 sheltering in place or the federal government doesn't effectively implement the stimulus bill that passed last week.
What about the market for buyers and sellers?
A lot of investors think that real estate is going to go on sale like it did in 2008. I disagree unless we really do a horrible job of managing the response to the virus. Check out this chart:
This chart is the historic housing price index in Savannah (bold blue line), and I added in a couple trend lines to illustrate trends in the data.
See the grey line? That's the trend line of increases in housing price index from 1984-2000. See how much slower the growth was back then? That's because mortgage interest rates were in the double digits back in the 80s and remained in the high single digits through the early 90s. High interest rates always equal lower valuations of assets.
The yellow line is the most important. That shows the average growth in housing prices in Savannah for the period of 1995-2003. This is important because interest rates were relatively low (about 5-6% on average), and this was before the 2003-2006 boom in prices. This boom was a result of shoddy lending practices that we don't see anymore. Check out how big that housing bubble got, and check out how much below historic trend lines housing prices got by 2012. We still haven't fully caught back up to where we should be.
This is the biggest reason that I don't foresee a drop in prices - unlike 2007, real estate in Savannah is not in a bubble. Will we see prices stagnate and maybe stay at the same level for a period of time? Probably. Will buyers be able to get more concessions out of sellers? I think so. Are you going to be able to steal deals? Not unless you find a juicy off-market deal and a seller who doesn't know any better - or unless we totally gorp up the response to the virus and don't execute the necessary economic stimulus measures. I think we could be doing better on that end, but I think we'll make it okay, especially after seeing that $2.2T stimulus bill pass. It was foreclosures that drove the drop in prices from 2008-2012, and we won't be seeing very many of those because of the stimulus bill that was recently signed into law.
Bottom line is this -- if you're an investor looking to steal some deals like it's 2012, it's probably not going to happen. Your best window of opportunity will probably run until about August. My recommendation? Be a little more choosy, bump down the year one rent estimates in your modeling, and keep more cash on hand than you normally would - but other than that keep buying. If you're truly worried then keep your cash on the sideline until early May, I think by then we'll have a good idea of how this will play out.
We'd love to hear your thoughts and feedback or answer any questions, especially if you're a local investor or thinking about investing in Savannah real estate. Please reach out anytime - we've got plenty of time on our hands these days!
Methodology on the COVID impact on downtown Savannah average market rent modeling
My independent variables (e.g., the variables that I will manipulate) are the percentage of SCAD students who leave Savannah, the unemployment rate, and the percentage of AirBNB owners that move their units to the long term rental market. These are what I see as the biggest drivers of changes in supply and demand in the rental over the next few months.
My dependent variables (the variables that will be changed based on differences with the independent variables) are market rent and excess rental supply.
I pulled a lot of different statistics to help me build this model. They include the following data points taken yearly from 2010-2019: average rent in the 31401 zip (Zillow), SCAD enrollment and dorm capacity, Savannah metro unemployment, population, per capita income, GDP, and housing starts, 31401 zip building permits, new apartment units, and population.
I then performed a linear regression for a few of these statistics and their relationship to market rent in the 31401 zip and I averaged the output of each regression to come up with a predicted fair market rent, which I adjusted up or down depending on whether there was an excess of supply or not. How did I determine that?
I used building permit data to get a clear picture of the number of new rental units coming on the market every year vs the growth in population, and I established that the ideal ratio of units/population is .26 housing units/person. Now, you might be thinking that there would be about 4 people per apartment in that scenario, but that's not really the case since a good portion of the population is homeowners and there's just no way to model that. So how did I come up with .26? Basically, I took the average ratio of the years 2011-2018 and used that -- I figure that the free market would come up with the best ideal ratio and I should just stick with that. So I can now use that constant of .26 to model how increasing supply or decreasing population would lead to a shortage or surplus in the market, and I adjusted market rent up or down 10 cents per unit of excess/shortage.
I then used these models to predict market rent for the years 2010-2019 to see how close my model was to the actual values. I saw that my model was off by an average of 3.12%, and 6.47% on the worst year, where the model was $100 off the actual market rent for that year. Not too bad for a guy who got a B+ in stats I guess!