In mid-July 2020, Forbes published a hopeful article stating, “The best-case scenario for the COVID crisis is a V-shaped recession.” The author, contributor David Rodeck, went on to explain that a V-shaped recession would be followed “by a quick rebound in growth,” as defines the concept. He warned that this type of recession and recovery would only be possible if COVID-testing swiftly enabled people to return to work while preventing future surges in cases and if the government enacted more large-scale interventions to protect consumers, jobs, and businesses.
By the end of 2020, the coveted V-shaped recovery was still in the headlines, but there was little or no consensus about how 2021 would progress on a national level. The result, many economists now begin to agree, is a “K-shaped recovery” in the making.
Understanding what a K-shaped recovery means getting a clearer view and being fully prepared for the opportunities coming in real estate, lending and finance, construction, and other investment sectors.
What is a K-Shaped Recovery?
The bad news is that in order to have a K-shaped recovery, you have to have a recession. However, most people fail to realize that this is true for any recovery! If we didn’t have recessions, we would not be looking for recoveries in any alphabetical category. So, it is important to abandon the reflex that says, “K-shaped recoveries are bad because they occur subsequent to recessions.” Then, an investor can begin to better understand the recovery itself.
A K-shaped recovery occurs when different parts of the economy recover at different speeds, usually referred to as recovery rates. When viewed graphically so that different aspects of the economy’s recovery are depicted as a line graph, the lines tend to split in two directions, with one going upward (the sectors recovering more quickly) and one trending downward (the sectors recovering slowly or, in some cases, declining further). The initial recession event may be viewed as the “backbone” of the capital “K” or, more commonly, the vertical line in the letter is depicted as the point in time at which the two lines diverged.
It is important to remember that a K-shaped recovery may not be analyzed in any way unless the discussion breaks various parts of the economy into separate pieces for analysis. In any format wherein the entire economy is reviewed as a whole, the “K” cannot appear. For this reason, K-shaped recoveries may look like gradual L-shaped recoveries or even other letter-descriptors like U or W, depending on how the different facets of the national economy affect the overall recovery rate.
Why is the K-Shaped Recovery Important?
Most investors are familiar with the more conventional recovery shapes, such as the coveted V-shaped recovery, the U-shaped recovery, and the L-shaped recovery. However, the K-shaped recovery often glides under the radar even for experienced investors, especially in real estate. This is largely due to the uniquely attractive aspects of real estate and real estate-related investments.
The real estate investor knows they hold an asset that is unique, limited, and will always be in demand to one degree or another. Most real estate investors and private lenders making loans collateralized by property simply watch the course of the economy as a whole to get a feel for the general recovery because conventional wisdom states that over the long haul “real estate will always go up.”
Of course, this is not necessarily true, although it is hard to dispute given that historically it proves out. However, as everyone has gotten sick of hearing since March 2020, the present day is “unprecedented.” If any asset were to veer off in unexpected directions, this is the year it will happen. That is why the K-shaped recovery matters. In the words of one of the 20th century’s greatest economists, Joseph Schumpeter:
K-shaped recoveries herald creative destruction.
Creative destruction is the process by which new technologies and industries replace older technologies and industries over the course of a recession. These replacements are nearly always permanent and, just as importantly, tend to shape public policy in ways that permanently affect the economy in the future. A K-shaped recovery in which entertainment, travel, and hospitality and the public policy surrounding these sectors is permanently altered, for example, will creative massive changes across all industry sectors, including real estate.
This is what may well be happening right now, in 2021 as the U.S. economy adapts to the massive upheaval created by COVID-19. Even as the housing market booms (housing is definitely on the upward “arm” of the K), permanent shifts in market mindsets are going to change how this most reliable and predictable of asset classes performs.
What Will the K-Shaped Recovery Mean for Real Estate?
In two words, massive opportunities. Thanks to the flexibility afforded real estate investors and others, such as private and hard-money lenders who invest in real estate-related assets, the real estate market is going to continue to offer the opportunities that nearly always accompany a U.S. recession.
While the last recession was largely a result of a housing crash, this more recent recession results from factors unrelated to real estate. However, it would be foolish to assume that this means real estate will be unaffected by the COVID-19 recession and eventual recovery, whatever shape it takes.
Real estate will be altered permanently, often on a state-by-state or even municipal level, both by the intrusion of public health policy into the housing market and by state and federal response to those downward-trending industries: travel, entertainment, hospitality, and food services.
Investors keeping a close eye on market shifts and consumer trends will likely find themselves in the position real estate investors most desire: that of being able to buy low and, later, sell astronomically high.
However, do not forget the lessons learned in the wake of the housing crash. Many investors who “jumped in” too early, buying up homes in hardest-hit markets like Detroit and Las Vegas ended up selling in distress themselves during the Great Recession when the downturn outlasted the capital that investors had held in reserve for holding costs or when investment strategies failed due to seismic shifts in the way the housing market operated.
As you observe and act in this recession, it is important to evaluate your strategies for flexibility as well as innovation. It will not be a safe move to assume collateral automatically may be valued the way it used to be. It will not be a wise decision to expect that simply buying a property at a discount will mean that the property and its current intended use will remain immutable, requiring no changes and resulting in a quick sale “when things go back to normal.”
K-shaped recoveries mean “return to normal” is not a guarantee.
Real Estate Remains the Most Reliable Asset Class Available Today
Despite all of this unpredictability, the good news for real estate investors is that the asset class remains among the most reliable available to investors today. Even better, certain sectors are skyrocketing.
Whether you choose to invest in physical property or to make private or hard-money loans to parties investing in that physical property, the key to success in the post-pandemic real estate market will be to remain vigilant, creative, and flexible in your strategies. Keep your eyes open for opportunities because whether we like it or not, the creative destruction is coming.
As always, it will be the real estate investors who start the reconstruction and usher in the new normal. It will be profitable and productive to be part of that process.