Why Analysts Think a Bankruptcy Wave is Coming

What Investors Need to Know to be Prepared.

By Strategic Passive Investments 

In March 2020 as most of the country “shut down” in an attempt to slow the spread of the COVID-19 pandemic, most everyone immediately started talking about how soon things would get “back to normal.” At first, the timeline seemed to be a matter of weeks. Then, it extended to months.

Now, at more than two years into the pandemic, even the most determined metropolitan areas like New York and Los Angeles are talking about walking back vaccine mandates and lifting masking requirements as the pandemic shifts to endemic (meaning it is considered a part of life, like the flu) status.

While that shift is likely to be positive for the economy overall since many public-health restrictions were devastating for small businesses and their employees, a return to “normal” will not be good for everyone. In fact, some analysts are warning that the return to normalcy could mean a wave of bankruptcies that will affect every sector, including real estate.

So Far, Rules Seem Made to be Broken

When the economy locked down, it was natural to expect a wave of foreclosures would follow, since many people were unable to work during the pandemic. To fight this possibility, the federal government, various levels of bureaucracy, and even a presidential administration intervened in real estate investors’ ability to collect rents and enact evictions not just for months but, in fact, for years.

This was, naturally, devastating for many investors whose own mortgages remained due and were not usually eligible for delayed payment options available to homeowners (many of whom are likely to find themselves unable to make up those postponed payments when those programs expire). Nevertheless, the majority of tenants and landlords figured out ways to make things work despite the administrative morass. However, the public-health bruhaha that came with the lockdowns and sent the rental industry into a tailspin was a mere harbinger of things to come.

In 2022, the “return to normal” will bring with it rising interest rates. In fact, the Federal Reserve has announced it could raise interest rates as many as four times this year. At present, interest rates hover near zero, making unaffordable homes just barely affordable in many markets. When those interest rates rise, most analysts agree that housing costs will have to come down because no one will be able to afford to buy in most markets.

However, this prediction relies on the “rules” of the economy and real estate holding true. They probably will not because COVID-19 has broken them. Many desirable and historically affordable housing markets like the southeast will likely not experience that cooling pattern in the near future because buyers from other wildly unaffordable markets are moving south in droves, thanks to the option of remote work and the allure of a year-round temperate climate that permits outdoor recreation 12 months of the year.

These buyers are flush with cash from sales in their own still-hot markets and will likely cause a significant lag on that cooling cycle. Investors thinking they will wait on the market to cool to begin acquisitions once more could be waiting far longer than they expect.

But What About Those Bankruptcies?

Real estate investors have long adhered to the maxim, “Buy low and sell high.” Lately, however, that has been adjusted to “Buy high and sell higher.”

Last time that modification was made, the country ended up with the housing crash. Thanks to more stringent loan guidelines, however, it seems relatively unlikely that a foreclosure wave will hit the housing market in the 2020s. What is more likely is that a wave of bankruptcies will hit certain companies too heavily invested in struggling real estate and commercial sectors.

For example, shopping centers and commercial buildings with office space have already faced an onslaught of vacancies. This trend is likely to continue and, with inflation, exacerbate difficult financial situations for owners unable or unwilling to shift strategies and usage to accommodate today’s real estate needs.

With rising inflation and higher interest rates combining to put serious pressure on owners of these types of commercial properties, investors with the skill and creativity to “make lemonade out of lemons” when it comes to adjusting property usage and purposes could find themselves in a good position to acquire commercial properties and change their usage to better fit today’s real estate market needs. For example, malls across the country are being acquired for relatively low prices and converted to warehouse space or multifamily living.

While not every property will fit the bill for these types of adjustments, if an investor has the ability to acquire the property and then develop it correctly – this means having the connections and know-how to syndicate large deals, in many cases – then the coming years are likely to be full of opportunity.

According to Kiplinger, it is time to “accelerate the timing of any major purchases … since looming inflation will make the dollar worth less and less.” While the analyst writing that advice was directly addressing consumers in his article, this holds true for real estate as well.

Real property has always been used as a hedge against inflation and, with some analysts predicting 7 percent inflation or more in 2022, the time to get locked-in interest rates and sink some capital into physical assets is definitely now.

Properties that are cash-flowing are not going to decline in value even if the “bankruptcy wave” does manifest because inflation is going to drive those values up. Furthermore, for investors considering liquidating portfolios before interest rates rise: Reconsider this strategy. If inflation continues, you will find that your liquidation dramatically decreased the value of your overall portfolio.

Real Estate is Still the Most Resilient Asset Available

When considering the potential “bankruptcy wave” of 2022, it is important for real estate investors to remember that a great deal of the alarmist language being used to discuss the national economy and many real estate markets in the United States is extremely misleading. For example, you might read this on nearly any media outlet: “The hot housing market is starting to cool in 2022,” or “This market [insert hot market] is heading for a slowdown by the end of this year.”

There is a catch, of course. “Cooling” these days does not mean values are going to fall. Instead, it means they might not rise quite as fast. In fact, recently in Fortune magazine, a real estate columnist made the following prediction about “overvalued” markets around the country: “While some of these cities are still showing up on lists of the fastest-growing markets, researchers say the premium figures indicate housing prices in these areas are poised to flatten in the future…. Sellers should brace themselves for a difficult time if they hope to get top dollar in the near future.”

Upon further investigation, the markets in question – Boise, Idaho; Atlanta, Georgia; or Austin, Texas, to name a few – are not poised to “tip” into declining values. They are, instead, poised for single-digit gains in 2022 rather than double-digit appreciation. Given that these markets and their surrounding areas are some of the most attractive and affordable in the country (relatively speaking), it is nothing short of misleading to say sellers could have a hard time selling at “top dollar” in the near future.

Investors must always make sure they have all the facts and have done all their homework in today’s environment. Otherwise, you could miss amazing opportunities simply because you have been told they do not exist.