Why This Downturn is Different for Multifamily
by Donald Davidoff | March 26, 2020
I often think of the economy as a metaphorical set of pipes with money (the "water") flowing through them. Recessions typically happen when the pipes "clog," causing the water to flow well below its normal pressure. Governments have to respond, taking actions to "unclog" those pipes to get the "water" flowing again.
But the recession I believe we've already entered is very different in kind, not just degree. The coronavirus pandemic has forced large sectors of our economy to close down, severely restricting consumption and economic activity. This time, the "pump" has broken. It may not matter how much anyone tries to unclog the pipes, as little will flow until the pump starts working again.
This metaphor has some significant ramifications for what we'll experience over the next few months (yes, months, not weeks). It feels like we will have a two-stage recession:
- Stage 1 will be unlike anything we've ever encountered before. This is the current stage, where the pump is frozen. Many industries will experience an inability to stimulate demand no matter what they do. For example, Las Vegas casinos are not allowed to do any business and thus can't even make an offer. Airlines can cut prices to practically zero, yet very few people will fly. Normal pricing and revenue management actions like lowering the price to boost occupancy simply won't work the way they typically might.
- Stage 2 will be more like a typical recession, where weak demand meets excess capacity until supply and demand rebalance. Government stimulus will drive investment and demand and slowly, but surely, the engine roars back to life. Whether this will be a "V shape" like typical recessions or a shape more like the balance sheet-driven "Great Recession" is hard for me to predict (I'm an engineer, not an econometrician). But whatever it will be and however long it takes, it will mark the process by which we get back to "normal."
One other big difference with past recessions is the pace of the buildup. Past recessions tended to build up over time whereas this one came on us almost suddenly. The just-announced unemployment application numbers for last week prove this point. We went from “normal” rates one week to 3.28 million last week. By way of perspective, that is almost 5 times the record for any week (695K way back in 1982). There were roughly 155 million people employed in 2018, so 3.28 million unemployed is roughly 2% of the entire workforce being laid off in a single week.
Understanding the Uncertainty
The two-stage nature of this recession and the general uncertainty surrounding both stages present us with several challenges. First, it is hard to know what to do during Stage 1, as we have no valid reference points from the past that help us. 9/11 shut demand down for a few days, but the 2002-3 recession was essentially a "normal" one. The so-called Great Recession was also one where the clogging of the pipes built up over time, but the pump was still running.
Next, we won't move into Stage 2 until we get past the lockdowns that are part of this current stage. Hopefully, this is weeks rather than months; however, it seems clear that "shelter in place" orders will become more restrictive before they are relaxed. Until people can leave their homes both legally and safely, the pump simply will not be pumping.
Once the pump is working, signaling entry into Stage 2, it's unclear how long it will take for the "water" (money) to get flowing. But at least it will be flowing. With such a sustained period of forced economic inactivity, it is hard to predict how quickly demand will recover.
Focus on what we do know
So, what does this all of this mean for pricing? The truth is that no one really knows for sure, but there are some things that experience and common sense tell us. Focusing on renewals, for example, should be our first refuge amid current uncertainty - properties should be as proactive as possible in incentivizing residents to renew. At the same time, we should take extra care to ensure that changes to new lease pricing do not impact renewal decisions. For the duration of "Stage 1" we will be even more dependent than usual on renewals.
Another thing that we know from previous recessions is that we have to pay close attention to the models that our PRM systems use. Forecasting models, for example, are designed to use recent observations to predict the future. We should not expect them to work in the same way when recent observations are so radically different from normal, as they are today. "Trust the system" is not a good strategy - we must understand what drives the underlying models in order to make good decisions about what to accept and what to override.
Finally, we must follow the market, as the situation is changing every day. A focus on renewals should make us cautious with changes to new lease pricing, but that should not force us to persevere at the wrong price point. We must maintain focus on what will maximize revenue over the next 12 months, and that may mean putting several of our most valued PRM policies and strategies on a back-burner while we make the best of challenging conditions.