Economic Prediction Part 1

Last week I attended a small private presentation hosted by my good friend Tom Wilson at the BACOMM monthly meeting held in Silicon Valley. The guest speaker was Dr. Doug Duncan, Chief Economist for Fannie Mae. Doug has been a guest on the show before. Doug leads a large team of nearly 200 economic analysts and have consistently won awards for having the most accurate economic predictions anywhere in the US. When I speak with Doug, he’s not just reciting data. He has layers upon layers of evidence to support the conclusions drawn. This one hour talk was packed with market insights that I have not seen anywhere else and I want to share these with you. If Dr. Duncan’s observations are correct, they will serve as a guide for what’s to come in 2021 and beyond.

On today’s show I’m going to share a few highlights from Dr. Duncan’s presentation that I believe are relevant for all real estate investors.

What we’re dealing with in 2020 is a pandemic and not an economic variable. We simply don’t have economic models that have a pandemic built in as an economic variable.

The Fannie Mae forecast is based on data over the past 4 quarters and is making reasonable assumptions about the trajectory of the disease in the first half of 2021.

There are a number of conclusions that can be drawn from the data that Dr. Doug Duncan presented.

What they found is that the highest percentage of renters are in the food and beverage, retail and hospitality sectors of the economy. These are the very sectors that have been most impacted by the pandemic. Therefore, they conclude that the impact to home owners has been proportionately much less.

The folks at Fannie Mae looked at the loans that are in forbearance. Again, the lenders are in direct communication with their customers. Fully 25% of those who took the option of a forbearance agreement did so out of an abundance of caution. They did not experience job loss, nor a reduction in income. They took the forbearance just in case.

Another 25% of those who took the forbearance option did experience a partial loss of income, but still had sufficient cash flow to make their mortgage payments. Strictly speaking, they didn’t need to take the forbearance agreement. When those forbearance agreements expired, those home owners were in fact able to resume mortgage payments and have not gone into default. Based on this, we can conclude that the state of financial distress for home owners is about half of what the total numbers would suggest. That’s a good sign.

So let’s see what’s going to happen to the remaining 50% of the homes that are in distress. Dr. Duncan believes that loan modification agreements will be signed with the borrowers that the banks believe are good credit risks. If a borrower is 6 months behind on their payments, they may extend the loan by a year, add the outstanding payments to the loan, spread over the remainder of the loan and bring the loan into good standing. Those properties will not go into foreclosure. That leaves a much smaller number that will actually go into foreclosure.

Dr. Duncan also shared that several large institutional players who are sitting on large sums of cash are prepared to step in and purchase portfolios of distressed properties in bulk. Therefore the impact to the lenders can be reduced with a few large transactions, rather than the waves of auctions on the court house steps that were daily occurrences in 2009 and beyond.

On this basis, I’m going back on what I’ve reported previously. Will there be distress in the coming months? Yes there will. But I believe that distress is going to be confined to specific sectors of commercial real estate. Specifically, I’m referring to retail, office and hospitality. I’m concluding that we will not see a repeat of 2008 with millions of homes appearing on the market at deep discounts.