Assessing real estate holdings during a pandemic

COVID-19’s sudden economic impact—from shuttered businesses to widespread unemployment—has landed especially hard on property owners who rely on rental or lease income. While the federal government and many states have stepped in to provide economic relief and forestall eviction for tenants who can’t afford to make payments amid the pandemic, landlords are contending with the ripple effects of lost revenue and declining market prices.

With no clear-cut end to this crisis in sight, many investors with real estate in their portfolios are pondering whether to sell those assets, borrow against them, or pursue another means of filling the income gap. As is true for any significant wealth management decision, I recommend working closely with a trusted financial advisor to map out a plan that aligns with your specific situation and long-term goals.

As a starting point, here are some key considerations and potential options for weathering the current downturn without having to liquidate real estate assets that may still merit a place in your overall investment strategy.

Real estate as a cog in your portfolio

Despite the short-term impacts of COVID-19, real estate ownership still makes sense as part of a diversified investment portfolio. Like any other growth-oriented asset, it also carries a degree of risk. Bear in mind that real estate is not liquid. Thus, you should approach it as a long-term, buy-and-hold investment asset.

Current market conditions have not altered the basic tenets of real estate. What has changed is that almost all parts of the market are feeling the pain of the coronavirus pandemic. If you can afford to ride out this temporary crisis—and most forecasts are linking sustained economic recovery to the release of a coronavirus vaccine sometime in 2021—the returns on your real estate investments are highly likely to rebound.

But what about investors who had been relying on now-interrupted lease or rental income to meet their financial needs over the next six to 18 months? There are options to help tide you over during the pandemic.

Short-term sources of cash flow

As an advisor, I first look at my clients’ cash flow in terms of how much monthly income is essential to their desired lifestyle vs. how much is desirable. Understanding the difference between what’s needed and what’s nice to have will help shrink the actual income gap that you are facing.

Next, consider drawing on the most liquid assets in your portfolio to fill that gap. These could include:

• Seeking mortgage relief for residential real estate. Under the federal CARES Act passed in March 2020, property owners with mortgages backed by Fannie Mae or Freddie Mac can request a forbearance on mortgage payments for at least 180 days due to the coronavirus and its impact on jobs, individuals, and families. Even if your loan is not federally backed, other lenders and some states have created similar relief options. Check with your loan servicer and state housing authority for details.
• Withdrawing cash from your investment accounts or savings. Tapping this source for short-term expenses will likely make the least impact on your overall investment returns, since cash typically earns a low interest rate. And when your real estate holdings start to generate income again, you can replenish the depleted cash.
• Borrowing against your real estate. If you and your advisor feel confident about the future appreciation and income-generating potential of your properties, using those assets as collateral on a short-term loan may tide you over until the market improves. You’ll need to pay interest, but you can retain your valuable assets.
• Liquidating other investments. This may be a strategically opportune time to sell off bonds and other fixed-income assets, which have generally held steady or risen in value in recent months. You can work with your financial advisor to re-evaluate your investments in stocks and consider letting go of those that are no longer performing. If you own publicly traded securities, you can sell any time and bear the loss if the value is down or the demand for the investment is low. Liquidate what has been profitable and let go of stock that has not performed but you may have fallen in love with.

As a last resort before selling real estate, you might also consider borrowing from your retirement funds. As part of the federal CARES Act relief package, Congress has allowed people below retirement age to take a distribution of up to $100,000 from a qualifying IRA plan without incurring the usual 10% early-withdrawal penalty. The distributed funds will be exempt from mandatory tax withholding, which is normally 20 percent. The penalty and withholding waivers apply to withdrawals made between January 1 and September 23, 2020. Borrowing funds from your retirement account is a last resort, as we mentioned, and only recommended due to the exemption of fees during 2020. However, removing finds from your retirement account earlier than expected can impact your overall retirement goals, so it would be important for you to discuss your options with your advisor to see if this is the most appropriate route for you.

Plan your alternative methods of cash flow with your advisor, who can provide objective input and potentially help you overcome a knee-jerk reaction to jettison those real estate holdings that are temporarily unprofitable.

Restoring real estate income post-coronavirus pandemic

Although your current commercial and residential tenants might not be making payments now, remember that they will still need places to live and do business once the economy gets back on track. In the meantime, you may have other means of helping maintain a profitable relationship with your dependable tenants.

Consider the following options:

• Rent abatement. As a landlord, this involves postponing or forgiving all or a portion of rent payments to you during the coronavirus-induced economic downturn. Although an abatement will certainly reduce your cash flow in the short term, you might be able to negotiate at least a partial payment of back rent in the future. Offering this option may help persuade tenants to remain in their rental or lease agreement longer, which will mean that you should eventually get your cash flow back.
• Moving into another market niche. As we start to emerge from this downturn, some property owners may find a more attractive long-range investment growth opportunity in a different segment of the real estate market. Ask a trusted real estate professional and your financial advisor to determine whether moving your capital from one property—or real estate-oriented investment fund—into another makes financial sense. Some niches that have more potential to flourish in the new economy include residential direct investments, proven private equity operators with residential portfolios, supply chain industrial warehouses, refrigerated warehouses, and medical clinics/facilities and urgent care facilities.

Managing cash calls

If you are invested in private equity real estate that has made a cash call, then you will want to do an in-depth review of the investment, including the cost to you to add funds, and determine if it is something you can and should do. It is important to speak with your advisor to determine the impact on your overall portfolio if you do want to add funds. However, now is probably not the time to enter into a new private equity real estate deal that may require cash calls.

Before you decide to sell real estate assets, ask:

• Why did you buy the property for the long term?
  • To provide current income? If it is not providing income now, you may be unlikely to sell at a profit—so this is probably the time to hold.
  • To sell for a profit? As with any real estate, there will be a tax impact if you sell at a profit. Timing of the sale should occur when markets are up not down. Also, consider whether you have an alternative investment that will do as well as the property has up to now.
  • To pass on the asset to your heirs? If this investment is meant to be part of your estate plan, then the current downturn is likely not a reason to sell.
• Do you owe more money to stay in the investment? If so, consider using a loan forbearance program offered by your lender.
• Do you have legal or debt obligations on the property? Your lender might be willing to forgive some payments and/or add them to the back end of your loan contract.
• Could you sell part of your real estate investment to cover the short-term cash flow change? A real estate professional can help you evaluate the pros and cons.
• What is your actual cash flow need vs. your desired cash flow?

Going through these steps should allow you to look at the situation objectively and stay true to your long-term goals.

Stay the course on your big-picture financial plan

COVID-19 sent financial markets on a wild ride in the first half of 2020, and the real estate sector did not escape the effects. But this crisis will not last forever. When considering options for your real estate investments, revisit why you bought the property and whether those objectives still feel valid. If so, then do not let a short-term income pinch send you into a panic. Many investments outside of real estate have also dropped in value. So, the real question is: Will the income from your holdings return once this current downturn is over?

Making short-term decisions about real estate is rarely in your best interest. Your real estate investments took time and forethought to accumulate; take that same approach when weighing your decision to stay the course or sell.