Key Takeaway: We are facing a deflationary depression followed by strong inflation OR stagflation.

Watch the real-time impact the Coronavirus has on businesses through a time sheet company. You can view business closure and employee hours lost by city and state. There’s a staggering 55% of lost hours by employees and 43% of businesses are closed as of March 24th.

The longer this viral crises continues the exponential larger and longer the impact will be to our economy.

This crises will:

  • Permanently impact a generation. Remember how the Great Depression affected our grandparent’s money and habits.
  • Disproportionately affect blue collar jobs which can’t be worked remotely.
  • Business will figure out how to do more with less. Positions deemed unnecessary will not be available post-crisis.
  • Impact how we do business. Remote work will be a new normal. Employees will appreciate working from home and want to keep that routine, as long as their kids return to school. J
  • Increase the empathy parents have for teachers followed by more support for teacher compensation.
  • Decrease need for office space as a result of more remote work.
  • Increase need for warehouse space to support deliveries and infrastructure for those who work from home. Why pay for a large expensive office space when a small office and warehouse combination can support many workers?
  • Shift some supply chains away from foreign manufacturing to domestic manufacturing or at least neighbor countries. We have yet to fully feel the impact of this supply disruption. There will be limited quantities and increased prices on foreign products like German beer, French cheese, Swiss chocolate, produce and other foreign manufactured products.

Beginning of the end?

Trump is considering easing social distancing guidelines against health care provider recommendations according to a WSJ article. Trump is looking to get the economy up to speed as quickly as possible.

Trump’s Tweet said another way, asks “how much do we allow the loss of life (1-4%) to impact the economy for all?” This alludes to the messy ethical question of putting a price on life. Is a life worth $1, $1K, $1M, $1B, $1T? Do all lives, young and old, matter equally? While I’d love to prioritize life at “no matter the cost” there’s a mathematical breaking point where we could not afford to save life. People are also willing to pay a higher price when it’s for a life they personally love and care about. There’s no easy answer.

On Sunday, March 22nd Goldman Sachs gave a presentation for their private clients titled “A light at the end of the tunnel”. In it they share the cooperation and freedom of healthcare providers working to stop the virus. The FDA has given approval for test kits being manufactured and distributed while laboratories have increased their capacity for testing. Existing drugs are helping, in particular a Malaria drug has reduced symptoms from 11 days to 4 days. However, it’s still too early as a proper study hasn’t been completed.

I’m not seeing the same level of uncertainty and panic as I was a week ago. There are now some other news stories that aren’t about the virus. There’s still a lot to be worked through. However, Americans as a whole are beginning to understand what we’re facing and in some cases coming together (figuratively) in this time of hardship.

It’s clear our president wants to get the economy back on track ASAP, mid-April as of writing. A strong economy is vital to his reelection. However, if we stop social distancing too soon we could have another wave of infections as Hong Kong is facing now.

In the 1918 Spanish Flu, it was the second viral wave that killed the majority of Americans.

Source: Wikipedia

If we see a resurgence in viral cases, how quickly do you think Trump will admit he’s wrong and respond? A second, worse viral wave would cause a much longer, second shutdown damaging our economy further. It would also likely shut the door on Trump’s second term as president.

The quarantine’s end will likely be extended several times based on the data. View the impact of spring breakers who did not observe social distancing or how far New Yorkers recently traveled in just two days.

My favorite article, Coronavirus: The Hammer and the Dance, provides a suggested response based on evidence. The government hammer locks down a country to initially slow the spread of the virus. Later, the government slowly loosens restrictions while everyone is on guard. Life returns to normal but anyone who is symptomatic gets tested and is quarantined while receiving government support.

The CIO of Guggenheim, a global asset manager, shared a well summarized reasonable outlook. In short, it’s going to take time to work through debt plaguing companies and individuals. Prices haven’t fallen significantly enough. Many anticipate the pain but few have felt it. Many are holding on to assets in precarious positions hoping market conditions will quickly improve. 50+% of Americans have less than $500 in savings and a ~$1,200 stimulus check will do little to help when they’re living off $2-3K a month.

The recession will last 6-18 months. As seen in China and South Korea, it takes time to re-start an economy. Jobs re-start first and schools come later. It’ll likely be 3-4 years before the travel industry returns to its pre-crisis level.

Economic Predictions

If you want to be wrong… make predictions.

After reading data and opinions from many economists and finance professionals I believe we are facing a deflationary depression followed by a strong inflationary period. The technical data to support these conclusions are beyond the scope of this article. The reasoning is, we have a significant loss in economic activity and employee wages have fallen. Demand for goods and services will fall due to people having less money. The government will provide some money through economic stimulus but it won’t be sufficient to offset the lack of cash. Most people live paycheck to paycheck and are using debt to survive. Too little money leads to less demand for the supply of goods and services which fuels deflation.

Later, if the Federal Bank acts as planned:

  1. purchases corporate bonds, treasury securities, and mortgage securities
  2. bails out corporate America
  3. interest rates remain low

Trump in an election year will be especially overzealous for a strong economy. He’ll push fiscal spending “no matter the cost.” Household spending will rise back towards pre-crises levels.

Following this government action there will be a surplus of money. This will increase demand and drive inflation.

I could be wrong. The Fed could give the right amount of stimulus. However, with so much desperation the tendency will be to over correct much like a driver trying to maintain control of a swerving car. Whether there is strong inflation or not, I don’t see a downside to planning for it.

A case can be made for stagflation as we had in the 1970’s. Stagflation is characterized by high inflation and high unemployment. There usually needs to be a shock to the system causing a spike in supply or high unemployment. The viral crises combined with historically low oil prices qualifies. Oil affects the price of many things including the cost of transportation to deliver those goods to you.

Stagflation is even scarier because there’s little the government can do. If they raise interest rates they decrease inflation which drive a cycle of greater unemployment. If they increase fiscal spending unemployment drops but inflation increases.

A stimulus package feels good, it feels like the government is doing something to help but a check to Americans will do little to stimulate the economy (but it may pay for groceries). Most American’s will put the money under a mattress because in times of stress and deflation extra money provides a feeling of safety and becomes worth more. People will only spend what they have to.

As of March 26th, initial unemployment claims were 3.28M, up from 665K in March, 2009. I think $3.28M is low. Reporting is delayed and many have yet to file.

How can you respond? – Deflation followed by Inflation

Get into a strong cash position. As asset prices fall, credit tightens, and people don’t spend the purchasing power of your dollar increases.

Debt, the cost of debt also increases since, in theory, you’re working harder for fewer dollars in a deflationary environment. However, because this deflationary period will likely be short and followed by an inflationary period, this risk is mitigated.

I would hold cash until it’s time to buy. This pandemic will likely be short enough (months not years) that it’s probably not worth seeking assets that do well in a deflationary period.

After restrictions are lifted move quickly to secure investment opportunities. Two reasons, (1) competition for opportunity (2) doors to opportunity could close if there’s additional waves of infection. Although, this would provide additional opportunities for house buyers.

Focus on buying as many assets as you can with the increased purchasing power of your dollar relative to discounted asset price.

Purchase distressed assets that do well in inflationary times:

  • Real Estate – I’m interested in apartments, hotels, warehouses and self-storage. I have experience with hotels and apartments
  • Businesses – I’m interested in buying businesses and taking a board level role, as I currently do in a few startups.
  • Oil – Still looking for an avenue for direct ownership and control
  • Stocks – I will buy dividend paying stocks at a discount if I don’t see better deals in the assets classes above

If you’re personally short on cash, leverage other people’s money to acquire larger assets.

If you use debt leverage, you’ll benefit from low interest rates and the real cost to repay debt will fall with inflation.

The Double-Dip

Beware, the economy and prices could take another hit if there’s a second wave of viral infections. Let’s say Trump does lift the quarantine in mid-April. Businesses and restaurants reopen. People go back to work and start earning income. They use their credit cards again knowing they have a paycheck coming. Americans celebrate the end of the quarantine and splurge based on a pent of demand for goods and services.

By July, viral infections have spiked to new highs with a possible deadlier viral mutation. Politicians and people are even less enthusiastic about going into a longer enforced quarantine. Either the virus will spread, mostly unchecked, or we will suffer a second, worse economic shutdown. Either way, moral drops and there is anger towards politicians. Trump does not get reelected.

Americans are even worse off financially and they’re deeper in debt. A democrat is elected who will enact sweeping social programs while raising our national debt. Many will agree this is “necessary”. More kindling is added to the future fire, the great reckoning when the USA government goes bankrupt 1-3 market cycles from now.

A better case scenario, we use the time to learn which drugs are most effective in combating the Coronavirus (July is likely too early to have a vaccine). We continue to work and the virus is more like a bad flu treatable with drugs.

Real Estate Investor Market Reaction

In January a friend of mine, and student of an apartment guru shared (seriously), “to get an apartment deal, it’s not the price you pay it’s how creatively you can underwrite the deal.” I’ve passed on many apartment deals in the past three years where ROI’s were under 10% including projected price appreciation and sale of assets. Monthly cash-flow had a 3-5% profit margin. The deals could go bankrupt if insurance or interest rates increased, occupancy dropped, inability to get rent planned increases, or timing of their plan didn’t go perfect due to little margin in the deal.

In Dallas, insurance rates have increased ~50% over last year. This cut the profit of one of my apartment investments in half.

It will take some time but we’ll start seeing whose financial tree had deep or shallow roots.

Real estate investors who were previously planning to sell houses they were flipping are now refinancing out of high interest, short-term loans to lower interest, long-term loans.

Most of the hard money lenders I know aren’t lending, those who are have increased prices.

Those with owner finance notes are expecting defaults with an investor response commensurate with the quality of their collateral.

Landlords are bracing for April 1st when rent is due. With eviction procedures being postponed tenants have less reason to pay their rent.

Commercial lenders are already seeing massive defaults on debt. Zillow has stopped buying houses and an insider friend shared they missed their last margin call from their lender.

Due to a tightening of credit, lenders may be unwilling to extend short-term loans, typically five year loan terms, to apartments and other commercial properties forcing property sales at discounts.

In speaking to successful real estate investors who have been in the business for more than a decade, many believe most opportunities are still two years out.

Defensive Tactics

Investors with significant assets and businesses are still focused on bolstering their defense. Concerns include:

  • Surviving
  • Running out of cash
  • Taking care of employees
  • Paying vendors
  • Paying high interest loans
  • Holding depreciating property (due to deflation and falling prices) while personally covering carrying costs
  • Legal liability to tenants and employees if response to Coronavirus is handled poorly
Defensive Measures:
  • Develop a plan A, plan B, plan C and plan D.
  • Flippers are working to refinances houses into long-term loans even if already have a pending contract
  • Draw down on lines of credit to the extent needed to cover cash needs for expenses, including PITI on property for at least six months. Paying interest is like paying for insurance for cash reserves.
  • Establish additional access to financing so you have multiple sources in case one or more dries up.
  • If you’ve suffered economic loss you could qualify for a 3.75% interest loan up to $2M from the SBA.
  • States, companies, and non-profits are providing loans, grants or other resources.
  • Sell assets like flips even at a loss to mitigate your risk of loss.
  • Convert flips to rentals
  • Defer large payments to vendors
  • Work with Tenants
    • Start calling tenants now. Make it a positive conversation not about rent collection. How are you feeling? Anyone sick? Are you still working?
    • Document their hardships, it might help you defer your mortgage payments.
    • Share business and unemployment resources to help tenants survive.
    • Landlords are still providing the legal late notice (depends on state) even through evictions have been postponed. Asking tenants for their plan. “A plan and some rent money is No plan and no rent money isn’t acceptable.”

Offensive Tactics

Wealth isn’t lost, it’s transferred during times of panic.

Many investors are scrambling to position themselves in anticipation of the many investment opportunities on the horizon. Those with significant assets are largely still focused on protecting those assets.

It’s still too early know how much and how long this crisis will affect real estate prices. Markets with the highest overvaluations will see the greatest price reversals.

Offensive Measures:
  • Deal flow
    • Relationships with brokers – let them know what you’re looking for. When desperate people decide to sell they’ll want to do it quickly and you want to be one of the first calls.
    • Touch base frequently with your network
    • Start increasing marking to sellers now
    • Follow-up with old leads
    • Passive investors should seek relationships with experienced lead investors in their chosen asset class
  • Build / keep your team
    • Growth – who do you need in place to survive and thrive during this economic crisis? Consider partners, advisors, accountants, attorneys, brokers, contractors, lenders, friends and key employees.
    • Retain employees – offer bonuses to employees to return if you put them on a furlough
    • Many established relationships will be shaken due to financial pressures. What has worked in the past may not continue to work in the future. Many will be open to new ideas and partnerships.
  • Secure leverage
    • Debt – develop access to multiple lines of credit and loans congruent with your chosen asset class
    • OPM – start building relationships and establish trust with passive investors now. Share what you’ve done along with plans and examples for what you want to do in the future.

Increase your expected ROI. Once you deploy capital it will take a while to return. There will plenty of opportunity in months to come. What are your expectations for a great deal? Expected ROI?

While I believe the best opportunities are yet to come, when you do see a great opportunity, secure the deal. It’s impossible to time perfectly. If I had a crystal ball I would be much wealthier. I expected the last market to end in 2017 and I was wrong.

How can you add value and serve others? This line of thinking has a way of producing wealth for those who become known for solving problems and adding value.

After Bill Gates took first place in his state’s math test, his school suggested he figure next year’s school schedule. He became known as a solver of complex problems. He was later asked to sort city traffic problems and eventually the local power plant, all as a high schooler. We know his wealth grew from there.

We’re all human

“Blood in the water” is a phrase I’ve frequently heard. Part of me is excited for the opportunity another part is sad. People have to bleed for there to be blood. Many are hurting and will suffer much more before this crises is over.

Some may point out that those bleeding were inclined to greed or incompetence due to buying and holding assets with such inflated prices. I’m sure that’s at least partly true.

However, I also know baby boomers are severely stressed watching the daily drop of their retirement accounts. Does a 30% drop mean they’re now going to out live out their money? How will they have to lower their lifestyle? Will they have to sell their house and move into a cheap apartment? Will they now have to rely on Social Security as their primary source income? Social Security is expected to go bankrupt around 2035.

Grant Sabatier, a leader in the FIRE movement, says, “I think the whole idea of retiring early will disappear because of this” (referring to the Coronavirus). The plan for many millennials has been to passively investment in S&P 500 index funds, live frugally, retire early and then withdrawal 4% safely per year. I’ve personally encouraged many in forums to look at other investment opportunities with a much higher ROI and stronger results. This is the first time most millennials have been affected by an economic downturn. Many are discouraged by the impact to their investments and selling out of panic. However, at least most in this group have some savings and aren’t living paycheck to paycheck like their peers.

I often speak of financial discipline and avoid making emotional decisions leading you to buy high and sell low. We’re human, we get emotional, it’s tough not to panic and make an emotional decision when you’re imagining the unexpected poverty or death you’ll experience due to a random virus.

As investors, it’s easy to divorce the personal hardship from the investment opportunity in the excitement of a great deal. Our own greed can get the best of us and we can miss an opportunity to help. Put yourself in their shoes. If you’re buying a house at a discounted price consider flexible terms or how you might be able to help the seller personally.

If someone’s child died because they put their finger in an electrical socket you don’t offer child proofing advice at the funeral. Time and place. Be gentle with those who have made panicked investment decisions, they’ve lost a lot of “blood”.

My goal is not to guilt trip anyone. My goal is remind you that someone suffered misfortune for you to receive opportunity. I encourage you to show compassion, grace and charity. In short, love people.

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