Summary: In this article, RealWealth® Investment Counselors tackle the major challenges facing real estate investors in 2021. They’ll share ways to weather current market conditions, prepare for the challenges ahead, and mitigate drawbacks to potential changes in real estate taxes.
Table of Contents
- 11 Major Challenges Facing Real Estate Investors in 2021
- The COVID-19 Pandemic
- An Economy in Recovery
- An Unstable Stock Market
- Buying Real Estate in a Seller’s Market
- Massive Public & Private Debt
- Lack of Affordable Housing
- Where People Want to Live is Changing
- Keeping Up with Technology & Workflow
- Underinvestment in Infrastructure
- More Evictions & Foreclosures
- Potential Changes to 1031 Exchanges & Ways to Mitigate
- What’s Next?
11 Major Challenges Facing Real Estate Investors in 2021
There are a number of major challenges facing real estate investors and the real estate industry as a whole.
Investment Counselors at RealWealth® are regularly speaking with property teams in different markets across the country. Aristotle Kumpis and Joe Torre, two of our Investment Counselors, discuss specific challenges investors should be aware of and how to best navigate the year ahead.
Here are the top 11 biggest challenges facing real estate investors in 2021.
1- The COVID-19 Pandemic
Only time will tell just how our lives will continue to be impacted by the global pandemic, well after it’s over. One this is certain, COVID-19 has forced us to leave our day-to-day habits behind and embrace new ones.
Will the demand for commercial and retail real estate go down as people shift to a permanent virtual office and desire to stay home for entertainment, rather than go out? A big question mark still remains about whether our future holds a necessity for social distancing and fewer people in public spaces. Airplanes, restaurants, movie theaters, offices, government buildings, concert venues, sporting events etc., may require bigger spaces (and likely higher costs) to accommodate these activities safely.
Real estate tends to fall behind other economic indicators. It’s anticipated that the economy will be in recovery for several years. As such, the real estate industry will experience longer lasting effects from COVID-19.
2- An Economy in Recovery
The Coronavirus has also caused massive uncertainty surrounding income. With so many people still out of a job, markets across multiple industries have been and will continue to be affected for years to come.
Key segments of our economy are still in disarray. Air travel, retail, construction, leisure and hospitality suffered huge losses in revenue. These industries are expected to slowly and maybe even only partially recover over the next few years.
There are some jobs that may never return to the workforce following the COVID-19 pandemic. New jobs will almost certainly be created to meet the demands of post-pandemic life. But over the next decade, we will have to find ways to adapt to our ‘new normal’.
3- An Unstable Stock Market
Instability of capital markets over the last three months has made it difficult to determine the cost of debt. With near-nothing interest rates, premiums for bearing economic risk, valuation metrics and underwriting have become essential to determining the cost of debt.
Financial help from the federal government for individuals and businesses has alleviated certain short-term implications caused by the Coronavirus. However, as late payments and defaults on loans have grown significantly, it’s difficult to know what a long-term solution may look like. What will risk look like in the future and how much will it cost?
4- Buying Real Estate in a Seller’s Market
While there has been a surge in new construction homes going up, it’s still not enough to meet demand. Inventory is hard to come by in a seller’s market because everything sells faster. And while new builds may be an option, they can take between 6-9 months to complete. Investors looking for renovated homes will also be competing with home buyers on the market.
Buying an investment property in a seller’s market can be a difficult proposition. But, there are some benefits that come from buying in a seller’s market.
RealWealth® Investment Counselor Aristotle Kumpis gives his expertise on the benefits of buying real estate in a seller’s market and potential pitfalls to avoid.
For starters, there’s a good chance that whatever you buy will continue to go up in value (at least for awhile). The value of homes increases in a seller’s market, so owning a property under these market conditions is a pro. Finally, if you’re thinking about selling, it’s always a good time to sell in a seller’s market.
Pitfalls for investors to avoid in a seller’s market typically include feeling pressure to make a rushed purchase due to lack of inventory and overpaying for a property. Or buying a property that isn’t the best investment opportunity.
Savvy real estate investors understand that real estate markets ebb and flow. While it may be a seller’s market now, eventually the market will even itself out.
5- Massive Public & Private Debt
In the last six months, the U.S. national debt has increased by more than $3 trillion USD (or $210,000 per taxpayer). More debt equals less investment activity and a strain on savings accounts.
Student loan debt has almost reached $1.7 trillion and now is greater than the overall credit card debt of $1 trillion. Millennials carry the greatest burden when it comes to student loan debt. Total personal debt has reached over $20.5 trillion and is only going up since the onset of COVID-19.
The rate at which national debt is growing isn’t sustainable long-term. Massive debt has an impact on several economic indicators. Lots of debt means higher interest rates and less money for necessary projects, such as infrastructure and commercial real estate.
6- Lack of Affordable Housing
Across the nation, there’s a huge lack of affordable housing. In fact, the National Low-Income Housing Coalition says there is currently a 7.2 million shortage of affordable rental homes for extremely low-income households (incomes at or below the poverty level). Further adding to the affordability crisis are the lack of homes for sale, which is contributing to rising rents and home prices.
The coming years could present more opportunities to invest in low-income or Section 8 housing…
7- Where People Want to Live is Changing
Last year, a Harris Poll revealed that almost 40% of people living in bigger cities were thinking about moving away from these areas amidst the Coronavirus pandemic. We are already seeing a shift in where people want to live. More businesses are looking to grow their facilities in suburban areas with more space and open floor plans. This trend may pick up steam as people look for ways to avoid highly populated areas and activities whenever possible (i.e. less reliance on mass transit).
With more people having the flexibility to move to areas with better employment opportunities, real estate markets should continue to feel the behavioral repercussions brought on by the pandemic. How long this shift in migration patterns may last, remains to be seen.
8- Keeping Up With Technology & Workflow
Drastic changes to technology and workflow within businesses began to take shape shortly after the pandemic hit. There’s been an incredible sense of urgency to come up with technologies and solutions to manage and minimize risks brought on by the virus. As companies look for ways to allow their employees to safely come back to the office, touchless doors and elevators, and the monitoring of air quality may quickly become a requirement, rather than a “nice-to-have”.
The pandemic has forced all of us to embrace these changes whether we want to or not. Buildings and spaces that are safer and more efficient will give investment property owners, landlords, and tenants greater peace of mind moving forward.
9- Underinvestment in Infrastructure
Historically, it’s been difficult to get funding for infrastructure projects. There’s expected to be a $15 trillion underinvestment in global infrastructure by 2040. Basic needs in infrastructure aren’t being met, particularly in already underserved and underdeveloped areas. This could very well have an impact on real estate prices and where developments are being built in the future.
More agitators of the infrastructure dilemma are the pandemic, extreme weather, cyber attacks and terrorism. Each demanding stronger, more adaptable and innovative solutions to our global infrastructure.
The way that retailers sell and deliver goods has become more complex and expansive with online sales taking over the greatest share of revenue. Will online shopping be a long-term trend that sticks? Or will people still want to go shopping when it’s safe? Real estate investors need to be aware of these potential shifts coming down the pipeline.
10- More Evictions & Foreclosures
The federal government has provided aid during the COVID-19 pandemic in the form of an eviction moratorium and stimulus checks. While this financial relief has helped stave off evictions and foreclosures for now, long-term solutions remain cloudy.
11- Potential Changes to 1031 Exchanges
There’s been much discussion about whether 1031 exchanges in real estate would be changed or terminated altogether. While many experts don’t expect a complete removal of the 1031 exchange process, there may be real estate tax changes coming in 2021. First, here’s a quick overview of how 1031 exchanges work:
- An investor buys a property for $100k
- An investor sells the property for $200k
- An investor uses the proceeds into replacement properties without having to pay capital gains taxes on the $100k gain.
Successfully completing a 1031 exchange on time when there is a low inventory of homes is a major challenge investors face in a seller’s market. Less inventory might cause an investor to buy something they don’t necessarily want.
Another major challenge facing real estate investors in 2021 is that new construction is taking a lot longer to complete than anticipated. These delays in new construction have been caused by a number of factors including: extreme weather conditions, lengthy permitting processes, shortages of lumber or labor, and COVID-19. All of these factors have resulted in months of missed deadlines on new construction homes.
Ways to Mitigate 1031 Exchange Challenges in a Seller’s Market
Even during a seller’s market, it’s still possible for investors to mitigate or avoid potential roadblocks. RealWealth® Investment Counselor Joe Torre shares his insights along with some helpful ways to ensure a successful 1031 exchange process during a seller’s market.
- Buy replacement properties first when exchanging for new construction (reverse 1031 exchange).
- Add three months to the anticipated date of completion
- Put Earnest Money Deposit (EMD) down in order to get construction started
- When the replacement property(ies) are within three months of completion, put relinquished property on the market to sell
- Identify more properties than you think you’ll need, in case one misses the deadline.
- I.e. Let’s say that one of your new construction replacement properties misses its completion deadline (or a renovated property falls out of contract), you’ll have a back up replacement property, still be able to complete the 1031 exchange on time and avoid the capital gains tax penalty.
- Add a “deadline contingency” in the purchase contracts for new construction.
- First look in markets with lots of inventory.
- If a deadline is missed, investors may consider buying the property with cash. Lenders won’t issue a loan on a property until it has a Certificate of Occupancy (CO). So if this certificate cannot be obtained before the 180-day deadline, you can choose to close with all-cash. Once the CO is issued, the property can be refinanced with a conventional loan.
The bottom line… When there is low inventory, it makes doing a 1031 exchange a bit more challenging for investors–however, doable.
“Get an inspection, even if you’re buying a new construction property. These days, builders are using sub-contractors more and more. As such, the quality of builds may vary. A rush to meet deadlines may result in a lower-quality product.”
There are many major challenges facing real estate investors in 2021–especially amidst the Coronavirus pandemic. During these unprecedented times, investors must be willing to adapt in order to survive. Smart investors will do their best to recognize and adapt to the challenges that we will inevitably face in the coming year.