a16z Podcast - Real Estate in a Pandemic: Renters and Landlords (Part 2)

Episode Date: June 17, 2020

This episode is the second in a two-part series that examines the pandemic’s impact on real estate. Part 1 focused on prospective home buyers, sellers, and existing homeowners. This episode, Part 2, addresses renters and landlords.The conversation with host Lauren Murrow features a16z general partner Connie Chan, whose experience as a landlord herself has fueled her interest in residential real estate and technology; Richard Green, the director of USC's Lusk Center for Real Estate, and Adena Hefets, the CEO of Divvy Homes, a company that allows people to build up equity while renting a home, with the option to eventually buy it.We begin with the pressures on renters—and the uncertainty around federal relief measures—as well as the cascading effects on mom-and-pop landlords. Then we turn to the outlook for prices and volume in the rental market, particularly in large cities like New York and San Francisco. Finally, we discuss the opportunity for tech to solve outdated and inefficient processes for both renters and landlords.For more a16z content on real estate and proptech, visit a16z.com/realestate.

Hi and welcome to the A16Z podcast. I'm Lauren Murrow. This episode is the second in a two-part series that examines the pandemic's impact on real estate. Part one focused on prospective homebuyers, sellers, and existing homeowners. While this episode, Part 2, addresses renters and landlords. The conversation features A16Z general partner Connie Chan, whose experience as a landlord herself has fueled her interest in residential real estate and technology. Professor Richard Green, the director of USC's Lusk Center for Real Estate, and Edina Heffitz, CEO of Divi Homes, a company that allows people to build up equity while renting a home with the option to eventually buy it. We begin with the pressures on renters and the uncertainty around federal relief measures, as well as a cascading effect on mom-and-pop landlords. Then we turned to the outlook for prices and volume in the rental market, particularly in large cities like New York and San Francisco. Finally, we discussed the opportunity for tech to some.

solve outdated and inefficient processes for both renters and landlords. The first voice you'll hear after mine is Professor Richard Greens, followed by Edina. So nearly a third of the country's 40 million renters didn't make the rent payment on time in April, around 20% didn't make payment in May. That's according to the National Multifamily Housing Council. So can you put that into context for us? What is the norm and are these numbers to be expected given the scope of unemployment? actually the may numbers are not that far off of what a normal month is so when they give that number

that's rent payments as of the first week of the month so you never see a hundred percent come in the first week you can explain that difference between the collection rate at the beginning of april and the normal rate just based on unemployment and a big difference between april and may is that our creaky unemployment systems hadn't got money actually out to people yet in april Whereas they've actually got okay at getting money out of people in May, which is allow them to pay the rent. And we saw this during the global financial crisis as well. People show that they really want to pay the rent if they can. I think what Richard said is exactly correct.

It was actually by the end of the month only a slight delta. With regard to how it ties to unemployment, unemployment tends to be higher in renters than it does with homeowners. Call it close to 20% unemployment amongst renters. And so if people get unemployment benefits, stimulus checks, if they have a way to make their payment, then they do. And what we're finding is that there's this delay in when folks can actually make their payment, but ultimately they are trying to fully meet those obligations. So should we be then encouraged by the data? Or perhaps as coronavirus lingers and stimulus payments have gone out,

do we expect that number of renters unable to make payments to grow? How do we think about it going forward? Well, I worry about a cliff coming. So these supplemental unemployment benefits expire in July. Congress has yet to pass a law that will continue those supplemental payments. If that actually happened, then I think the rental sector will be in really good shape for a while. But if Congress doesn't come back and pass something, then I think we are going to face real problems toward the end of the summer this year. Yeah, I'm worried not just on the renter payment side, but potentially, if you think about all the folks who are doing short-term rentals beforehand, who then started putting their units on market for long-term rentals and they're not getting takers, that dynamic is not getting captured in that statistic.

How do you anticipate this crisis shaping the rental market in the short term? In particular, I'm interested in volume and prices. Well, it certainly slowed down the pipeline of new supply in two dimensions. One is there are places that new construction is banned. There are other places where it's going on but with social distancing. Now the interesting thing is when I talked to builders, and these are apartments a month ago, they were saying it was slowing down their construction by about 50%. Now they figured out how to now return to production speed. that's quite similar to what it was before COVID.

But that by itself, of course, slows down the pipeline of new supply. And the other thing is what developers are telling me is nobody is acquiring land right now to build on. And the reason is nobody knows what the price of land should be at the moment. So I think there's no way around it. You're going to see a slowdown in supply of new stuff for the next 18 to 24 months for sure.

Meaning less supply is so prices should hold. What was striking to me is during the low financial crisis, you look at a place like Los Angeles, which was disproportionately hit. You saw rents fall, but they fell by only about 10%. And you never saw a big increase in vacancy. And that's because, again, they're just weren't enough units available. The other interesting dynamic, if you look at rental pricing falling already in some early cities, is that's based off a very small end. And you have to also remember we're in the midst of COVID, where some folks, even if they want to move out, are just, not dealing with the process of moving?

It's sort of inevitable that as people are unemployed, they're going to start moving out of places, and so we'll see vacancies rise and rents fall as a result of that. I think we have to get a little bit more specific. You need to be more nuanced. Do I think that multifamily rent might fall? Yes. Do I think that single family? I've actually, what we've seen is a flight from multifamily to single family homes during the COVID period.

And so rent and supply and demand fundamentals within those two different sectors might vary pretty significantly. It also depends on what metro you're located in. Where we saw some rents soft in an area like Dallas, we actually weren't seeing that at all in Atlanta. It's very supply dependent, so different metros are going to have different amounts of supply coming on market. We're seeing prices hold up on the single family side, on the owner's side. And I think it's because nobody's being forced to sell their house now because they have forbearance on their, loan, so you don't have this flood of people trying to get out. And as a result of that, sales are down like 60%, but so are listings. So I think both on the existing side and the

new side, yeah, there's going to be a substantial reduction of supply for a while. But I'd be curious what Adina has to say about that. Let's say three months goes by and there's a wave of evictions. And so there's a ton of rentals that are all available and there's not a ton of demand. well, then rental prices will probably drop. If that's not the case, if stimulus continues, if landlords are willing to work with their tenants and there's a limited amount of supply of rentals, I think what we'll actually see an increase in demand for rentals,

in which case rents will hold. My personal belief is we're seeing more demand for single-family rentals. It is harder than ever to get a mortgage. The average FICO of individuals who are applying for DIVI has gone up significantly. We actually track the percent of people who have mortgage declines on their credit report who are applying to DIVO of individuals, and that's actually gone up pretty significantly since COVID has started. Basically, people cannot access a mortgage.

And so they're starting to turn to rentals to try to access getting into a single-family home and moving away from multifamily rentals. And there's going to be, I think, a real problem because people who are going to see their FICO scores get trashed. Now, if they have forbearance on their mortgage, that's going to be fine because services have been told not to report that as a credit event. But renters who default on their leases, that can be a credit event. And on the other side, we're seeing lenders do what lenders always do,

which is behave pro-cyclically and tighten up credit standards for getting a mortgage. I think we're now in a world of a basically $7.60, $5,000 or above to get a home mortgage. I want to touch on a point that the majority of those who have lost income due the pandemic are renters rather than homeowners and rent. The renters typically have lower incomes and savings and typically less job stability than homeowners to begin with. So for that reason, this has been called more of a renter's crisis than a homeowners crisis. At the same time, federal relief efforts have thus far primarily focused on homeowners. For example, the CARES Act gave homeowners the ability to deferred mortgages.

But the majority of renters are not covered by that. So if this is indeed impacting renters more so than homeowners, why this skewed relief? I think it's important to note that in general owners have been favored over renters, not just through this crisis. One of the reasons for that is homeowners vote in greater numbers than renters do. Not only are there more owners than renters, but among those that are owners, they're more likely to go out and vote the renters. I think that has implications for a wide swap of land use policy decisions we see along with

subsidy policies. Only about a quarter of renters who are eligible for a subsidy actually get one. And I think thinking about changing that balance and how we subsidize housing would be a worthwhile thing, not just at this time of crisis. This is a really, really hard time on a lot of consumers, and we get it. No parents should have to decide to bring food on the table for their kids and paying their rent. And I'm a landlord, so sympathetic to the landlord side, I think it's important to be sympathetic to what the tenant is going through.

I would love for the government to backstop all rent payments and take care of that perenters. That would be ideal. but the government did cause evictions, and they also closed down all the court systems. They did encourage landlords to work with tenants and to accept partial payments, to waive all laypies, and they gave guidance that they should encourage credit counseling and offer to pay for that. So if you choose not to pay your rent, for the last two months, there is nothing your landlord could have done. They couldn't evict you, but the stimulus check that did go out, the point was that it would be used for bills and your payments that can do, including your rents.

Dina makes a good point, which is in the short term evictions are on hold in many cities. It's obvious many renters are facing hardships and thus activists and politicians are calling for rent forgiveness. But landlords with mortgages are still responsible to the banks who answer to investors. So what does that impact on landlords? So as a private citizen or a corporate, you still have obligations that you have to meet even if that person is not paying rent. Now, I'm not saying that we should be pushing tenants towards making payments who are going

through financially hard times. But I think that there is this balance to realize that landlords are not eating off a ton of profits. If you look at profits by landlords, it's insanely thin margins, right? If you look at least at single family rentals, single family is 98% owned by mom and pops. And it's not the government that owns that. It's individuals, right? It's not wealthy corporations generally. And so there was no way in which the government can, without providing some sort of a stipend, just say, hey, renters, you don't have to pay because the owners were, we're private citizens, right? And so it's this fine balance between figuring out how to provide relief for renters, but then also recognizing that landlords have these fixed costs that they can't

get out of. I think that's a good point. So much of my interest in prop tech comes from being a landlord. And a lot of those landlords, because it's an investment property, they're not necessarily eligible for those home equity loans that banks will give much more easily to an owner-occupied home. So a lot of these landlords who do need that money for maintenance, they are now looking to even hard money lending options just to have that bridge for that short-term cash flow. I think a lot of people imagine that landlords are people who sit on their couches just watching the money roll on in. It takes a lot of work to be a landlord. So when you're asking people to take no compensation for their work and they don't get unemployment benefits for that,

that's asking a lot of people, along with the fact that they need to pay their insurance and they need to pay their property taxes and they need to pay their maintenance. 62% of rental properties are owned by people for whom that is the only rental property that they own. So, yeah, the idea that you just say to a very narrow group of people that you need to bear the burden of this crisis by yourself seems on its face pretty unfair. It seems to me, again, the best way to get at this is you do it directly, you give the tenants the resources they need to pay. And then mandate that it's used for rent.

And then you say to landlords, in exchange for this, you're talking to your tenants and you're not kicking them out. And you're certainly not being opportunistic. We hope, of course, that as we start to see things open back up, then employment bounce back and people will be able to pay their rents. But if that's not the case, and this continues, or in the fall there's another wave and tens and millions of tenants are not paying rent, then I am a change. interested in that cascading effect and what solutions you propose.

Well, this is, I think, where there's a lot of data of what happens in a recession to rent prices and people's ability to pay. Yeah, so house prices are much more volatile than rents are. And so rents fall, but not by that much. And don't they bounce back quite quickly as well? Yeah, they do. In Los Angeles, after the global financial crisis, we were back on our previous path about three years after.

I don't want to extrapolate that what happened during the last recession, which was a housing-led recession, is going to be what happens during this recession. What we saw during the last recession was actually quite a bit different, but during the last recession as unemployment spiked, we saw that there was a pretty high correlation with home prices, and home prices started to drop. But you have to live somewhere. You either rent or you own or you live with a family member, we actually saw a flight to rentals. And so if you actually look on a month-over-month basis, going back almost as far as we have data across, the U.S., there were only like five to ten months, literally in the history of time, that rents actually declined. And most of them were during the recession where it stayed roughly flat. So I would say rents do actually tend to hold, because during these times of recessions,

people can't actually access a mortgage. And so they end up turning a bit more towards rental invitation homes. And all the major single family restarted during the Great Recession wide, because they saw this, which is rents held even during downturns. But now we have to get two regional differences. And here's why sort of the places with 20% unemployment, which is what we're talking about here, you know, Las Vegas did see rent declines. The inland empire of California saw rent declines.

Arizona saw rent declines. I agree with that. But it is metro-specific for sure, yes. I think the last recession didn't hit unemployment in the way that this current situation is hitting unemployment too. Right. Which is why I think Vegas is the place to look at because Vegas did see an unemployment rate of 20%.

a last recession. That is fair. I actually recently ran a correlation between home prices and unemployment during the last recession. And it's actually like an offset of about two years where your unemployment would determine your home price two years later. And I agree with Richard completely. When you do look metro specific, there could be more nuanced. So this is something we've all circled around, but I want to pose the question, which is do you anticipate the pandemic will have lasting effects on the rental market? I think 10 years from now, things will be fine. But I do think in the near term, again, very metro-specific, things could get shaken up quite a bit. Yeah, I think for three to five years, tall buildings are going to have a really

hard time of it. I think in the absence of the vaccine, I think any kind of density, particularly for Americans, is going to be unappealing. I think the single-family rental market makes a lot of sense to me. But I think tall buildings with elevators for the next three to five years, that's going to be a tough segment. And then in 10 years, do you think it's going to be a wash? Yeah, I think people in 10 years forget. One of the things that I find miraculous is the world's great cities seek to overcome anything, not immediately, but ultimately. I mean, the ultimate example was Tokyo's GDP was 90% wiped out after World War II. Japan could have reorganized its economy all over the islands. What happened? It all came back to Tokyo. You look at lower Manhattan,

it lost 150,000 jobs in the immediate aftermath of 9-11. And within six years, all of those jobs were back in lower Manhattan. People didn't care they need to be back. So yeah, I think 10 years from now, unless we have another event like this between now and then, New York will be New York and San Francisco will be San Francisco. The other thing is marriage is an important predictor of other people, owners or renters. And one of the reasons that millennials are not big owners is because their marriage rate is just very low relative to past generation, even controlling for how old they are.

We have way more 30-somethings who've never been married than ever before in American history. And maybe this is a little fanciful, but I'm wondering if the pandemic is getting in the way of dating, how do people date right now? And could that delay marriage even further? And that would have a positive impact on the rental market. The thought has crossed my mind. There's a thing called Zoom dating now. Everyone does it.

It's love in the time of Corona. Lots of my friends are starting Zoom relationships. So you're arguing this could actually speed up marriage? I'm not making that argument, no. I'm just saying people have found ways to make it work. Adina, what's your perspective? Do you anticipate the pandemic will have lasting effects on the rental market? If you think we're going to have a vaccine by January,

and you think the government is going to continue to stimulate the economy and offer straight cash to a lot of the citizens here, but I think everything will be fine. However, if you think it's going to be two years until we get a vaccine, and you think the government will not continue to stimulate the economy and unemployment states where it is, I think it's going to be tough across the entire economy, including housing, which is the largest share of GDP, right? There's no way we have 20% unemployment for the next two years, no vaccine and no government stimulus and the larger share of GDP doesn't get impacted. I personally think over the short term, single family home rentals are set up pretty well for success. I agree. I think any kind of a

rental investment property, I would probably put single family rentals at the top just because there's also more liquidity. If you are a landlord and you own that home, you could rent it out, but you can also sell it. And so you do have other options. But for me, the issue with single family rental has always been the management issue. And so the reason we tend to have multifamily rental and single family owning is you get economies of scale in property management. The single family stuff, a lot of it is do it yourself. If the plumbing goes, you either go to Home Depot and buy a toilet and try to figure out how install it yourself or you call a plumber. Whereas if you have 300 units, you can actually have your own plumber who just deals with stuff under your

daily basis. So how do you manage those sorts of day-to-day issues when you're doing single family? Do you have a plumber or an electrician on call? How do you solve that work? I'd say, yes, this is the biggest challenge, and that's pre-invitation homes or American Home's friend. Everyone thought this was impossible. They built with what I would call very little technology. We're able to make it scale. The way that we handle it at Divi is if a maintenance request comes in, it actually gets automatically assigned to a specific category. It gets priced out and it actually gets automatically routed out to a bunch of subcontractors that we have on the ground. Those relationships takes a lot of time to build up because you're right, we couldn't

operate otherwise. But because we're setting them volume and it's automated and we pay them within 24 hours, they actually offer you better discounts because you're supplying them with jobs in bulk. And so we were able to automate a large portion of the maintenance and then use subcontractors on the ground. A lot of younger folks don't have the patients to go through Yelp and call 10 different plumbers. They don't want to go through that kind of hassle. They want to do something like the ticketing method that Adina described. I take a photo of the thing. I send it to my land order. It automatically creates a work order. I get in real time transparency over how it's being handled when it's being scheduled to get fixed. It's quite a challenge, but it's something that

technology can address. I think it's a good segue into the opportunity for tech. Real estate is traditionally a pretty inefficient market. Where is there opportunity for tech in the face of these challenges, to either streamline processes or solve some of these pain points? There are not a lot of technology companies that focus on rentals, and those that do tend to focus on taking rent payments, reporting rent credits, so basically reporting rent to the credit bureaus so that they can track that and report it. To some extent, you can look at apartments as being like seats on an airplane or rooms in a hotel. It's a stack of capital, and you want completely fill it and so developing algorithms that maximize yield and the problem is right now

I don't think those algorithms are sophisticated in the following way is you will look at an existing tenant and you evaluate them the same way as you evaluate a new tenant that's a bad idea is an existing tenant as a track record with you and if they move out even in a strong market that's among the fourth bond rent because you need to pay need to do the maintenance that you have to do. And so a really good price elasticity algorithm that would tell landlords what is the right rent to charge given market conditions. I think it's a place that technology could contribute to help landlords ring the most

efficiency that they can out of their properties. Certainly. There is no good data source for small mom and pop landlords right now to figure out what to charge. They basically go on Craigslist Sorzillo. they look at other homes in the neighborhood, their data is sometimes based on a very small number of listings. And I think another problem that tech can help solve is helping landlords and banks understand what's behind the credit score. You know, the FICO score that got hit

from a one-time medical emergency versus the FICO score that's low because the person always overspends and always has overdraft issues should be viewed upon differently, right? So how can we use tech to better measure responsibility and truly get a sense of, is this person now going to be able to make their rent payments? I think that's a big opportunity for software. Right. In many ways, the way we underwrite people is based on 1980s, 1990s standards, even though Fennie and Freddie and others have models. They're still using FICO5. That means they're using a 20-year-old algorithm to evaluate people's credit. At the end of the they don't believe the models, they still go back to heuristics, and the heuristics are not

particularly good in terms of measuring credit risk and are really problematic in that people from non-traditional backgrounds, immigrants, people of color, older people who are very good credit rates, don't get easy access to credit. You have large swaths of people, largely immigrants, who pay for stuff with cash. People who pay rent every day. month, month after month after month are good credit risks. So the interesting thing is if you pay rent every month, you don't get any credit for it. But if you default on your rent and get kicked out, evicted, then that hurts your credit score. So there's an asymmetry to how that's done. And if you use a simple econometric model to evaluate credit based on actual payments going in and going

out, you do a much better job of predicting loan performance than if you use the methods we have right now. I would love to see a world where we use data, where we use modeling as a foundation for doing underwriting in all kinds of dimensions of life. And I think we'd have a more inclusive world as a result of that as well as a more accurate evaluation of credit. Yeah, and the reason why this is important is that FICO score is not just used when the person's trying to get a mortgage. Landlords are all looking at credit reports when they decide which tenant to choose. So where we found that technology has been able to really help on the rental side is, one, quickly assessing risks in financial services, this idea of underwriting models is something

that's only come about. I'd say in the last 10 years, which is being able to pull in someone's entire credit history and assess if they're getting into a rental situation that they were set up for success or failure. And what I mean by that is you can go on crisis and post $2,000 rent a month in San Francisco and do you want this apartment? And someone can make a judgment as to whether they can afford that or not. However, understanding really what your debt obligations are, what your income is and really what you could afford and what's a safe amount is something that's pretty hard to do as an individual. The second place is driving efficiencies through managing a large rental portfolio. So things like, for example, on the maintenance side, making sure you can actually

scale up a large rental portfolio be able to offer it and get some efficiencies for mapping technology automate a lot of the back end. So I'd say not a lot of technology in the traditional industry where most of the whom's their own, technology has not fully penetrated it yet. But I think that's also the opportunity, right? Because there is a lot of friction. There are multiple players. A lot of the processes are somewhat predictable or foreseeable. And so there is a lot that technology can do.

In real estate, even just on the payment side, it's crazy what percentage of it happens through checks or cash. Speaking on behalf of the small mom-and-pop landlords, I used to accept rent with checks, right? My mom used to accept rent with direct bank deposits. But if you think of it from like the small landlord side, checks is not necessarily a great option. Checks can bounce. You have to go check your mailbox. You have to go to a bank or use your phone to cash it in.

We can't rely on PayPal, Venmo and so forth. Actually, not only do they have limits on how much money you can transfer it to your bank account every week, there's also a lot of stuff you put yourself in danger of around partial payments and other things. And now we can use mobile apps to collect rent, and we use the same app to chat with our tenants, so everything's in one place. And so I think there's a real need for software in this space. Even those small things around rent collection make a huge difference.

I think once people realize you don't have to go drive to the rental to pick up a rent check, and there are safe ways to do it online, how can you go back to the old ways, right? We use Stripe to power our entire back end where people opt in, and then we've automatically debit their account, and then we literally pull that money in, parse it between what is actually going towards building their equity savings in the house and what's actually going towards us as rent, and then waterfall that out to our investors and debt providers, and all this is done completely automatically, which is something that 10 years ago couldn't have been done. So there's definitely a lot of technology that has smoothed out the process,

but one of the things that is just true is owning a rental property, be it a multifamily building or a single-family home is highly capital-intensive. That's not sort of course, right, this capital that's generally more legacy players. And so what we've seen is it's just taken longer for technology and innovation for people to actually come and fully own the asset and be able to actually provide a rental experience. That's why 98% of single-family rentals are mom and pops, even the largest company invitation homes, even though they're backed by Blackstone, they have 80,000 homes, and that is the biggest company, right?

They own less than half a percent of the market, and their $20 billion enterprise value, they were a couple months before COVID. So all that's to say is technology is new because it is capital intensive, as is most fintech companies, which is something that has to be chipped away at slowly. I think Adina raises a really important point about when you have a very capital intensive industry, it's hard, I think, for technology to be transformative. Do you think of places where it's transformative, it's in places where it's in places with relatively little physical capital and where ultimately you can get big margins.

And in real estate, getting big margins is a really, really hard thing to do. However, one counterthought, though, is yes, real estate is operational and capital intensive, but also so much of the dynamics around real estate is created by government. Think about what percentage of mortgages are backed by the government now, right? So many issues around getting a loan around tenant landlord law. These are all government instituted policies. And therefore, if you look at something like an Airbnb, when they can come up with a business model that unlocks either additional supply,

whether it's investors or homeowners or renters or what have you, that could also be a huge opportunity, right? When you look at any kind of sector that has so much government intervention and shaping. There's got to be arbitrage opportunities. There is definitely arbitrage opportunity in the space, which is why we stay very optimistic on PropTech. I agree on the experience. It was kind of like when there were SBA loans

that were the cheapest possible loans and then Lending Club came out, which was you can get a small business loan much quicker, but you're going to pay more, right? We can definitely improve on the customer experience on how quickly you can apply, how quickly you can get a mortgage to have people like better mortgage

on the home purchase side. The issue is that the government subsidizes home purchases. You can get a loan for a house cheaper than you can get any asset loan, period. If you are a qualifying borrower, which is shrinking in terms of how easy it is to qualify. 100% agree. All that says it's hard for private corporations to compete on price. What you can compete on, though, is providing a better customer experience and opening up the housing market to a larger percentage of Americans, whether it's on the rental

or a home purchase side. That's why I'm so acutely aware of the lack of technology, the fragmentation. the value of all the data that actually is being generated, not just how much you're paying for rent, but all other kinds of things around how well that house is being maintained. I think real estate's super exciting to me because it has all those things. Strong fragmentation, which technology is generally a great solution for. Finding more use cases for the data that's really right now stuck in people's memories or Excel spreadsheets or filing cabinets.

So again, you also have a treasure trove of data. You have lots of financing needs, and we've talked before about how fintech is really an obvious, huge opportunity for both renters and homeowners. So I do think the need for technology, even just to do our everyday business, is there. Great. Well, thanks for joining us on the A16D podcast. Thank you. Thank you. Thank you very much for having me.