To follow up on last month’s letter, we’re sharing a detailed analysis of how we believe the pandemic will continue to evolve, and the latest measures we’ve put in place to protect our entire investor community.
- We believe that we are still on the upward slope of the curve when it comes to the spread of the coronavirus across the country.
- As a result, the extent of the negative impacts on the broader economy remain uncertain and the risk of a prolonged downturn is real.
- Our duty, as investment managers, is to take the hard but necessary steps to protect the interests of our investor base as a whole during this time.
- Therefore, we’ve suspended redemptions for our mature eREITs and eFunds in order to maximize cash reserves and ensure the portfolio is in a position of strength.
- Lastly, we completed an extensive stress test of every asset we hold and are sharing the results in order to provide transparency into why we feel confident our portfolio will outperform most other investment assets through an extended recession.
Less than thirty days ago, we sent a letter to all our investors describing our concerns about the emerging coronavirus (COVID-19) global outbreak. Since then, it has been a sobering experience to witness how quickly the world has changed.
At that time, the US had approximately 1,000 known cases of COVID-19. As of this writing, there have been more than 245,000 confirmed cases reported.
It’s difficult now to remember that, even then, many people were still skeptical about the potential scale of the outbreak and most could not imagine the prospect of America’s major cities going into lockdown. But here we are.
Today, we suspect that there is not a single one of our investors who has not been directly impacted by this pandemic in a significant way.
It’s important to reiterate a point that we often make when sharing these types of letters, which is that our goal here is transparency. We do not attempt to predict the future, nor do we believe that we are always right in our assumptions. We do, however, believe that being transparent in our thinking and the resultant course of our actions is imperative.
To that end, we want to walk you through the details of how we believe this situation will continue to unfold, and the critical steps we are taking as a result.
The virus and the economy
We are not scientists. Nor do we believe that anyone can truly feel confident today forecasting the near future. But as investment managers, we have a responsibility to prepare for a wide range of outcomes and rely on the data to help us make the best decisions possible for our investors.
Though painful to acknowledge, we believe the evidence suggests that we are still on the upward slope of the curve when it comes to the spread of the coronavirus across the country.
As the case count continues to rise, and stories of overwhelmed hospitals become more and more frequent, it’s difficult to imagine that many people will not shift towards more genuine panic. We believe that this period of panic will reach its peak somewhere between 2-6 weeks from now (the exact timing being somewhat dependent on locale).
Yet, as more cities and states fully embrace the need for “shelter-in-place” mitigation, we also believe that cases will eventually begin to taper. What remains unknown is just how long it will take for these steps to actually bring the virus under control, and what the new normal looks like then. It is not unreasonable to assume that we won’t be able to return to a world more like what we knew pre-COVID-19 until a vaccine is developed, which even in optimistic scenarios is likely a year off.
What’s so different about this crisis (that many others have also identified) is the fact that the keys to combating the outbreak itself simultaneously act as massive brakes on the broader economy. Like trying to bring a high speed train to a full stop in only a matter of seconds, this kind of universal emergency shut-down is creating an extraordinary (and unpredictable) cascade of negative side effects.
The big question which no one knows the answer to is if this domino effect of having to close such a large number of businesses will lead to a prolonged recession… or worse. At more than $21 trillion in annual gross domestic product (GDP), shutting down the entire US economy for only a few months could mean such a huge loss in output that even the unprecedented combination of the $2 trillion congressional stimulus package and the Federal Reserve’s promise of unlimited quantitative easing may not be sufficient to restart the metaphorical engines.
There’s simply no “on-off” switch for the economy.
Fundrise investor portfolios
Given our ongoing concern that what started as a health crisis will spread into a liquidity crisis, followed by a credit crisis, and ultimately end in a recession, the next logical question is, “What does this mean for my Fundrise portfolio?”
In short, we’ve spent the last several years building the broader Fundrise portfolio, and by extension the many unique permutations owned by our community of 130,000+ individual investors, to be a fortress specifically designed to withstand this type of severe downturn.
We view each property that we collectively own or have invested in as another brick that’s been carefully laid by hand to form a secure barrier. And the dollars that we hold in reserve are the stores of grain, meant to ensure that our entire investor community can endure a long, harsh winter.
Up until now, our singular focus has been on acquiring assets that we believed would outperform during a period such as this. At times we’ve looked smart, when the stock market crashed and fears of a potential recession started to surface. And at times we’ve looked foolish, when the stock market rallied and prospects of endless prosperity swept over the country.
But regardless we kept at it, unwilling to compromise in our convictions.
We’ve also been intentional in telling our investors what we were doing, sending the same letter to every single person who’s ever invested with us.
“We [consistently seek] to make sound investments with strong fundamentals, even if it means being slightly more conservative in our approach than others around us. We focus on the intrinsic value of the real estate, choosing to invest in areas with high barriers to entry and at prices that are at or below replacement cost (i.e., below the cost to construct a new building of similar quality). We believe strongly that if we invest in markets with stable or rising demand and own properties at a lower cost basis than our competition, then over time our investments should experience stronger than average performance — even if the market goes through a downturn.”
Today, the result of that work is a portfolio which is more than 80% made up of rental apartments and residential senior loans (an asset type that we’ve stated before we feel is likely to be one of the best-performing investments during this crisis). In addition, virtually all of the remaining 20% of the portfolio consists of mixed-use property investments located in major urban markets, owned 100% equity with no leverage — an approach, we also believe, is one of the lowest-risk options available today. Lastly, the portfolio also has roughly $175 million of cash reserves (our grain stockpile) currently held in government money market funds.
In total, from a risk-adjusted-return standpoint, we believe the portfolio is as well positioned to be able to sustain a severe economic downturn as any other investment asset with which we are familiar.
Portfolio stress test
To substantiate this belief, we’ve spent the last few weeks conducting an in-depth analysis of every single asset in the eREIT and eFund portfolio (213 in total) and stress tested them against an extreme downside scenario — a forecast period where stabilized multifamily apartments experience more than 30% economic vacancy for approximately twelve months (for reference, this is approximately 3 times the amount experienced during the financial crisis of 2008, which according to the Federal Reserve peaked at around 11.1% nationwide).
Summary of stress test results
As evidenced below, we believe that even under this scenario where we experience greater distress than in the Great Recession of 2008-2009, nearly the entirety of the portfolio would still be able to perform with little to no principal risk, assuming that a minimum $50 million of our $175 million cash reserve was available to either cover potential operating shortfalls, continue with development that is already in process, make debt paydowns, or in the very rare instance step in and take over as manager of the property. Of course, while we believe the assumptions made in this stress test analysis are extremely severe and ultimately unlikely to occur, we cannot guarantee how the future will play out.
*In the stress test scenario, some assets may experience temporary dips in value or periods of lost income, which we believe would rebound over the full lifecycle of the investment. However, there can be no guarantee that the conditions created by the ongoing COVID-19 global pandemic, or any other future unforeseen event, will not result in greater stress on the assets than is demonstrated here.
Detailed stress test results
Click here for the full set of assumptions and property-level analysis.
Why we are suspending redemptions
Fundamentally, Fundrise investors own real property, which is simply not liquid. Fulfilling redemption requests in today’s environment would mean either substantially depleting vital cash reserves, or even worse, potentially selling assets into a down market, and likely at a price far below actual value.
As highlighted above, the availability of cash reserves is a critical piece in our stress test scenario of an extreme downturn. Having lived (and invested) through both the 2001 and 2008 recessions, we have learned that no matter how strong the quality of your assets, the ability to make additional capital infusions when necessary is an indispensable element in successfully navigating unexpected economic shocks.
Therefore, we’ve determined that it is necessary to suspend redemptions across all of our mature eREITs and eFunds.
Some may question why, with such confidence in the portfolio, could we not use a portion of the cash reserves to fulfill existing redemption requests?
And the answer is that we strongly believe choosing to reduce cash reserves or sell assets at this time would cause a material increase in the risk of unnecessary loss or otherwise avoidable problems for the vast majority of our investors who intend to stay invested for the long term.
Time may prove that our concerns about the severity of the downturn never come to pass, however, there is a legitimate possibility that this pandemic unleashes the greatest threat to our economic prosperity since the Great Depression. In such a world, the liquidity reserves held at the funds would become the safeguard that protects our investors against the threat of meaningful losses.
Although we’ve made significant efforts over the years to communicate that this type of suspension was an eventuality that comes with the territory of investing in real estate — such as including the following statement in the aforementioned letter about what to expect from us during a financial crisis:
“...while under normal market conditions we seek to provide our investors with liquidity through the redemption program, during a financial crisis, investors should expect us to pause the program to allow enough time for whatever events may unfold.
— we’re also mindful of the fact that this will ultimately be a difficult and unpopular decision for the relatively small portion of investors who have an outstanding redemption request at this time.
We know that there will be those investors who’ve been disproportionately impacted by this pandemic; some may have been recently laid off and are seeking to redeem their funds to help pay for critical expenses. Telling that individual we cannot process their redemption at this time will be, without question, one of the more difficult conversations we’ve had since starting the company.
However, as manager of the funds, it is our obligation to put the interests of the entire investor community first. We could not, in good conscience, make a decision that was directly in conflict with the framework we’ve provided every investor as to how we would act in such a scenario. Nor could we give preference to the small percentage of the investors seeking to redeem today and risk not having access to those critical cash reserves in the future, again to protect the vast majority of our investors who intend to stay invested for the long term.
We truly hope that over the ensuing weeks and months it proves out that we were in fact more conservative than necessary. That would mean the virus was subdued quickly and economic conditions could return to a more stable state. In such an event, we would most certainly return to normal operations and once again resume fulfilling redemption requests. But while we hope for the best, we must plan for the worst, which means not delaying the hard decisions, just to spare ourselves tough conversations.
What it means going forward
Since starting the company, our mission has always been to treat every individual investor with the level of respect and transparency that a professional investment manager would demand. Rather than assume individual investors were not sophisticated enough to understand the world of alternative investments (and therefore should not have access to them), we set out to provide our investors with the same type of investment product that had traditionally been reserved for only the largest institutions and then gave them the power to make their own decisions through a user-friendly digital experience.
The result is that today Fundrise investors are arguably able to own real property in a more direct and low-cost way than was previously ever possible. But it also means that collectively, in times of financial crisis, the Fundrise investor community is agreeing to forgo individual liquidity in order to maintain shared stability within the portfolio and preserve value for the whole.
Unlike in the stock market, where you are alone in a zero-sum competition against thousands of financial services firms and their software algorithms whose purpose is to make money for themselves at your expense, Fundrise exists to direct the collective force of 130k+ individuals into one cohesive actor, providing our investors with the power and opportunities that otherwise only exist for the billion dollar institutions.
As we’ve shared many times before, our loudest skeptics have always told us our fatal flaw would be that in a time of financial crisis the individual investor would panic, attempt to liquidate their shares, force us to sell assets, and in the process drag their fellow investors down with them.
We’ve waited for almost ten years to prove them wrong.
Going forward, our more mature eREITs and eFunds, in which redemptions have been suspended, will also pause accepting new investments. These funds were raised and deployed in the pre-COVID-19 world, and because we believe that the panic from the coronavirus outbreak will still get worse before it gets better, our immediate near term focus for these funds will be on shoring up existing assets and moving forward with those projects that may specifically benefit from continuing to make progress in today’s environment.
At the same time, for those investors who continue to invest for the long-term, new investment dollars will go into new funds that will raise and deploy into strategies tailored specifically for the COVID-19 world in which we live in today. While much of the real estate market has frozen, as the country moves from a state of panic to broader acceptance of the hard but necessary steps to quell the outbreak, we expect that the current extreme levels of uncertainty will give way to a relatively more predictable period of contraction.
Eventually, as the fallout from the extended nationwide shutdown works its way through the economy, we believe that new and attractive opportunities to proactively deploy funds will begin to present themselves. And further, that our diligence in maintaining sufficient cash reserves will be rewarded as many of the large incumbent financial institutions will still be wounded and vulnerable.
Such a world may set up perhaps the most poetic response to our skeptics, who may have to sit back and watch as we, and our investors, are proven to have in fact been the more disciplined group and, as a reward for our patience, collectively go big game hunting.
Till then, onward.
The Fundrise Team