2021 Status of the Market: The Resilient Church
by Nathan Artt, on January 2021
2020 proved yet again that our economy is incredibly resilient. Despite a global pandemic that nearly shut down the economy, we are seeing [truly] unbelievable statistics demonstrate a positive outlook on the future. While the national GDP was down 3.8% for 2020, the very conservative outlook posted by the Federal Reserve shows an anticipated GDP growth of 4.2%. Investment banks such as Morgan Stanley predict as much as 6.4% growth. Our biggest concern in 2020 was the expectation of an incredibly high unemployment rate. While retailers, airlines, restaurants, and hospitality companies felt an enormous amount of weight from the COVID impact, unemployment maintained a relatively low rate of 6%- up from 3.5% pre-pandemic. A 6% rate isn't necessarily good, but it's a lot better than what some expected. The Central Bank predicts that rate will fall to 5% by the end of 2021, an improvement of a 2020 projection of 7.6%.
In our first Status of the Market blog written in April last year, one month after the economic shut down, we predicted that this economic "crisis" would be very, very different from the 2008 Great Recession. Thankfully, it appears that will be the case. However, the impact of this pandemic will prove to be a disruption with long-lasting effects, not an interruption before we go back to normal.
The impact on churches and higher education are highly varied, and run a consistent corollary to what we are seeing in retail. While there were major bankruptcies for retailers whose models predicated on foot traffic, retailers with an online presence saw astronomical increases in revenue and market share. We saw the same in churches. Those churches who had some level of digital presence had higher levels of attendance, slightly lower income, but drastically lower expenses and actually increased liquidity during the pandemic. We are also seeing a record number of churches closing, which is largely because of the lack of a digital presence, but also (in our opinion) an acceleration of a process that began with gentrification in major cities.
So what does all this mean for your organization? Let's dive into some things that we feel will provide some great opportunities for the church to thrive in 2021.
Interest rates hit historical lows in 2020, and still remain low. We wrote a lot about this last year, but it was an unprecedented time in the bond and asset backed securities markets. First, we experienced an inverted yield curve, which means that long term interest rates (7-10 year fixed) were actually less expensive than short term interest rates. Toward the end of the year the curve flattened out. Now that we have a fully democratic White House, the expectation is that long term interest rates will increase this year by 1% to 1.5% (not a political statement). However, there is an expectation the government will want to keep short term interest rates low in order to curb inflation.
The Federal Reserve does have one motivating factor to keep long-term interest rates low- the housing market. Last year the Fed bought up a lot of debt which kept mortgage rates low. The result was a booming residential real estate market whose median price increased by 13.4% in a pandemic year. Now, by keeping those mortgages prices lower, this can create both a continued purchase frenzy and a large refinance boom- which would save homeowners $150-$300 per month. This would continue to stimulate the economy by creating more expendable income.
We have been recommending for a year now that churches look at refinancing their existing debt to lock into long-term interest rates. Between Q4 of 2020 and Q1 of 2021 we will help churches close on approximately $150M in new debt and refinances. And we are still seeing 7-10 year fixed rates in the high 2's and low 3's.
What do I do with my swap?
We talked to a large number of churches this year whose debt was in a swap agreement. Due to a major decrease in interest rates over the past two to three years, these swap contracts have been in the red by a few hundred thousand dollars up to several million. This means that churches in a swap agreement would face a cost-prohibitive hurdle if they want to refinance and achieve a lower rate. But not all is lost. If that is the case for you and your church, you do have an option to achieve an interest rate savings without the requirement of a large termination fee. If that is you please contact us and we will be happy to walk you through the process.
Banks are lending money. And yes, they are lending to churches. However, we have seen a much higher level of scrutiny due to the church models that are heavily impacted by physical attendance limitations. There is a misconception in the church that traditional lenders don't have an appetite for churches. This simply is not true. The issue is more that banks don't do a lot of church financing, which means that they don't always keep a major focus on keeping updated credit guidelines. When these financial packages are presented properly in terms the bank can understand, there is a much higher level of success than when financials are sent and a church relies on a bank’s interpretation.
This is important mostly because of pricing. Most "church lenders" lend money on what is called a cost of funds. As an example, they raise money by issuing CD's, deposits, and/or bonds with returns of 1.5-2% and then lend the money to churches at 4-5%. They make their profit off the margin. Traditional lenders are borrowing money from the government (fed funds rate) at 0% to 0.25% or by buying up 10-year treasury bonds at 1%, which means that they can make the same profit by lending it to you at 2-3%. During this season we believe there is a strong market appetite for churches without having to pay higher fees and interest rates with "church lenders".
There were a great number of planned commercial real estate projects- mainly in hospitality and retail- that were postponed or canceled during the pandemic. We also saw a major decrease in the Architectural Billing Index (ABI) in 2020, which is a great predictor of future construction spending. Because of this, it was our hope that we would see construction prices begin to fall in Q4 of last year and Q1 of 2021. That has not been the case. Due to the impact of social distancing guidelines on the labor force in manufacturing, we have seen the price of materials actually increase versus decrease. This means everything from lumber, to drywall, to HVAC units and beyond has not seen an increase in demand, but an astronomical decrease in the ability to create supply.
While construction prices haven't dropped, they also haven't increased dramatically. We expect those prices to begin to fall as the vaccine is administered to the larger workforce and those people can get back to full-time work. Even then there will be some catch up time. In short, we believe we will see a slight drop in construction labor costs and this will be offset by slight increases in construction materials- keeping construction prices relatively flat.
Real Estate Market and Churches
Let me first say that tracking delinquencies in commercial real estate (CRE) is very difficult right now due to forbearance and loan modifications. Forbearance allows for CRE mortgage holders to simply defer their mortgage payments to the end of the loan. Loan modifications negotiate the terms of a loan without a notice of default. In both cases there are billions of dollars worth of retailers, hotels, restaurants, and others who are not currently making mortgage payments, but also not showing up as defaults. This keeps the clients in good standing financially and protects the banks' ratings and regulatory requirements, but it hides the true impact of COVID on these sectors. Even with forbearance and loan modifications, in Q4 of 2020, nearly 1 out of every 10 CRE loans was showing up as a default. These are mainly in the sectors mentioned above (malls, shopping centers, single tenant retail buildings, restaurants, and hotels). These numbers do not include tenants ability to pay leases, just the CRE clients. Based on what we have heard and seen, it's worse on the leasing side.
These trends are also being shown as most prevalent in the major markets, such as Atlanta, New York, Houston, Chicago, Los Angeles, etc. where rents are much higher and real estate is far more expensive.
As discussed in previous posts, there is a large number of existing churches who are closing their doors. Most of these closures are happening in more highly populated areas largely due to a combination of gentrification and the inability to meet in person. As these sites become available, there will continue to be opportunities for financially strong churches to acquire these sites or merge. Due to the nature of the 501(c)3 tax-exempt status, there are a lot of good reasons for churches not to sell their assets and to merge.
Our good friends Jim Tomberlin and Warren Bird have recently released an updated version of Better Together: Making Church Mergers Work. We strongly recommend this resource for leaders looking to begin those conversations with other churches.
The real estate market presents an enormous opportunity for the churches who have been putting their surplus to their bottom line. There will be a large number of opportunities to expand "big box" buildings (although we are seeing those buildings get much, much smaller). There is an increasing inventory in the real estate market with low interest rates and static or slightly lower construction costs. What does this mean for the church? Churches have expanded their regional footprint through digital platforms. Now we look to 2021 to bring people back to church. The increased inventory in the market, low interest rates, and static or lower construction costs will allow more opportunities to plug people into an in-person experience.
We hope that you find this information useful and helpful. While there is so much uncertainty in the market, we also believe these types of markets create the biggest opportunities for organizations who are willing to adapt.
Our passion is to help churches thrive in reaching their communities for Jesus. If we can help in any way, we’d love to have a conversation with you with no cost or obligation to you. It’s been through so many conversations this year that we have been able to learn so much. Thank you for allowing us to be a part of your journey.
How can we help you? Feel free to click on the link below to set up a time to chat.