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Amid Fears Surrounding The COVID-19 Outbreak, The Question Isn’t “Is CRE Recession-Proof?” But “Where Does The Market Go From Here?”

Lowery Property Advisors

03/18/2020

When we first entered 2020 a little over two months ago, commercial real estate across the U.S. was enjoying a very rosy outlook.

Then came coronavirus disease 2019 (COVID-19).

If China’s experience is any indication, the full economic impact of this pandemic will probably not be measurable for months. What we do know, however, is that markets everywhere are coping with profound uncertainty. How long will the outbreak last? How will efforts to protect public health, centered as they are around “social distancing,” affect consumer behavior? Is a recession imminent, or has one already begun?

LPA’s resident thought leaders have been tracking the COVID-19 situation since January. Although we can’t hope to answer all of the CRE-related questions our clients and partners might have in this one article, we have endeavored here to share the best business intelligence we’ve gathered thus far.

As you might imagine, what follows is a mix of good and bad news. In the former category: CRE is likely to remain among the most resilient assets in any coming economic downturn. In the latter: landlords, developers, and lenders whose holdings include certain property types can expect to feel some acute short-term pains.

Supply chain disruption impacts industrial inventory

While efforts to contain COVID-19 continue to ramp up across the United States, day-to-day life is trending back toward something resembling normality in China and South Korea. Consequently, we’re only now getting a glimpse of what the virus has done to their manufacturing sectors. In January and February 2020, China’s industrial production declined by 13.5 percent.

To place that number in context, consider this observation from a Transwestern report published just last month: “In February, U.S. port volumes are projected to be nearly 13 percent lower when compared with the same period last year and 9.5 percent lower in March.”

What does this mean for warehouses and distribution centers? Moody’s Analytics now expects real GDP growth to settle in below its 2 percent potential growth rate: 1.5 percent. Nevertheless, this supply chain issue doesn’t mean a wholesale shift in industrial leasing is to follow. As Moody’s further notes, “[t]he delivery of goods and services may be delayed, but it is unlikely that long-term leases of industrial buildings (with some stretching to 20 years) will be renegotiated (unless a wide-scale rash of business bankruptcies and a major global recession ensues).”

Remote work has staying power

If you haven’t been instructed to work from home in the last week, then it’s likely that you know several people who have. At the moment, full-time remote work makes up less than 5 percent of all U.S. jobs. That figure may seem low based on anecdotal evidence, but, as Sara Sutton, the founder of job listing site FlexJobs, notes, “[a] lot of organizations are doing remote work right now in a very ad hoc manner,” making precise measurements — not to mentions projections — tricky.

However, should employers adopt a more concerted and organized approach to work from home (WFH) arrangements, the demand for office space could decline. The same holds if, after the initial growing pains of pivoting to WFH subside, businesses realize that white-collar job performance in particular may not be adversely affected by lack of access to a traditional office.

Either way, companies everywhere are about to get a crash course in both the benefits and disadvantages of remote work. Until all of those pros and cons have been sorted out, it is unlikely that we will see a massive, permanent shift in where Americans conduct their business.

Dramatic curtailment of travel and tourism will hurt more than hospitality and restaurant spaces

It’s no secret that the tourism and travel industries are taking a serious hit during this outbreak. We’ve seen numerous conferences, festivals, and sports leagues either postpone or outright cancel their events. In Austin, SXSW’s cancellation is expected to cost the city $350 million, with event spaces, restaurants, bars, and hotels shouldering the biggest losses. Worse, margins for these industries are already razor-thin. The next cancellation notice they receive can mean the difference between a good year and not making it to 2021.

Travel restrictions also directly impact the CRE industry. Canceled professional conferences, a cap on business travel, and government-mandated “sheltering in place” all make it harder to execute existing or upcoming deals. Will proptech come to the rescue? This is not a science-fiction scenario. For example, to maintain a healthy volume of transactions, CREModels has announced free access to a suite of collaboration tools designed to help CRE professionals keep their negotiations moving toward a close. Watch for other proptech providers to follow suit should the coronavirus outbreak be prolonged.

Money may dry up for some lenders, especially non-banking financial institutions (NBFIs)

It’s too early to tell how ratings for financial institutions will be affected by COVID-19. Yet S&P Global economists have already sounded a note of caution, stating that “particularly under an adverse scenario, we would expect stress on loans to borrowers in areas dependent on consumer discretionary spending (retail, leisure, transport/travel, and infrastructure) or supply chains (autos, technology, and commodities), and in energy.”

These same experts deem it not improbable that “pockets of commercial real estate in certain geographies and asset types, such as retail and office space, could also worsen.” If there is a port in the storm, it might be Net Lease REITs, and thanks to the quality of these properties’ tenants. Nevertheless, even the ability of these assets to bear the brunt of coronavirus-related market uncertainty will be tested.

Rent rebates, already a reality in Asia, could come to the U.S.

If we can treat Asia’s Q1 2020 economic performance as a kind of crystal ball, then tenant relief could be on the horizon. Rent rebates and rent cuts have been implemented in Singapore and Hong Kong to help keep tenants in business as they deal with shutdowns and quarantines.

How big of a rebate or cut? According to Singapore’s The Business Times, “[a] number of mall operators, including CapitaLand, Mapletree Commercial Trust, and Perennial Real Estate Holdings, had announced rental relief in a bid to pass on savings from a 15 percent property tax rebate announced during Budget 2020 to qualifying commercial properties.”

Additionally, CRE stakeholders should not be surprised at local grassroots efforts to place a moratorium on evictions and implement rent freezes and as long as quarantine-like conditions obtain. If so, the impact could extend beyond retail and into the multifamily sector.

Texas can weather economic turmoil better than most regions

Any more good news is welcome at this point, so it’s important to note that Texas is the best-equipped state to handle a recession. According to a study conducted by Fit Small Business, the Lone Star State can claim “the second-lowest debt-to-income ratio in the nation at 1.16, the third-highest total exports per capita, and a diverse range of industries that make up its GDP portfolio. What’s more, its top export countries — Mexico, Canada, and China — are relatively big players in the international trade scene.”

Additionally, the North Texas communities of Frisco, Plano, and Denton recently made the Top 5 in SmartAsset’s rankings of the U.S.’s most recession-resilient cities. The main factors in SmartAsset’s calculations? Employment, housing, and social assistance. With respect to the latter, SmartAsset observes that “Texas performs particularly well for its state’s rainy-day funds as a percentage of state expenditures — ranking second-highest of all 50 states at almost 19 percent.” That augurs particularly well for residents, individual as well as corporate, should the COVID-19 outbreak cause significant financial hardship.

During difficult times, accurate, actionable, and principle-centered commercial real estate valuation services are needed more than ever. At LPA, we firmly believe that our valuation experts have a duty to help keep our financial system in good working order by continuing to produce timely appraisals. That’s why they’ve equipped themselves with the most up-to-date information available and, whatever the circumstances, stand ready to provide our clients with the analysis they need to make sound business decisions.

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