Experts Everywhere Are Weighing In On What The COVID-19 Pandemic Means For CRE In The U.S. What Are They Predicting — And Why?
As a nation, we are now about a month into an extended socioeconomic experiment. We are all learning social distancing etiquette, adjusting to the idea that some businesses are essential (and others not), and coping with anxieties we could not have imagined feeling mere weeks ago.
Yet some of the uncertainties we covered in our last installment of Insights have been since dispelled. Whiplash is no longer a fact of life for traders on Wall Street. Public health officials are beginning to gain a better understanding of the scope and scale of the COVID-19 infection — not to mention the efficacy of the unprecedented measures taken to “flatten the curve.” And, on March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security (CARES) Act into law.
This $2-trillion stimulus package carries only a few CRE-specific provisions, nearly all of them directly impacting landlords and tenants. Businesses can apply for forgivable loans to help them cover rent, utilities, and even mortgage interest. Further, multifamily borrowers with federally backed loans can request a 90-day forbearance. The CARES Act also places a 120-day moratorium on evictions from public housing or properties secured by a government-sponsored enterprise (GSE).
More importantly, the CARES Act signals a renewed willingness on the part of Congress to intervene in our economy. Additional phases of legislative response are being debated even now, including a jobs program focused on infrastructure. Such a sweeping initiative could have a profound impact on the construction industry.
What else might the future hold? What are CRE experts seeing as they eagerly look forward to the end of the present crisis?
“The real estate industry is being clobbered by the coronavirus, and it’s going to get worse before it gets better.”
So writes Brad Hunter, Managing Director for RCLCO Real Estate Advisors, in Forbes.
What accounts for his pessimism? Hunter is particularly concerned about regional “hot-spots” like Florida, whose economy relies so much on out-of-state tourism.
“Florida, for example, is exposed across a number of important industries, including:
- Theme Parks
- Conference Centers
- Sports Venues
- Restaurants and Bars
- Cruise Ships
Additionally, it remains to be seen how Florida’s congregate senior housing industry will be impacted.”
But Texas makes Hunter’s list as well, primarily due to the steep drop in oil prices — and accompanying “economic drag” — that has accompanied the COVID-19 outbreak.
Does Hunter see any silver lining? Perhaps in multifamily. Again, Hunter is worth quoting at length on this topic.
“The long-term outlook for rentals is still bright, however, in light of demographic shifts that are still unfolding. Lease renewal rates were strong before the crisis, and apartment construction was running at more than 500,000 units annually right before the crisis, so it has some ground to give. Class ‘B’ properties will likely fare better than expensive ‘A’ properties or Class ‘C’ developments that may be more susceptible to job losses and lost income among tenants… The single-family-built-for-rent business might be a long-term beneficiary as we may see a shift toward larger units that better accommodate working from home (allowing more space for a home office or office nook).”
“Forecasting models are simply not designed to capture this scenario.”
That’s the note of caution sounded by Andrew J. Nelson, CRE. Yet he follows a more optimistic trajectory than Hunter, going on to say that “the best course of action for most market participants is to defer major decisions until there is greater clarity as to market directions.”
To help provide that clarity, Nelson has also conducted a thorough, sector-by-sector overview, examining both the short- and long-term prospects for a variety of property types. While several industries have been hit especially hard already, Nelson does call the CRE community’s attention to conditions that may spell immediate trouble in multifamily.
“Also vulnerable in the very near term are two demographically-favored niches that have been the darling of investors: student housing and senior housing. Student housing especially is likely to see financial strains as college campuses are closed, and students are sent home. And senior housing may see a short-term drop in demand as vulnerable older Americans shelter-in-place to reduce the likelihood of contracting the virus. However, both should see a rapid snap back in demand as the crisis eases.”
Meanwhile, Nelson notes, some landlords experiencing acute pain right now may be feeling relief once something resembling normal economic activity resumes. Consider co-working spaces, which are facing lost revenues that traditional office buildings managing one-, two-, and five-years leases are not.
“We might also anticipate a sharp and permanent shift to telecommuting, to the long-term detriment of traditional office leasing... But some of the shift will prove permanent as firms learn to work remotely and are making material investments in telecommuting infrastructure to ensure their business can succeed with at least some of their employees working remotely. Thus, expect firms to continue the long-term trend of reducing the amount of office space leased per worker. One beneficiary should be flex-office space, as workers needing quiet space outside of the home seek affordable workplaces near-by.”
Rapid changes in consumer behaviors are also reshaping the CRE landscape, Nelson writes, and with implications that reach far beyond retail.
“These shifts [in buying patterns] will continue to benefit the industrial property sector, particularly logistics and last-mile facilities, as retailers and manufacturers deliver goods directly to consumers at home. After a short drop-off in leasing during the shutdown, expect a rapid bounce back. Not all facilities will benefit equally, however. The pandemic has laid bare the risks to producers associated with global supply chains. Expect the nascent trend to “near-shoring” to gather strength in favor of more localized suppliers. Thus, we may see some shift from port-focused warehousing to those closer to domestic manufacturing centers.”
Yet, as the Federal Reserve Bank of Dallas reported at the end of March 2020, manufacturing in the Lone Star State has come to a virtual halt, and abruptly.
“The production index… plummeted from 16.4 to -35.3, suggesting a notable contraction in output since last month. … The new orders index dropped to -41.3… Similarly, the growth rate of orders fell to 44.9. The capacity utilization and shipments indexes fell to -33.43 and -33.8, respectively… Other indexes for future manufacturing activity also fell sharply into solidly negative territory.”
These are bellwether numbers, as Texas accounts for about 10 percent of domestic manufacturing. Therefore, even those more local supply chains are not immune from the effects of this pandemic. What our state's experience augurs for industrial — one of the most in-demand property types entering 2020 — over the next three to four months bears watching.
“I’m hearing that one-third of the deals are dying, one-third are pausing, and one-third are still happening.”
From Kidder Mathews’ President Brian Hatcher’s perspective, this split is not abnormal. “Compare [it] to 2008 through 2010 when there was absolutely nothing happening. If everything stays on course here, I think this might be the easiest downturn we have. I say ‘if’ with a capital ‘I.’”
Hatcher also asks us to conceive of the current circumstances as a slowdown rather than a downturn. “Any deal with a retail component is going to get a lot more scrutiny than perhaps it has in the last five years,” he says. “This disruption will make everybody check themselves and pause.”
But are such “big picture” takes examining these issues through the right lens? Forbes Senior Contributor Mayra Rodriguez Valladares is not confident that they are.
“In my view, it is also important that investors, analysts, and regulators look more at the fixed income market, which includes sovereign debt (Treasurys), municipal debt, corporate debt, and asset-backed securities, which... includ[e] leveraged loans, residential and commercial mortgages, student loans, auto loans, and credit cards… Investors in corporate debt are certainly signaling that they fear that defaults are imminent, especially in those corporations whose rating is speculative… [Meanwhile,] [a]lready, before the COVID-19 crisis, consumer delinquencies had started to rise.”
The upshot? “I am more and more convinced that the COVID-19 crisis will be far worse than the 2008 financial crisis,” Valladares admits. But she has not completely given up hope. “With any luck, it will be shorter-lived.”
If that’s true, where might we turn to see the first signs of economic recovery?
“The core takeaway from the pandemic’s geography — measured in COVID-19 cases, county-by-county — is that of clustering.”
According to HousingWire's Editor at Large Kathleen Howley, that recovery will have to first come to those regions of the U.S. caring for the largest populations of COVID-19 patients. Her reasoning?
“The nation’s COVID-19 infections concentrate in a short list of economically central, often job-rich counties on the coasts and the Great Lakes region. The nation’s 50 hardest-hit counties support more than 60 million jobs and $7.4 trillion in economic output, good for 30% of the nation’s employment and 36% of its GDP.”
In this one observation, public health and economics intersect to reveal why COVID-19 poses such a risk to our nation's financial health. Those large, densely-populated metropolitan areas most susceptible to the spread of an airborne disease also happen to be, in Howley’s words, “most central to driving the nation’s big-city, globally networked economy.”
In a recent editorial penned for The Dallas Morning News, Professor Steven Pedigo of the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin echoes this sentiment, then gives it a local spin.
Major disruptions tend to accelerate existing trends. Already, 8 out of 10 Texans live in cities and metropolitan areas, which run the gamut from global centers like Dallas, Fort Worth and Houston to startup hubs like Austin, border cities like El Paso, college towns, and oil patches.
Our Texas cities will become ever more important, because the same things that made them vulnerable to COVID-19 — their international connectivity, dense living patterns, and gathering spaces — will also make them the engines of our recovery, powered by the cutting-edge industries that cluster in them, like software, fin-tech, tech-driven manufacturing, aerospace and renewables.
Nevertheless, those of us who survived the Great Recession may be concerned that CRE is headed for the same fate: collapse. But, while Andrew J. Nelson sees real challenges ahead for capital markets (especially alternative lenders), he also reminds us that the COVID-19 crisis is fundamentally different from the one we witnessed in 2008-2009.
“Perhaps the best news on the financing front is that leverage rates overall tend to be much lower now... Moreover, construction in most markets has been more moderate in this cycle than is typical, yielding strong property fundamentals with record-low vacancy rates, despite relatively modest space take-up. Thus, depending on the severity of the downturn, defaults and bankruptcies may be less likely this time around as most financed properties have more fiscal room to absorb revenue declines.”
Brad Hunter makes a similar point.
“Unlike in the Great Recession, once the virus is contained and immunity starts to take hold in the population, even though supply chains will take some time to re-engage, it may not feel like the cold start that followed the housing and mortgage crash. The cycle could look like a ‘V,’ or possibly more of a narrow ‘U,’ with a sharp drop but also a strong upswing, coming at some time in the second half of this year.”
In other words, the economy may bounce back in dramatic fashion, with those areas of the U.S. where CRE has proven to be most resilient over the past decade leading the way.