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Commercial Real Estate Markets react swiftly to COVID-19

Posted by Jeff Finn on May 27, 2020 10:44:45 AM

The RealNex Webinar Series continued May 21, with Dr. Jeffrey Fisher providing a Commercial Real Estate Market Update based on Q1 2020 data. The data and results marked a first glimpse of the impact of the COVID-19 pandemic’s impact on CRE markets. Even with just one month of the quarter realizing the full brunt of the change in the world order, industry performance was starkly different than Q4 2019. Private Real Estate values are largely backward looking based on appraised values and comparable sales, while public markets are more forward looking. Thus, the NCREIF Property Index (NPI) of privately-owned real estate eeked out a positive .7% return for the quarter whereas REIT prices dropped a staggering -23.4%. It is expected that in Q2 with the NPI will move into negative territory for the first time since the Global Financial Crisis and that REITS will be buoyed to more closely align with the drop in underlying asset values. With transaction volume plunging in March and even more in April and May, price discovery has yet to be realized.

Dr. Fisher reviewed recent recessions to see what we might expect this time around. In the 1990 recession NPI dropped 25% over a 5-year period and took 11 years to recover. While the 9/11 induced tech-bust had a very limited impact on commercial real estate values and within 2 years values were up. The Global Financial Crisis was real estate centric with values dropping 27% in just a year and a half. Massive stimulus enabled the market to return to former record values in just 5.5 years. In the 90’s and tech-bust REITs recovered much faster than private real estate, 2 years and 1 year respectively. While in the GFC Private Real Estate recovered in just 2.5 years with REITs taking 8 years!

Based on data from Real Capital Analytics, the Global Financial Crisis resulted in a distressed real estate cycle that went through distinct phases: Shock and Triage (6-9 months), Price Discovery (6-9 months) and Workout (24-36 months). Unlike the GFC which was capital driven, the COVID-19 crisis and ensuing recession is demand driven and is expected to be less severe and shorter lived. Although the industry will be weighed down by carnage in hospitality and retail it will be propped up by strong industrial and multi-family sectors. Indeed, there is already a record spread of 14% between industrial and retail property returns. Chiming in on a poll during the call, 79% of attendees expected industrial to continue to be the best performing asset class in 2020.

When asked how far will values drop during this cycle the audience responded:

0-10%

26%

10-20%

44%

20-30%

24%

30% +

6%

And, when queried as to where would cap rates be by year end vs the pre-COVID 4% level the audience responded:

< 4%

9%

4.0-4.5%

19%

4.5%-5.0%

13%

5.0%+

60%

Fisher’s analysis indicates that Lodging, Malls and Strip retail will be most severely impacted while data centers, cell towers, industrial facilities, apartments and self-storage will actually remain in high demand. Overall, rental rates are expected to decline with a massive wave of lease restructurings required to mitigate business failure particularly in the retail sector. With many retail businesses yet to re-open, offices operating with remote staff and travel restrictions devastating hotel occupancy we remain early in the Shock and Triage stage. As markets reopen and the massive wave of unemployed get back to work, we will discover a New Normal. Until then the impact on demand, rents and asset values will remain murky. What is clear though, at least in the short term, there will be less density, with fewer people in Malls and restaurants, more Zoom and less travel, and new space design to allow for physical distancing in many work environments. However, as we look back on past pandemics and traumatic global events property markets have continued to evolve and adapt, workers have continued to collaborate, and people have continued to congregate. As cures or remedies are discovered and the acuteness of COVID-19 recedes into memory, markets will adjust and recover. In the interim opportunities will be created for longer term commercial property investors.

Click the link to view the session recording or access the presentation deck.

Topics: RealNex Webinar Series