With data now available from the first full quarter since the Covid-19 pandemic shut down the economy and forced work from home rules, RealNex hosted its quarterly Market Update with Dr. Jeffrey Fisher. Based on his research using data from the National Council of Real Estate Investment Fiduciaries (NCREIF) and others, Dr. Fisher presented his findings and analysis of a dramatically altered landscape. Although the impact was mitigated by government programs that enabled more rent to be paid than otherwise might have, rents, NOI and returns all dropped for the first time since the 2008 Global Financial Crisis (GFC).
With data limited due to a precipitous decline in transactions, true price discovery is difficult to ascertain. Buyers, with hoards of cash, continue to wait on the side-line, as owners are reluctant to sell, and lenders have yet to force their hands. Similar to the start of the GFC, quarterly transactions were off nearly 90% with just 30 trades in the index against a peak of 300.
In the GFC, levered returns, as measured by the NCREIF Property Index (NPI) dropped for 6 quarters, starting with a 1% decline before falling roughly 15% in each of the ensuing 3 quarters. As we enter the Covid-19 induced cycle, the unlevered NPI spiked down from positive territory to drop 1%. Interestingly REIT prices plummeted from +18% in 2019 to negative 25% in Q2 2020 before tracking the S&P to sharply recover to 2019 levels. In 2008 the NPI and REITS dropped in tandem, but REITs recovered nearly 1 year faster. Historically the NPI has generally tracked GDP with somewhat greater volatility and amplitude. During the GFC for example, Quarterly GDP dropped 2% while the NPI declined 8%. In the most recent quarter GDP declined a staggering 10% while the NPI dropped only 1%.
During the webinar Dr. Fisher conducted a series of polls to again participant feedback and real-time market perspective. The results of the first poll indicated the decline in returns was expected to continue.
What will the annual unleveraged total return for institutional grade real estate be for 2020?
|
A. Below negative 3% |
24% |
|
B. Negative 3% to negative 2% |
19% |
|
C. Negative 2% to negative 1% |
29% |
|
D. Negative 1% to 0% |
14% |
|
E. Above 0% |
14% |
Interestingly Cap Rates continued to decline slightly to approximately 4.6%. This seems to be the result of rents dropping faster than property value, rather than prices increasing faster than rent. Cap Rates are also being bolstered by the further drop in interest rates and an historically high spread. At the market peak in 2007 the Cap Rate spread to the 10-year Treasury was a tight 50 bp before expanding to 400 bp at the 2012 trough. In 2018 the spread tightened to 160 bp and now is back to trough-like 400 bp.
Asked what they expected for Cap Rates, attendees responded fairly optimistically.
What will cap rates be for the nation by the end of 2020?
|
A. Below 4% |
7% |
|
B. 4% to 4.5% |
33% |
|
C. 4.5% to 5% |
33% |
|
D. Above 5% |
28% |
Not surprisingly, even with the slight decline in Cap Rates, the Market Value Index dropped for the first time since the GFC. Like in that last cycle, write-downs spiked with over 80% of properties declining in value (in 2008 write-downs peaked at 90%).
When asked how far property values would drop before recovering, the audience indicated more caution and concern.
How far will market values drop before we return to the pre-COVID-19 level?
|
A. 0 to 10% |
27% |
|
B. 10% to 20% |
52% |
|
C. 20% to 30% |
17% |
|
D. More than 30% |
4% |
Looking at returns by property type, the disparity of impact across segments was pronounced and reflective of the unique nature of this cycle. Not surprisingly given the heavy demand from online delivery services, industrial actually remained positive with a 1% quarterly gain in NPI. While the virtual shut down in travel, left hotels in free-fall – down 16%, and overall retail declining nearly 4%. Office and Apartments were little changed. These values mirrored rent collections which plummeted 49% at hotels and 12% at retail properties with only modest declines in collections in the other classes. Hotel revenue was further exacerbated as it is lost forever, while in other classes some of the loss was actually deferred with some hope of future collection.
Returns were also impacted by geography with dense CBD and High-Rise properties losing favor to suburban properties.
Not surprisingly the poll focusing of sector clearly favored Industrial with apartments a distant second.
What Property Sector do you think will perform best in 2020?
|
A. Apartment |
23% |
|
B. Hotel |
0% |
|
C. Industrial |
75% |
|
D. Office |
1% |
|
E. Retail |
1% |
And, in trying to forecast the bottom, the final poll pointed to at least a year before returns would turn positive.
How long will it be until NPI returns are increasing again?
|
A. Q3 2020 |
6% |
|
B. Q4 2020 |
4% |
|
C. First half of 2021 |
26% |
|
D. Second half of 2021 |
52% |
|
E. 2022 or later |
18% |
The Summary of what we know about the impact of Covid-19 as of the end of Q2 2020 -
- Market values have turned negative
- Causing returns to turn negative for first time since financial crisis
- Returns turn negative for all property types except industrial
- Transactions lowest level since financial crisis
- Far more write-downs than write-ups – greatest since financial crisis
- Cap rates down just slightly due to rents falling more than values and declining interest rates
Click the links to access a copy of the presentation deck or session replay.
