The February 19, 2021 episode of the RealNex Webinar Series featured Dr. Jeffrey Fisher for his quarterly CRE Market Update. The session titled “V-shaped so far” focused on the impact of Coronavirus on commercial property market prices and returns. The findings highlighted the winners and losers among all the major asset classes based on his research with NCREIF (National Council of Real Estate Investment Fiduciaries) with supporting data and perspectives from a host of industry experts. The data, as of the end of 2020, paints a picture of the precipitous drop in market activity and the equally dramatic recovery by year-end.
Total Returns presented the first "V" of the session. From a quarterly run rate of 2% in Q4 2019, returns spiked down to -1% by Q2 2020 only to return to 1.2% by Q4 2020. While returns were dramatically impacted by negative NOI Growth, they were largely balanced by a decline in cap rates. Expectations are for the trend to continue with overall annual returns of 5% in 2021 and approaching 8% in 2022. Not quite at the 10-year average of 9.1%, but not far off that long-term pace. The overall market recovery continued to be led by industrial with office and apartments modestly positive, retail negative and hotels although somewhat improving, still extremely negative. Dr. Fisher drilled down into the drivers of return by each asset class and then further by sub-class.
When surveyed with the question What Property Sector do you think will perform best in 2021?
The results were:
Next, Dr. Fisher took a look at transaction velocity…another “V” The NCREIF members hold approximately 10,000 properties and typically trade in the range of 150 – 250 assets per quarter. Year-end 2019 actually pierced the high-end of the range approaching 300, only to drop to under 50 in Q2 2020. By year-end 2020 the pace had recovered back to the 250 mark. Real Capital Analytics which tracks the much larger market of assets above $2.5 million reported an overall annual drop of nearly 25% after hitting a low of about 80% decline at the mid-year point.
While the pace of capital raising slowed in 2020, redemptions have been moderate and the level of “Dry Powder” is at near record levels. Indeed, Dry Powder grew from about $25 Billion in 2000 to a 2009 cyclical peak of $175 Billion, dropping during the Global Financial Crisis to about $140 before rocketing to $340 Billion in 2019. Today we sit at roughly $325 Billion.
This heavy weight of capital has continued to push the BAA bond rate and real estate cap rates to record lows. Supporting the thesis that cap rates can drop even more is the recent expansion of the spread between these two metrics. Cap Rates are now nearly 100 bp above the BAA bonds.
The final “V” Dr. Fisher pointed to was that of GDP. After plummeting 10.1% in H1 2020, in Q3 alone in recovered 7.5% and is on a path to return to its long trend line before continuing to grow at its steady 2.5+-% potential.
With this strong economic growth and the massive stimulus about to enter the market, the industry continues to be concerned with a return of inflation and rising interest rates. This tug-of-war between growth and interest rates will determine if we have reached a bottom in cap rates or if they have further to fall.
Once again, the audience weighed in with a poll. What will cap rates be for the nation by the end of 2021? (currently at just above 4% for institutional assets)
|4% - 4.5%||47%|
|4.5% - 5%||17%|
Although the session demonstrated a solid “V” shaped recovery overall, the world has changed dramatically due to Covid-19. The social impacts have been profound, and business has responded accordingly. While yet to fully play out, commercial real estate is transforming to meet the new reality of a digitally connected and enabled world where work from anywhere is possible for many and consumption and delivery of goods and services is often just a click away. With density now out of favor and quality of life the pursuit there is a bifurcation of Winners and Losers. After years of a return to the city, the suburbs are once again in favor. Single family residential is white-hot and urban residential towers are losing out to garden apartments. Strip centers and malls are giving way to a boom in industrial warehousing and data centers. Life sciences and medical office have the wind at their backs while sectors like seniors housing, student housing and hotels will continue to face headwinds. While Work from Home has proven that it can work, people still need and want to congregate, and business finds value in the dynamics of personal interaction. So although office markets, particularly dense urban ones, have taken a hit, they will recover as vaccines become pervasive and “herd-immunity” is realized.
Before wrapping up one more poll was conducted – Where will real estate values be by the end of 2021?
|Values will be significantly lower by the end of 2021||13%|
|Returns and values will probably bounce around the current levels||75%|
|Values will be significantly higher by the end of 2021||5%|
|I have no idea!||8%|
Summing up his thoughts, Dr. Fisher concluded:
- Per Oxford Economics:
- After a dire 2020, growth in 2021 will be the strongest in 40 years, but it may not seem like boom times for many.
- Inflation will rise this year, but this will be largely transitory, and we expect underlying price pressures to remain contained.
- Big worry is the spread of more transmissible coronavirus strains.
- National returns continue to improve
- Primarily due to the continued strong performance of industrial warehouse
- Retail continues to be worst performing sector
- Transactions return to normal levels
- Cap rates continue to decline even at historic lows