Covid-19 Impact on CRE Market
Dear Clients, Colleagues and Friends,
First, our thoughts are with you as we all navigate through these very challenging times! Given the rapidly evolving government, community and business actions in response to the COVID-19 virus, we wanted to take a moment to share with you our perspective on the impact to commercial real estate. We understand it is difficult to forecast what the full impact will be, but it is imperative we be prepared for the short-term implications. To that end, below is our take on what to expect in the coming days, weeks and months.
Debt and Capital Markets
Many are likening this event to the 2008 Great Recession, but it is vastly different in terms of the strength of financial institutions and underlying economy. At this time, 70-75% of lenders are still operating and providing loans! It comes down to what and where but there is still money to borrow.
We can expect investment and lending activity to slow in the first half of 2020 as investors react to uncertainty, with the retail and hospitality sectors being the most affected. A shift to less risky assets is expected with key considerations to include income stability, operation criticality and occupation density.
Expected Sector Performance During Crisis: High to Low Impact
The impact of travel restrictions, event cancellations and individuals’ reluctance to travel have been immediately felt in the hospitality sector. Occupancy rates have fallen dramatically and will continue to do so. There is potential for a fairly rapid rebound if the virus is contained quickly.
In the short term we expect hotels will close and/or be foreclosed. On the sale side, hotels are currently essentially unfinanceable. However, we expect opportunities for buyers in Q3 2020. It will be a “kick the can down the road” for now.
This market was already facing a headwind but will get even more challenging since most people are not going to place their parents/loved ones in an assisted living facility, because of the high infection rate, unless they have absolutely no choice. In the short term, investment activity will be constrained as asset-level due diligence is restricted. Expectation is the weaker players will be thinned out and the strong players will pick up facilities at a discount.
The impact on retail is a mixed bag depending on the business type. Experience driven retailers, bowling alleys, movie theaters, salons, gyms, are especially feeling the impact; however, we expect this to come back rapidly once the crisis passes. Essential service stores, like grocery stores, gas stations, pharmacies, have seen a huge surge in business.
Retailers with the infrastructure to fulfill online orders through home delivery are currently being perceived as beneficiaries of consumers’ reluctance to visit stores and we are seeing an increased use of online purchasing. Amazon can’t hire people fast enough! Greater emphasis will be placed on the shift towards a flexible omni-channel retail model and sustainable fulfillment; strengthened partnerships between landlords and retailers will need to emerge to achieve this.
The Covid-19 outbreak could put greater pressure on markets which are already in a late stage of their cycle, creating the potential for a delay to investment activity and softer rental growth than previously forecast. An increase in remote working is likely to reduce office utilization rates, and landlords with exposure to short-term leases will be the most vulnerable.
Over the longer term the outbreak will probably fast track the adoption of remote working and investment into collaborative technologies. A risk is that with so many businesses having their employees telecommute now, will businesses adopt this more fully and risk future growth?
This is a very optimistic area as more people are relying in deliveries and those who were reluctant to opt-in now will. As such logistical and last-mile locations will see increased demand.
In the short term, focus should be on health and safety as well as collections. Landlords should consider allowing partial payments, payment plans and weekly payments. We expect low to no rent growth but skyrocketing retention rates. Class A faces the biggest risk due to high rents and ability of tenants to move down to Class C. Class C has the highest risk of inability to pay rent due to lack of reserves. Class B is the most stable.
Real estate investment has fluctuated during previous crises, but the overarching trend over time has been for increased allocations to the sector and we see no reason for this to change. Real estate continues to offer attractive relative returns in comparison to other asset classes.
In the interest of the health and well-being of our employees and clients, our offices are closed but are available to serve you though virtual options. We’re here for you – ready to listen, support and navigate this together!
Sources: CrowdStreet and PSU CRE Market in Tumultuous Times presentation and JLL’s Covid 19: Global Real Estate Implications