Sharp Downturn in CRE Market in Q2 2020 Due to the COVID-19 Outbreak

David Cohn
Oct 19, 2020
Industry Insights

It's no surprise: The pandemic has caused massive disruptions in the commercial real estate (CRE) market. Top industry executives confirm sharp downturns as the US continues to struggle with the coronavirus outbreak.  

The 2020 Real Estate Roundtable Q2 Economic Sentiment Index plunged from the first-quarter score of 52 to just 38-massive 14-point decline. This report measures the views of key commercial real estate industry executives. Any score above 50 is considered positive.

Here's what the report revealed:

• Market volatilities are causing uncertainty about the future of multifamily demand and retail real estate.

• Tenants are finding it increasingly difficult to pay rent obligations as a consequence of massive job losses and widespread economic uncertainty.

• Stay-at-home orders and lockdowns have likewise reduced most survey participants' ability to accurately evaluate commercial real estate assets. The result is a slowdown in transactions.

• According to most respondents, the availability of and access to debt and equity are worse today compared to a year ago.

CRE executives believe that there is sufficient capital on the sidelines but that most investors are unwilling to bet on the market without price discovery. Debt funds are right now mostly absent, with only the most pristine commercial real estate assets qualifying for fresh debt capital.

According to Jeffrey DeBoer, president and chief executive officer of Real Estate Roundtable, the economic damage to CRE is particularly obvious in the lodging and retail sectors.

He also said that while Q2 survey results indicate optimism that conditions will improve by 2021, there are considerable concerns that when government assistance runs out and jobs fail to rebound; other CRE sectors may be dragged down.  

Many survey participants are worried that if unemployment persists, tenants will fail to meet their rental obligations. The report also shows concerns that both commercial and residential tenants may eventually fail to pay rent outside the sectors that have already been impacted and are struggling to rebound.

Plea to the government

Real Estate Roundtable has expressed its support for the government's efforts to alleviate the pandemic's economic impacts. Still, it urges lawmakers to create temporary assistance programs for commercial and residential tenants who need help meeting rent obligations.

According to DeBoer, such a program can go a long way in helping businesses and people survive the economic downturn.

For example, it can aid building owners in continuing to employ a workforce that is essential for ensuring that building visitors are safe and healthy, ultimately taking some pressure off of local governments and financial institutions.

Some case studies

With countless restaurants and small retail businesses that may soon be forced by the economic slump to permanently leave their commercial spaces, the CRE industry is truly on choppy waters. Add to this the fact that a growing number of larger chains are starting to default on their rent.

The Wall Street Journal recently reported that WeWork-which provides shared workspaces for startups-has ceased paying rent while trying to renegotiate leases in some of its US locations.

However, it continues to charge membership fees to its co-working tenants. Many well-established brands like Subway, Mattress Firm, and Staples have also ceased paying rent-a strategy that is seen as a way of forcing commercial building owners to provide lease amendments, rent reductions, and other assistance.

The future of the commercial real estate

A McKinsey report indicates that commercial real estate operators and owners across almost all asset classes are open to adapting to the pandemic's potentially longer-term effects.

For example, there may be sharp reverses in the open-plan and densification trend that has been the norm for many years in the commercial office space sector. Building codes may be amended by public health officials to limit future contagions' threats.

This can potentially affect standards for square footage per person, HVAC, and the allowed volume of enclosed space.

Simultaneously, fear of outbreaks like the current coronavirus may prompt baby boomers to stay in their homes longer instead of moving into senior homes. This can dampen the demand for senior living real estate assets or force these assets to change altogether to cater to more intensive operational requirements and more physical space preference.

Of course, senior-living facilities may very well prove they are well-equipped and better organized to handle viral outbreaks-and this can accelerate demand.

COVID-19 will change many other commercial real estate sectors, too. It may permanently alter human habits and dramatically affect the demand for hospitality properties, short-term leases, and other assets. Even the moratorium on non-essential business travel may change the market as people realize that video conferences are sufficient (even superior).

Supply chain near-shoring can also further reduce the demand for business travel, and leisure travelers who are worried about going overseas may travel to local destinations instead.

It's not all bleak

All these said, most executive respondents are hopeful about how the CRE industry is quickly adapting to the so-called new normal where social distancing is standard. There has been a massive implementation of online processes and technologies to provide operational continuity.

Most of the respondents also expect businesses to eventually reopen. This should help ensure that rental obligations are resolved and will ultimately lead to much-improved CRE market conditions.

The industry is hoping for a medical solution to the pandemic, which will likely cause renewed business activity, reopening commercial properties, and investment underwriting.

The report also foresees improvements in market conditions by next year, depending on how quickly businesses can safely reopen and return.

Brighter days ahead

Even though the Q2 Current Condition Index fell by 13 points from the first-quarter score, the Q2 Future Conditions Index soared to 62-12 points higher than the first-quarter score of 50.

It's also worth noting that there is a difference of 49 points between the Q2 Current Index and Future Index--the most significant disparity registered in the report's 12-year history. This seems to indicate a positive outlook that hinges on the resolution of the COVID-19 public health issue.

The second-highest difference was observed in the first quarter of 2009 at 40 points. This was recorded during the 2009 recession and global financial crisis.