There’s no sugarcoating that commercial property markets are taking a beating from the economic repercussions of COVID-19. Though experts say that the impacts of the expected economic fallout and its effects on the commercial real estate (CRE) sector are still largely speculative, the ground’s sentiment is undeniably negative.
Efforts made to contain the virus—from travel bans to social distancing—have both near-term and longer-term impacts on CRE. Marked pauses in dealmaking and the possibility of a temporary credit freeze also threaten financing and future deal flow. Many experts also believe that the recent downturn in public valuations may indicate that private valuations will eventually take a hit (if they haven’t already).
Here’s the sobering math: until next year, the pandemic is expected to cause anywhere from a 7% to 19% decline in transaction volume and a 16% to 32% decline in overall dollar volume transacted from highs in 2019.
This novel coronavirus problem is predicted to push CRE transaction count back to levels that have not been seen since 2015, and since 2012 when it comes to transaction volume. All in all, the COVID-19 pandemic should cost the CRE market around $100 billion in deal volume and around 25,000 transactions.
How we got here
The market was optimistic at the end of 2019, and economic expectations for 2020 were overwhelmingly positive. All this has changed, however. Economists now believe that the first six months of 2020 will mark the end of the lengthiest economic expansion ever recorded.
The World Health Organization (WHO) announced a global health emergency in late January. The next month, new COVID-19 cases surged and spread to more countries, prompting drastic government reactions that triggered a temporary decline in global financial markets. By March, the outbreak was declared a pandemic, urging central banks to implement crisis programs and policies as markets continued to fall.
As we enter the third quarter, the severity of the pandemic’s economic effects is still vague. Why? Because no one knows how long lockdowns and other such efforts to contain the virus will continue, and if such measures are even effective.
The economic impact was initially predicted to be a “supply” shock from temporary interruptions in supply chains worldwide. But when the virus reached the US, the outlook darkened; there was suddenly concern that both a supply and a “demand” shock would ensue from reduced business and consumer activity. The abrupt cessation of regular economic movements will likely pose longer-term implications on both local and national markets.
Effects of COVID-19 on Commercial Real Estate
The coronavirus situation is still developing, but trends that have implications for the CRE markets are starting to emerge.
- Companies that rely on Asian supply chains have felt the pandemic’s brunt, announcing downward earnings guidance. They have become financially-weaker tenants. This may cause potentially more turnover and lower rent growth for the CRE sector.
- Travel bans have caused hotels and lodging properties to suffer, too. Even the largest hotel chains are furloughing staff and closing several locations altogether. Fewer people are traveling, and it is not known when the trend will reverse.
- Social distancing rules and regulations have hit retail properties. Both anchor tenants and smaller inline tenants continue to close shops in compliance with recommendations by government health agencies.
- Smaller businesses—especially those without an online presence—are reeling most from the pandemic’s economic turmoil. March statistics show a 31% reduction in the hours worked by retail-sector employees and a 55% drop in the total hours by restaurant staff (compared to January figures).
- If unemployment filings are an accurate indicator of unemployment rates, then the rapid rise is genuinely concerning. High rates of joblessness may lead to longer-term declines in consumer spending—which will likely hit both the hospitality and retail industries and ultimately slow down rent growth multifamily properties and related areas.
- There is an evident freeze on CRE transactions because of rapid market changes stemming from near-total economic shutdowns. Lenders are discouraged from taking on added risk.
- Publicly-traded US REITs were also battered, showing some of the worst year-to-date performance in history:
- Self-storage: -16%
- Industrial: -24%
- Residential: -29%
- Office: -35%
- Healthcare: -46%
- Retail: -50%
- Lodging and Resorts: -62%
For the first six months of 2020, total commercial property transaction volume is predicted to show a 20% year-on-year drop in the first quarter, and then drop by 25% year-on-year in the second quarter. These national-level estimations suggest that the pandemic will cost the CRE market 25,000 transactions and over $100B in deal volume—a decline that hasn’t been seen since 2015 and 2012.
- Local-level estimates will be different. Metropolitan statistical areas such as Hawaii, Orlando, Las Vegas, others that have significant exposure to the travel industry, are expected to see more significant contractions when it comes to market activity. The same should be valid for New York, San Francisco, and other areas where stricter containment and social distancing policies are imposed. Finally, areas whose economies are already weak should also see dramatic market activity contractions in 2020.
The numbers will continue to change.
The lockdowns and containment efforts that have been and continue to be implemented are meant to control the COVID-19 outbreak and save lives. Whether they are effective at all is still not known. What’s clear is that they come at an enormous economic cost.
There are no reliable estimates of how long this crisis will last and how profound its impacts will be. Still, consumers, businesses, and governments’ coordinated actions suggest that a more significant part of society feels comfortable paying these economic costs. That said, the situation continues to evolve continually, and attitudes are changing.
CRE investors need to remain alert on adjustments to initial estimates and prepare themselves for new challenges and opportunities. Are you a commercial property investor? It never hurts to explore financing options available to you to take advantage of lucrative CRE investments if they come up. Talk to Capital Investors Direct today.