COVID Impact on Commercial Real Estate

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COVID-19’s Impact on Commercial Real Estate

The economy was on a roll in February. Even as the severity of the pandemic was taking shape in China, the U.S. remained on the upswing. But, since then, the economy, markets, jobs and businesses have been dwindling. Last week, Yardi Matrix hosted a webinar on how COVID-19 is affecting commercial real estate. Below are highlights from the webinar.

The Economy: Expectations & Responses

Social distancing measures have shuttered 20% to 25% of the economy. Q2 GDP estimates are ranging anywhere from -10% to -44%, with most of the pain being felt in travel- and experience-related industries, such as hospitality, airlines, restaurants, retail and events. The collapse of oil is also weighing heavily on the energy sector with at least one company already having filed for bankruptcy.

However, the U.S. monetary and fiscal response to the pandemic has been broad and rapid. The Federal Reserve has adopted a “whatever it takes” approach to this crisis and is pulling every lever it can to support the financial markets.

Furthermore, the $2 trillion CARES Act is adding immense liquidity into the economy by offering one-time payments to individuals and boosting unemployment benefits, as well as providing $349 billion in small business loans, $117 billion to hospitals and veterans’ health care, and $29 billion to airlines and cargo carriers.

Notably, the CARES Act also has specific provisions that will help commercial real estate, as well. In particular, small businesses can borrow up to $10 million per business, and if the money is used to pay rent, employee salaries and other related expenses for the next two months, it can be converted into a grant. It also allows for a business net operating loss carryback of five years for tax years 2018, 2019 and 2020, and provides a $5,000 refundable tax credit for retaining employees — which isn’t limited to just small businesses. Moreover, payroll tax payments for employers are delayed for the remainder of the year and Building Owners and Managers Association (BOMA) members — as well as the restaurant and retail sectors — can fully expense tenant improvements as part of a Qualified Improvement Property (QIP).

And just yesterday, April 9th, the Federal Reserved announced an additional $2.3 trillion in loans to support the municipal debt market and to small- to medium-sized businesses through its Main Street Lending Facility.

Effects on Commercial Real Estate by Sector

In the office market, larger companies that are well capitalized should have fewer problems with expenses, but small businesses with shorter runways won’t fair as well. Offices also might look a little different after the recovery with smaller spaces and possibly more work-from-home options for their employees.

Coworking will likely take a large hit as many short-term tenants have vacated or ended their leases due to shelter-in-place orders. This will certainly have a near-immediate impact on cash flow and vacancies.

Yardi Matrix predicts that the industrial sector will likely perform the best through the crisis. E-commerce demand has only increased as people stay inside but still need consumer staples and groceries. Cold storage has done well, and even online discretionary spending is up. As a side effect, the value of logistics and distribution also went up, seemingly overnight. Even so, 44% of the industrial market is comprised of multi-tenant properties, which may be hit harder due to the nature of its small business tenant mix.

Retail is taking the hardest hit. Social distancing has crushed the experiential retail market across the country. Theaters, events, resorts and restaurants are all feeling the most pain right now. However, some retail — particularly grocery-anchored — will perform better than most.

Industry Reactions & Uncertainty

So far, institutional investors have adopted a “wait-and-see” approach, according to Yardi Matrix Director of Research, Jack Kern. They’ve frozen all acquisitions and portfolio decisions and are focusing on improving cash flow by cutting expenses wherever possible. Meanwhile, individual owners with larger risk profiles may look to take advantage of opportunities that arise in the distressed market. But, overall, it’s too early to tell what’s going to happen, so most investors are sitting tight.

Yardi Matrix Vice President, Jeff Adler, said rent payments over the next two months are going to tell us a lot. Some businesses, such as those in professional services, are able to do business without much hardship. Similarly, small business loans from the CARES Act and subsequent stimuli may help many others. In the investment environment, the 10-year has collapsed and spreads are blown out, so cap rates aren’t likely to fluctuate much. As real estate is a lagging indicator, we’re likely to see improvements elsewhere before we see them in the commercial real estate markets.

Listen to the entire commercial real estate webinar, as well as webinars covering multifamily and self storage.

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