The COVID-19 health crisis has dramatically altered the landscape of the CRE industry, with many commercial buildings forced to sit vacant for months while others have stayed open to provide essential services to local communities. Accordingly, the outlook of real estate borrowing and lending has hovered in uncertainty as markets have reacted to the sharp downturn induced by the coronavirus and the government’s efforts to bootstrap the financial foundation for businesses and consumers alike.
Now, with more US states cautiously reopening their economies under social distancing protocols and the race for a vaccine underway at full speed, CRE investors are evaluating their prospects in the new normal of stalled construction projects, reduced building occupancy and demand, and potential tenant defaults. In this article, we’ll look at the current situation of commercial asset classes and capital and perhaps even discover a silver lining or two amidst the pandemic.
Putting the Brakes on Recession
Nobody knows exactly how and when the global economy will fully recover from the shock effects of the coronavirus, but market experts generally agree that we aren’t seeing a replay of the 2008 financial crisis.
Unlike the Great Recession, the current downturn was precipitated by external factors rather than any instabilities in the economy itself. In the May 2020 edition of its Financial Stability Report, the Federal Reserve Board confirms that regulatory reforms implemented after 2008 have made the U.S. financial sector more resilient overall.
The report goes on to chart the successful measures that the Fed has undertaken swiftly since March to further stabilize financial markets, including:
- Lowering the benchmark interest rate to near-zero
- Shoring up the Treasury securities and mortgage-backed securities at the foundational core of the financial system
- Establishing emergency short-term funding to help businesses meet debt obligations
- Reducing the costs of long-term credit for consumers, businesses, and state and local governments
However, the Fed also cautions that pre-COVID CRE holdings were overvalued in relation to their cash flows, making these assets vulnerable to repricing corrections as the economic fallout continues.
The Pandemic’s Impact on Commercial Real Estate
So in light of the Fed’s warning, should you rethink your strategy to keep or acquire CRE holdings in your portfolio? It all depends on the asset class.
As McKinsey & Company observes, COVID-19 has impacted the valuation of different CRE asset classes to a greater or lesser degree, in proportion to how much a property relies on physical occupancy for generating cash flow. High-occupancy property types such as hotels, healthcare facilities, assisted senior living, and student housing have clearly suffered the most in the short term from travel restrictions, suspensions of elective medical procedures, and closures of college and university campuses.
The future of these asset classes remains unknown, and will likely depend on how well owners and operators can adapt to new health mandates and assuage the public’s concerns about reentering communal spaces. For example, hospitality brands could implement more low-touch technologies like self-service check-in kiosks, motion-activated lights and faucets, and smartphone-operated door locks. In the long term, hotels might even coax more guests back from the home-sharing industry, which won’t be able to offer the same standardized and regulated levels of sanitation.
Similarly, brick-and-mortar retail stores and shopping malls have struggled to stay solvent under widespread quarantines and bans on nonessential business activities. This can mean sleepless nights for asset owners but bargain deals for opportunistic buyers. Expect increased scrutiny from lenders, however, as they carefully consider tenant rolls and long-term revenue forecasts before releasing the funds for such investments.
Commercial office buildings also face an unclear future, as companies reconsider the open-plan layouts and shared co-working spaces that had been trending right up to the start of the COVID-19 crisis. The abrupt reversal of priorities triggered by the pandemic means that many facilities managers must now refurbish physical workspaces before employees return to the office—if they ever do. After all, some leading tech firms like Twitter are allowing their employees to work from home permanently.
Still, not all high-occupancy asset classes are necessarily in trouble. Some experts predict relative stability in the multifamily sector, given the essential need for affordable housing and the mortgage forbearance options for Fannie Mae and Freddie Mac borrowers. Other observers believe that multifamily properties might even enjoy long-term demand from millennials, who are likely to postpone first-time home buying in the face of economic uncertainty.
And on the other end of the occupancy spectrum, industrial assets like self-storage facilities and warehouses are experiencing a boon as a result of the pandemic. Just think of all the activity occurring now inside Amazon-style fulfillment centers to meet the e-commerce demands of people stuck at home under lockdown.
Current Trends in CRE Lending
- How does the number of lenders in the market differ today from when you did your loan then? Are interest rates higher now as a result of the Pandemic/virus?
- Has underwriting (by lenders) changed over the last 2-3 months?
- Are lenders being more conservative now because of uncertainty in the market-place?
- How will lenders size loans and predict cash flow over the next several years given the unknown trajectory of COVID-19
Who is or is not lending? What are the criteria & requirements?
Private Equity lenders
Institutional Lenders- (insurance company, etc.)
What is the government agency doing? What are the criteria & requirements for lending
Last but not least, remember that commercial real estate is an industry that thrives on relationships. CCIM Institute’s Chief Economist K.C. Conway has this keyword of advice for CRE asset owners: Communicate. Communicate early and often with your lender if you feel the need to renegotiate debt arrangements. And communicate with your tenants to stay informed about their business or employment situations, so that you can anticipate disruptions to cash flow and mitigate the potential impact of delayed or temporarily suspended lease payments.
By keeping a strategic eye on the market and fostering a resilient yet agile attitude towards evolving economic conditions, CRE investors can weather the downturn and emerge stronger and even better positioned with their lenders and tenants when the COVID-19 crisis passes.
Black Collie Capital is a real estate finance & capital advisory firm that empowers clients to make strategic financing and investment decisions. To learn how we can help you with your commercial real estate finance & capital solutions needs, contact us here!