COVID-19: Despite Dark Clouds, Some Reasons for Optimism

“We’re going to bounce out of this a lot faster than some of the most pessimistic people think.”

That’s how Spencer Levy, chairman of Americas research and senior economic advisor for CBRE, opened a webinar last week with members of NAIOP Maryland on the impacts of the coronavirus on commercial real estate. In addition to laying out several reasons for guarded optimism amid this unprecedented time for the industry, he also praised the remarkable level of cooperation he’s seen so far among real estate professionals during the crisis.

“I’ve been in this business for 25 years, and it’s a dog-eat-dog world most of the time,” he said. “That is exactly the opposite of what I’ve seen in the last couple of weeks. I’ve seen landlords and tenants and lenders and the government act in ways that I’ve never seen before, which gives me confidence, combined with the facts on the ground, that we’re going to come out of this stronger than we did going into this.”

Current Economic Conditions

While he opened on an optimistic note, Levy also delivered plenty of bad news. He believes that the second quarter is going to see GPD shrink by 20%, and that it’ll end up down 3% for the year. Goldman Sachs sees a 24% GDP decline for the second quarter, and Morgan Stanley predicts it will fall 30%, he said. Unemployment is expected to spike to 13% in the U.S., which would be the highest level since 1948.

The good news? Most analysts see a massive rebound in the fourth quarter and into 2021. Levy said analysts expect U.S. GDP in 2021 to approach 6%, which is almost three times higher than it was as recently as a few weeks ago.

“So, a really horrible situation right now, but a really impressive bounce back,” he said.

The total amount of fiscal and monetary stimulus offered by the Treasury and the Federal Reserve is $4 trillion, equal to 20% of U.S. GDP. Levy said that U.S. authorities are pumping the equivalent of four times the expected second-quarter decline into the system. Other countries affected by the coronavirus are also taking exceptional fiscal measures.

“You get the point here,” he said. “The world gets it, and they are pumping the system with money like it’s never happened before.”

What’s Happening in CRE Right Now

Despite the current dire situation, Levy said that the mood of the commercial real estate market in terms of debt and structured finance has improved rapidly.

“The predominant opinion of our team is that from a debt and structured finance perspective, the market bottomed [the week of March 16],” he said. “I know this not only from the anecdotal evidence, but also from survey evidence.”

However, there has been a massive decline in equity transactions.

“From the supply side, it’s down enormously based on the number of transactions coming to market,” Levy said. “From a demand standpoint, we’ve seen bidders fall off.”

Levy said most of the bidders who have fallen off have been institutional, not private. Institutional investors are pulling back because their portfolios are getting hammered.

Levy said he’s seeing banks taking on more forbearance for mortgages for many property types. However, one challenging area is conduit lending, or the CMBS space.

“That space is most challenging because they are subject to very strict documents, and are not necessarily subject to the same federal supervision as are these other areas where Fannie [Mae] and Freddie [Mac] have specifically said they were going to forbear in the multifamily space,” he said. “The FDIC has given specific guidance in the bank space, and we have reason to believe that insurance companies will come next. So in this conduit space scenario, we’re working very, very closely with all the trade organizations and others to see if some of the federal stimulus can give a similar level of relief.”

Levy said CBRE has also seen an increase in the number of requests for price reductions, also known as repricing asks or retrade asks.

“Those accelerated in the past week,” he said. “Many of them were above 5%. About 50% of our deals are asking for this 5%-plus retrade.”

While Levy thinks that repricing activity won’t be worse than in other periods of market distress, he said he’s seen a lot of deals completely collapse during the past month. They’ve either fallen out of contract, or folded when “material adverse change” clauses were invoked. However, he said the 1031 market remains comparatively busy.

“The 1031 buyer is still out there, they’re active, and I have yet to hear anything where the Feds are going to extend the identification period for 1031 buyers to buy transactions,” Levy said.

When – and How – Will Markets Recover?

Levy said it’s not useful to compare the coronavirus pandemic to past market crashes such as the 2001 tech bubble or the 2008 global financial crisis, which both led to recoveries that took years to play out.

“I think the two best comparisons are the SARS period in 2003 in Asia, and the facts on the ground today in China with respect to COVID-19,” he said.

During the SARS outbreak, economies in Asia saw a six-month material drop in transaction activity and a fall in values, followed by a rapid bounce back because there were no fundamental flaws in the economy. China was essentially shut down for more than three weeks after major coronavirus lockdowns began on Jan. 25. Today, Levy said that more than 90% of all Starbucks in the country are open [Starbucks has since reduced the number of stores open], more than 80% of all shopping centers are open, and more than 85% of all industrial capacity is back online.

Impact on Property Types

Turning to specific property types, Levy said that hotels have been hit especially hard by the pandemic.

“Over 50% of hotels have gone to almost total shutdown today,” he said. “I am directly aware of lenders who have reached out specifically to hotel borrowers that have personal guarantees and told them that they would forbear on their loans for three months unsolicited. So people are going out of their way, certainly in the bank space, to help people in the hotel space.”

Levy said retail is “a mixed bag of very bad with an actual silver lining.”

Among the worst-hit properties are malls. They’re largely closed, as are the stores within them. Levy also said that “a very high percentage” of restaurants may never come back, even if the overall hospitality industry rebounds strongly when the coronavirus crisis ends because of pent-up consumer demand.

He said one very bright spot right now is grocery- or pharmaceutical-anchored centers, which are pulling in record sales.

Grocery chain H-E-B in Texas does about $1 million a week at a typical store,” Levy said. “They’re currently doing $1 million a day. That’s a pretty good example of how strong the grocery space has been during this period.”

In the long term, Levy believes that the office sector will come back because it isn’t bearing the brunt of job losses. However, there will still be a lot of short-term pain. For example, Levy said the current actual physical occupancy rate in New York City has fallen to less than 5%.

Longer term, Levy doesn’t see a secular shift in which people never go back to their offices after the pandemic is over.

“Even though we believe that more people now see that working from home is doable, every survey we had done prior to three weeks ago showed that working in the office is much more productive,” he said. “It makes people want to actually work better than being at home. We think that’s not going to change.”

One thing he does see changing is office densification in the wake of social distancing.

“The average square footage for an average person in an office, which had gone so dense, we believe that pendulum will swing back to adding more square footage for the average employee,” Levy said. “That comes directly out of my conversations with some of the largest occupiers in the world, which I’ve been having over the past several days. “

As for coworking, Levy believes it’s here to stay. The facilities might change, though.

“What might change is No. 1 the design of the space, and No. 2 the physical design of the building, typically as it relates to HVAC systems that are going to have cleaner air circulating in a different way,” he said. “What’s the best example I can give you? Medical office buildings. They have a higher standard for things like redundant power, better HVAC and otherwise. You may see that type of thing become more standard in offices going forward.”

Read more in a Q&A with Spencer Levy.

Visit the NAIOP Response: COVID-19 page for critical resources and knowledge to support you now.

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