Timothy H. Savage, Ph.D., is a clinical assistant professor at New York University’s Schack Institute of Real Estate and co-author of the NAIOP Industrial Space Demand Forecast. During a webinar for NAIOP members this week, he answered several questions from attendees about the COVID-19 pandemic and its effects on the broader economy and the commercial real estate industry in particular.
Q: Is there a view that monetary policy is no longer effective and that fiscal policy is the only measure available to stimulate the economy?
A: When we think about monetary policy in the current crisis, we need to distinguish between traditional interest-rate setting and the older function of monetary policy, which is as the lender of last resort. There, we are seeing central banks around the world essentially saying, “We are the lenders of last resort.” That is an important function in the marketplace to help provide stability to prevent short-term liquidity problems from becoming long-term insolvency problems.
On the fiscal side, we need to recognize that markets react very quickly now – not only on Wall Street, but also employment markets in the current crisis are reacting very rapidly. During the height of the global financial crisis, we were losing about 800,000 jobs a month. We may be currently losing in the U.S. 200,000 to 400,000 jobs a week. So on the fiscal side, if you look at the core elements of the stimulus bill, it is addressing those sorts of issues. It is addressing things like unemployment insurance, the duration of unemployment insurance, the amount people are compensated for having lost jobs in order to provide income in what is a short-term disruption to labor markets. It also provides the Federal Reserve with guidance on how it should be acting as a lender of last resort.
But if you look in the totality of both the fiscal and monetary policy responses, I think in general we are heading in the right direction. In particular on the monetary side, where we’re recognizing the function of the lender of last resort.
Q: You talked about how secular tech destruction will continue to impact the commercial real estate sector. Will companies move a work-from-home model or the opposite?
A: Let me first talk about retail. We always have to think about retail as a distribution mechanism. It’s a fundamentally different asset class than office. It’s basically to move goods from the producers to the consumers. This has been undergoing evolution since the Sears & Roebuck catalog was introduced more than 100 years ago. Arguably, Amazon is just a digital version of the Sears & Roebuck catalog. And looking at the impact on retail, arguably the current crisis may accelerate the amount of purchases online. What we purchase isn’t changing very much, but the mechanism by which it’s distributed is changing a lot. This has the potential to accelerate that process. In that world, industrial space is valuable. It helps solve last-mile distribution issues, to address the idea that we do actually have to have stock of these goods within reasonable proximity to large population centers.
On the office side, we have to recognize that coworking, in the sense that it provides space for lease on a short term, is a little like instantaneous pricing. It’s a little like distinguishing between bonds and equities. There is an option value to short-term leases. It is valuable both to the tenant and the landlord.
The question is, does coworking accelerate through this process? Yes, quite possibly, if we recognize essentially that what we are doing now by teleworking during the coronavirus pandemic is a form of coworking. The value of that optionality shouldn’t be lost on the industry. And that’s why I think the current crisis accelerates these trends because it begins to drive technologies that we may not have thought about. For example, I taught a number of classes online yesterday. It was virtual, but we didn’t lose any of the pedagogic function in the class.
Q: What are the pandemic’s short-term and long-term impacts on supply chains?
A: Short term, it’s very difficult to judge. We’re starting to see economic activity return to China, which is a good thing. Longer term, these sorts of supply chains took decades to develop. This was not a process that began recently. This has been going on even prior to China’s entry into the World Trade Organization in 2003.
Longer term, it may be possible to begin onshoring more production. We may make a national security argument that certain types of production should be done here. But longer term, I’d rather let the economics drive the supply chain, rather than intervention on behalf of government.
Q: Is there a case for cap rate compression in favored asset classes once this passes given the reduction in Treasury yield curves?
A: Yes, I think so. If you look at more sophisticated studies of cap rates, they very much suggest that as treasuries fall, cap rates should compress, all things being equal. Setting aside the current circumstance, I would hazard a guess that cap rates would continue to compress, as they have been doing since before the global financial crisis in 2008.
Q: Any sense of industrial value declines as a result of COVID-19?
A: In the short run, there’s nothing I can see at the moment that should drive down values. Longer term, to the extent that the current crisis accelerates e-commerce, arguably values will rise in industrial space. A well-placed industrial location in an urban or suburban location could be very valuable.
Q: How do you see small businesses’ ability to get back to being productive after the pandemic?
A: I think that depends very much on the type of small business. Something like a restaurant that operates on daily cash flow will take the brunt of this. They will have access to borrowing and will be able to borrow at very low rates. That could help their capacity to come back relatively rapidly. Small businesses with heavier capital components will benefit from a reduction in rates, but it very much depends on the type of small business.
Q: Do you see U.S. industrial benefiting in the medium to long term with more companies onshoring more of their supply chains to the U.S.?
A: There’s going to be a tradeoff there, in part because our exports need to be stored before they’re exported and our imports need to be stored before they’re distributed. Onshoring of production probably doesn’t change that. I think the bigger-impact event is technological disruption and the role that industrial plays in the changing consumption patterns. We aren’t changing what we buy; we’re changing how we buy it. In my mind, that continues to redound to the benefit of the industrial sector.
Q: Why is it important to decentralize the employees of a company?
A: You could look up something called the Coase Theorem and why firms exist in the first place, which is to think of this idea of the economics of conglomeration. A firm of 100 people is more productive than 100 firms of one person. Technology allows us to exploit the economics of conglomeration while decentralizing the location of employees. Conference calls between employees working remotely is a perfect example of that. This is the central argument around coworking — the idea of decentralizing employment.
Q: REIT share prices have dropped significantly, thus the implied cap rates have adjusted higher across all product types. How should real estate investors and developers contrast this shift in the public markets to the underwriting of individual transactions at the local submarket level? How do these two environments correlate, or don’t they?
A: It’s always difficult to bring our thinking from finance, driven so heavily by equity prices, into the REIT space. We have to still recognize that the assets that comprise a REIT are illiquid. Informational symmetries may drive REIT values in a way that they don’t necessarily drive equity values.
In the conjecture that I would put forward as most probable, the V-shaped recovery, I would suspect that REIT share values would recover quickly, and I would not put much informational value on where they stand today.
Read a full recap of the webinar presentations by Timothy Savage and Anirban Basu.
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