As the COVID-19 pandemic continues to spread, it appears that the impacts on the U.S. commercial real estate industry could be substantial and long lasting.
On Tuesday, NAIOP hosted an Advantage Series webinar, “COVID-19’s Impact on CRE: What We Know Today (and Don’t),” to provide an overview of the current situation and to help CRE professionals navigate the challenges – and even some opportunities – that these unprecedented times present.
The Economic Picture
John Chang, national director of research services with brokerage and investment services firm Marcus & Millichap, opened the session by examining the state of the economy, policies that are being put in place to support it, and hurdles for the commercial real estate industry going forward.
According to Chang, one small bit of good news is that the U.S. economy was exceptionally strong when the coronavirus crisis began.
“Job creation, corporate profits, the unemployment rate, consumption levels, interest rates and inflation were all in a very good position,” he said. “We had 113 months of continuous job gains through February. It looks like that winning streak may be coming to an end. But again, we’re in a very, very good position regarding the employment market to start this.”
Chang praised the Federal Reserve’s decisive action in response to the coronavirus pandemic’s economic convulsions. The Fed slashed interest rates on March 3 and March 13, then announced huge commitments to unlimited quantitative easing and the acquisition of treasuries and mortgage-backed securities.
“Basically, the checkbook is open and they’re going to do whatever it takes to maintain the liquidity of both the financial markets and backstopping businesses with lines of credit,” he said. “That includes large businesses, small businesses, municipal bonds and credit facilities for sectors of the economy that are most at risk. Essentially, they have about $4 trillion ready to support businesses in the country.”
Chang said these unprecedented actions by the Fed demonstrate the lessons learned from the global financial crisis of 2008.
“At that time, they were very tactical in their approach,” he said. “They tried to surgically backstop certain pieces of the economy. This time around, they’re unleashing everything in the very beginning, and they’re continuing to make all the resources available that the economy will need to sustain itself through this shock.”
Congress is also working on a plan to provide unprecedented economic relief. Early Wednesday, the House, Senate and White House agreed on a $2 trillion stimulus package; the legislation must now be finalized and passed.
“They’re not just trying to backstop the individuals and the households out there,” Chang said. “They’re also trying to protect the businesses as well. When we get through this, it’s going to be very important that we have those businesses in place with staff in order to support a recovery and growth cycle.”
For perspective, the stimulus bill passed during the financial crisis in 2008 was about $800 billion.
“They are being very aggressive about getting out in front of the situation as opposed to trying to respond after things have already hit a tough patch,” Chang said.
Beyond the government’s economic actions, Chang reiterated the importance of a phrase that everyone is familiar with by now – “flattening the curve” through social distancing, quarantining of the ill, travel restrictions and other measures to slow the spread of the coronavirus and ease the strain on the health care system.
“That’s one of the key dimensions, which really creates two tracks,” he said. “If we’re effective in staying under that health care capacity limitation, the impact of the coronavirus on the economy and on jobs will be lesser, and we’ll be able to recover faster. If we blow past that capacity, it creates a lot more problems that are going to have to be dealt with, and it will make it more difficult for the economy to recover. And at this point we really don’t know where we are. It is something will all need to pay attention to and consider. We need to do everything we can to support that. But it is going to be a big variable as we go forward.”
Office and Industrial Markets
Chang then discussed the state of office and industrial markets before the coronavirus pandemic.
“Industrial has been very strong,” he said. “We have very good momentum and stability in the transaction market. We had about six years of very strong transaction activity coming into 2020 that reiterates the momentum of the sector.”
According to Chang, absorption levels had outpaced completions for a long time. That drove vacancy rates to very low levels and supported the industrial business segment. Overall transaction activity has been up 18% from the peak of the last cycle.
Looking at office demand and construction during the past few years, Chang said it’s a similar story, with absorption keeping pace with the limited pipeline of completions for office space. This has allowed the vacancy rates to decline at a steady pace and get to what he called “a very good position overall” prior to the pandemic. Vacancy rates are about 13% overall for office properties, which Chang said is a sound foundation. The transaction market has been quite strong, up 14% from the peak of the last cycle.
Actions Investors Should Take
Next, Al Pontius, national director of office and industrial with Marcus & Millichap, discussed steps that real estate investors can take right now to navigate a challenging market.
Confirm long-term strategic goals. “This doesn’t mean they’ve shifted, but this is certainly an extreme moment in history that causes and inspires reflection,” he said. “Recalibrate. Is my strategy today consistent with where I’m going in the long term? Because we will get through this.”
Review existing portfolio and evaluate the alignment of that portfolio. “Does it accomplish what you’re intending to accomplish as you move through not just the next few weeks but the longer term?”
Existing debt – evaluate leverage and rates. “Certainly we have a volatile situation in the debt market. But let me make it clear: Debt is available,” Pontius said. “We are securing financing for our borrowers today, but it’s fluid, and one lender might be in and another might be out as the situation moves. The quality of your advisory service is really important right now. But look at leverage, and look at rates. In any given year, there’s a lot of debt rolling, and candidly, the environment is pretty good right now given the rate situation. It’s good for refinance right now.”
Engage your partners – lenders/tenants/brokers. “Some tenants are going to be needing and looking for relief. So will borrowers. Everybody is in this together. So start communication early where it makes sense. Be cognizant of staying ahead of things with the tenants. What’s the tenant dialogue today, and how are you partnering to get through the short term? What are brokers hearing and seeing, and how can you utilize that information? Organize your financial paperwork. Not everybody is up to speed with the detailed terms of their agreements. You hear the term ‘force majeure’ a lot these days. What does your agreement say? These are actions that every investor should be taking right now.”
This is the first of a two-part series. The second part examines conditions on the ground in the commercial real estate industry at this time based on questions from webinar attendees. Visit the NAIOP Response: COVID-19 page for critical resources and knowledge to support you now.
Trey Barrineau is the Managing Editor, Publications for NAIOP. In this role, he supervises day-to-day operations of Development magazine.