Financial analysis

COVID-19 Q&A: Spencer Levy, Americas Head of Research and Senior Economic Advisor, CBRE

Spencer Levy is the chairman of Americas research and senior economic advisor for CBRE. During a webinar with NAIOP Maryland on Wednesday, he answered several questions from attendees about the COVID-19 pandemic and its effects on the commercial real estate industry.

Spencer Levy, CBRE

Q: How will the unemployment situation play out over the next few weeks?

A: The short term is going to be horrible. The long term is going to be a rapid bounce back, starting as soon as the doors are open again. There will be pent-up demand once again for people to go back to many of the service jobs that are most hard hit. These are disproportionately in the restaurant, hotel and other service industries. It’ll be the worst second quarter in the history of the United States, but with a strong, rapid bounce back thanks to the massive monetary and fiscal stimulus. That will give rocket fuel to businesses to come back and for new businesses to be born.

Q: Which of the asset classes will take the longest to recover, and which will be the shortest?

A: I think the two asset classes that are going to be most resilient are industrial and multifamily. The ones that are going to take the longest are hotel and retail. Office is somewhere in the middle.

If you take a look at the consumption pattern that’s happening right now in China, you see that retail is actually bouncing back faster than we anticipated, but I would be very careful about this because it’s not high-end retail. … The comeback period for major purchases is going to extend well beyond this six-month period that we’re talking about. It might be a year before you get back to normal patterns. But immediate-consumable retail will come back faster than people think. The reason why retail is probably going to be second only to hotels to come back is that once again, regrettably, a high percentage of restaurants are not going to come back at all.

In the office sector, I think we’ll come back because most of the jobs being lost are not office jobs. When you look at the job loss, you’ve got to segregate it between service jobs and office-using jobs. Again, there’s going to be a terrible tragedy in the office-using jobs space too, but nowhere the same as we’re seeing in services, which is why I think office is going to bounce back faster. Right now, everyone’s hit the pause button in terms of new office leasing, and they’re hitting the pause button in new retail leasing. There will be pent-up demand for both, which you’re going to start seeing strongly in the fourth quarter.

Q: Will the $2 trillion stimulus be enough?

A: It’s probably not going to be enough, because I think what they’re doing is giving us a pillow to land as softly as mathematically possible. What they’re going to need to do is really give rocket fuel to small-business formation starting six months from now when they realize that despite their efforts to cushion the blow, a lot of small businesses are going to close. A lot of people are going to be hurting, and they need to give loans as cheaply as possible. They need to give money away to form new businesses so they can blossom, not only in retail but in office and flex industrial.

And beyond that, people just need a healthy dose of confidence. That’s more important than anything else, and the Fed[eral Reserve] can’t give you confidence. They can give you cash. So it’s going to be a combination of cheap money and what John Maynard Keyes called “unleashing the animal spirits.” I think that’s going to happen. The day this is over, you’re going to see restaurants packed with people saying ‘I’ve had enough of this.” I think that’s the kind of animal spirit you need from the consumer. But we need some more rocket fuel from a cheap-cash perspective from the Fed and Treasury as well.

Q: What’s going to happen with cap rates?

A: Do I see massive cap rate expansion? I do not. I didn’t see it after global financial crisis. I don’t expect it today, either. There might be a short-term spike for those people who need liquidity, and there might be a short-term spike in value-add assets. That’s the one area that I’m a little concerned about right now. I’m not concerned about their long-term health. I’m more concerned about their short-term health. Many of these value-add assets have bridge loans and/or construction loans, which have a much more challenging capital structure. If I’ve got value-add assets or assets under construction, I’d be focusing almost all of my capital markets’ attention on those assets to make sure they’re bulletproof, because during your lease-up period, whatever risk you assume is clearly going to be a lot longer.

I see cap rates going up slightly, though a lot more for value-add assets and for secondary-market malls and power centers. But for almost everything else, I see modest upward pressure, but not a lot, and I see it coming right back down again within about a year, or a year and a half.

Q: As an investor, at what point do you start taking your finger off the pause button and start looking for the buying signals? What do they look like?

A: While deals have slowed down materially, we’re still doing deals. We’re still closing deals. And the cap rates haven’t blown out except for deals where you have a distressed seller. I do see opportunities now among those people, regrettably, who have distressed capital stacks. And the distressed capital stack is disproportionately going to be in the conduit space. Because the conduits at this point have not been willing to negotiate, there’s going to have to be a significant federal intervention for that to happen. Now, I don’t want anybody in this industry going down – zero. I am the advocate for this industry. But that’s the area where you’re going to see the immediate opportunity.

For longer-term assets, for assets that are in great markets and submarkets, I don’t think you’re going to see a blowout in cap rates.

Q: You talked about a change in square footage per person in offices. Can you tell us why and how you see that manifesting in space?

A: As everybody knows, there’s been a densification trend going on now for at least a decade – less square footage for the average employee. That’s for both macro reasons (you don’t need as many copy rooms, you don’t need a law library if it’s a law office) and micro reasons (people think it’s more efficient, they’re more collaborative, they’re happier working in an open-air environment). Now, I know there’s a lot of criticism of open offices, particularly regarding the noise level and other things. Guess what? Now you’re going to see more criticism because of health concerns.

So we’re likely to see more square footage so that people have more separation between each other. You’ll likely see a change in office design, where there are more temporary or permanent walls between people. You’re still going to see the common areas. But I see an upgrade in the HVAC system to make them similar to medical office buildings.

The idea that people aren’t going to go back to the office is bunk. People are still going to want to go to the office after this.

Q: What has this crisis revealed about supply chain weaknesses? What does it say about the future of the industrial sector?

A: There’s a book called “Us vs. Them: The Failure of Globalism” by Ian Bremmer, who’s the president of the Eurasia Group. The thesis of the book is that pendulum will swing back from all of our supply lines going to Asia and elsewhere to bring them back here. The reason they’re coming back is because automation is getting less expensive, as well as because of protectionism.

But there’s also resiliency. It’s proven that our supply lines aren’t resilient. And what’s going to happen is you’re going to see on these conference calls with these public companies, the analysts are going to ask, “How resilient is your supply chain for the next shock?” That’s going to force some of the large corporations to bring some of their manufacturing back. Not necessarily to the U.S., but also to Mexico and Canada, so they’re not as impacted by things like the coronavirus. And that’s going to be a good thing for the U.S. in terms of more demand for manufacturing space. It’s also going to be good for the U.S. in terms of jobs. Probably not as many jobs as people hope because many of them will be automated, but I do expect this trend to accelerate.

Q: What are your projections for when we get back to business?

A: It depends upon your industry. The biggest risk factor out there is called the double dip. That means we get the all-clear notice from the authorities to open businesses, and then they have to reshut the gates again in July or August because the infection is clearly not under control.  That would be a disastrous scenario. My most realistic date for the gates to reopen is in June, because that’s where Treasury Secretary Steve Mnuchin is. 

Putting that aside, based on what we saw with SARS and based on what’s happening in China today, we believe that in June, you’re going to start to see things slowly creep back into the market from a business perspective. You’re going to see it happen very rapidly in certain forms of retail.

For offices and other businesses, it’s going to take longer to ramp up depending on consumer and business confidence.

From an office and industrial standpoint, you’re going to see a huge spike in leasing in the fourth quarter. I think retail is going to be a little bit of a laggard into the first or second quarter of next year. The reason why is that retail tends to be a much more seasonal business where a lot of the setup for the deals is done in the spring so they can close in the fall. That whole thing has been upended by this.

Q: How are you advising clients to deal with tenants who are saying they can’t pay rent on April 1?

A: Have that conversation with your tenant now rather than waiting for April 1.

Read a full recap of Spencer Levy’s webinar presentation.

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