The spread of the novel coronavirus across the globe and its arrival in the U.S. and Canada have prompted analysts to assess the disease’s potential impact on the North American economy and commercial real estate industry. Much remains uncertain about the new disease, including its incubation period, infection rate and mortality rate. Recent news reports and industry publications provide some insight into the virus’s potential economic consequences.
China’s Ripple Effect
China’s ongoing experience with the disease has already sent ripples through the global economy and highlights the commercial real estate sectors that are most vulnerable to an epidemic. Initial factory closures and the quarantine of workers across China have disrupted the global supply of raw materials and intermediate parts needed for manufacturing as well as finished consumer goods. Major U.S. ports, such as those at Los Angeles and Long Beach, have already experienced declining shipping loads from China. Reports from news outlets like the Wall Street Journal suggest that many small- and medium-sized businesses in China are currently struggling to pay their workers and may close before economic activity returns to normal levels. Business closures could further disrupt global supply chains and slow China’s recovery.
Impact on the Industrial Sector
Gregg Logan and Taylor Mammen at RCLCO Real Estate Advisors expect that demand and pricing will soften for industrial real estate in markets near ports that handle a significant volume of Chinese trade. They also predict supply shortages for retailers that rely on Chinese imports once current inventories are exhausted. Taylor Coyne and James Cook at JLL note that textiles, consumer electronics and automotive supply chains are most vulnerable to disruption due to their complexity and dependence on Chinese production. However, most analysts currently project that healthy fundamentals and strong investor interest should allow current industrial assets and new industrial development to weather short-term weaknesses associated with these disruptions. In an interview this week with NAIOP, Timothy Savage, Ph.D., co-author of the NAIOP Industrial Space Demand Forecast, said he believes that industrial real estate would face significant harm only if there were a long-term disruption to global supply chains.
A Potentially Heavy Blow for Retail and Hospitality
If China’s experience is any guide, the retail and hospitality sectors could be hit hard by the spread of the virus in North America. Shops, restaurants and movie theaters will suffer if customers opt to stay home rather than risk infection. Savage said that fears of the virus may hasten consumer migration to e-commerce, exacerbating the disease’s effects on bricks-and-mortar retailers. An epidemic could hasten the closure of retailers that are already heavily indebted or have poor cash flow. Writing for the Wall Street Journal, Soma Biswas and Jennifer Smith note that junk-bond-rated retailers that are particularly reliant on Chinese imports are most vulnerable to the effects of the virus. On the other hand, if those effects are relatively short-lived, healthier retailers may eventually recoup short-term losses when consumers return to stores to satisfy pent-up demand for goods and services.
Hospitality firms that rely on travel and tourism may be less fortunate. Savage observed that the hotel and hospitality sector is already experiencing declining demand because operators price their services in real time. Logan and Mammen predict that hotels will likely feel the effects of cancelled or postponed business meetings, conferences and personal trips for the first half of 2020. Writing for Deloitte, Daniel Bachman, Ph.D., notes that unlike delayed consumer goods purchases, many losses associated with cancelled travel are likely unrecoverable.
The Outlook for Office and Multifamily
The office and multifamily sectors are unlikely to be significantly affected unless there is a deep and prolonged recession. Most economists currently predict that the virus’s effects on the economy will be short-lived. However, Bachman notes that the coronavirus could have a more lasting impact on global supply chains if rolling outbreaks occur slowly from region to region. A recession is possible if governments take severe measures to contain the virus, disrupting supply chains and economic activity. If economic disruptions associated with the virus are more prolonged than most currently predict, heavily indebted companies may default on their loans, potentially causing a financial crisis.
Revised Forecasts for U.S. Economic Growth
Writing for JLL, Ryan Severino takes a similar position, noting that JLL has lowered its baseline forecast for 2020 U.S. GDP growth from 1.8% to 1.5% while adding that there are significant downside risks to that forecast. A more significant response to the virus by consumers or the government could result in a more pronounced impact. If Americans significantly reduce their expenditures and stay home from work, the combined reductions in demand and supply could expand and extend the impact on the economy. Severino notes that while rate cuts by the Federal Reserve might prop up confidence in capital markets, they do not directly address the problems posed by coronavirus. Fiscal policy, especially if targeted to the industries combatting the virus, could produce a greater benefit for the economy. Savage concurred with this assessment: “Absent fiscal policy, we are running out of policy tools.” He maintains that the virus has the potential to reduce GDP growth in the first half of 2020 by 50 basis points and could dramatically slow employment growth.
Construction Costs and Labor Disruptions
In addition to the potential risks faced by the retail, hospitality and industrial real estate sectors, the coronavirus could also increase costs and risks for all types of construction, particularly for projects that rely on materials or equipment shipped from China. In its H1 2020 Construction Outlook, JLL notes that the U.S. imports between one quarter and one third of all construction products from China. Illnesses and quarantines could also disrupt the construction labor supply in areas affected by the virus, resulting in significant project delays. Rising construction costs and labor disruptions could be particularly painful for projects that are already operating on thin margins.
In comments to National Real Estate Investor, Manus Clancy, senior managing director at Trepp LLC, observed that lenders for commercial mortgage-backed securities are increasing spreads between the interest rates they charge for AAA-rated and BBB-rated deals to account for higher risks associated with coronavirus. When combined with declining treasury yields, however, all-in rates are close to what they were in early February.