“This is Not a Financial Crisis … This is a Natural Disaster”
Two economic experts presented webinars to NAIOP members on Wednesday that explored the most pressing issue in the commercial real estate industry: the COVID-19 pandemic and its impact on economic activity in the country.
“We have to recognize that this is not a financial crisis,” said Timothy H. Savage, Ph.D., of NYU’s Schack Institute of Real Estate during a webinar for NAIOP members across North America. “This is a natural disaster. It’s a natural disaster in which it is not the physical capital that is being affected – it is the human capital. It is each one of us essentially isolating ourselves, and that directly impacts the economy.”
In a webinar for members of NAIOP’s DC|MD chapter, Anirban Basu, chairman and CEO of Baltimore’s Sage Policy Group, echoed those sentiments when he described how the crisis might end.
“Ultimately, we’re counting on Regeneron, Gilead Sciences, Merck, Pfizer, Bayer AG,” he said, naming companies that are working on treatments and vaccines for COVID-19. “That’s who’s going to solve this economic problem. The economic problem is not going to be solved in a bank or in a brokerage or on the trading floor of the New York Stock Exchange. It’ll be solved in a laboratory. The brilliant minds who work in global life science are going to save the day.”
Savage said the current situation is unprecedented, and comparisons to the Great Recession don’t really work. Because of dysfunctions in bond markets that reflect the degree of uncertainty caused by the pandemic, investors have fled to the most liquid financial instrument that remains: cash. Because of that, the U.S. economy is facing a liquidity trap, in which people and businesses hoard cash because they fear an adverse event.
“Trying to use the lens of the 2007-2008 global financial crisis isn’t particularly useful at this moment,” he said. “We are in a world in which traditional monetary policy is ineffective. The role of monetary authorities now is very different than it was two or three months ago.”
Strong Start to 2020 Before the Crisis
Basu noted that the U.S. economy was in great shape prior to March 9. It added 277,000 jobs in January and 273,000 jobs in February. Overall, 22 million jobs were created during the long recovery from the Great Recession that began in 2007. Thanks to the exceptional job-creation performance of large metropolitan areas in the U.S., unemployment had fallen to a 50-year low. That low unemployment rate boosted wages for workers, which in turn lifted retail sales.
“It was a perfect set-up for commercial real estate,” Basu said. “Lots of job growth, which means more demand for space for workers to inhabit.”
And then the pandemic hit. State and local governments ordered social-distancing measures and business closures. Economic activity, especially in the retail sector, ground to a halt. That, in turn, led to 3.3 million jobless claims this week, the largest figure in U.S. history. (According to the New York Times, the most applications filed in a single week previously had been fewer than 700,000.)
“You hear chatter about the unemployment rate possibly rising to 20%,” Basu said. “I don’t think we’ll get that high. My prediction is during the next quarter we’ll get up to somewhere in the range of 10% to 15%. Still, the second quarter of the year will be the worst quarter of our economic lives.”
While that might not be as staggeringly high as some earlier predictions, Basu said it will still be enough to put pressure on commercial real estate. If tenants can’t pay rent, owners could have difficulty making loan payments. And beyond immediate cash-flow problems, businesses could start rethinking their space needs.
“At that point, do you think the motivation will be, ‘Hey, I really need to be in this Class A or A-plus space?’ Some people say yes,” Basu said. “They’re still looking for top talent, and it’s always scarce. But others might look to dial things down a little for their next lease. So what’s going to happen to all that new construction?”
The Eventual Recovery
Citing a Goldman Sachs analysis of GDP changes during the 2003 SARS outbreak in China, Hong Kong and Canada, Basu said there is almost always a sharp contraction in activity during pandemics, then a strong bounce back in activity. He said he expects that will happen during this cycle. Low interest rates and the amount of government stimulus money in the pipeline will be a big help.
“I’d characterize this as short and vicious,” he said. “But the short part will be a public health issue – how quickly we can flatten the curve.”
Basu predicted that a recovery could begin in the third quarter of the year.
“The second quarter is lost to us,” he said.
Savage echoed those sentiments, citing the 1957 flu pandemic that killed 1.1 million worldwide and 116,000 in the United States. In the fourth quarter of that year, the economy contracted by about 4% and in the first quarter of 1958 it contracted by 10%, but it fully recovered by the end of the year.
“It was very much a V-shaped recovery in a pandemic that is barely mentioned in the history books but is recorded in the data,” Savage said. “I think Ben Bernanke [former chairman of the Federal Reserve] mentioned earlier that he thinks this will follow a V-shaped recovery. This is not the global financial crisis. Remember, that arose in a situation of considerably more private leverage than we have today, and the protracted recovery required a fair amount of time for that leverage to work through the system. This is a very different situation.”
Follow these links for Q&As with these economic experts:
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.
