How Will COVID-19 Change How Lenders Evaluate Deals?

How Will COVID-19 Change How Lenders Evaluate Deals?

One doesn’t have to look far to see the immediate impact of the novel coronavirus on commercial property markets. Across the U.S., millions of white-collar workers are now working from home, stores and restaurants have closed their doors, and nearly 17 million Americans filed for unemployment insurance in the first three weeks after the pandemic began shutting down cities. Nearly one-third of apartment dwellers didn’t pay their rent in the first week of April, in addition to the countless retailers and hotel companies that are unable to make their lease or mortgage payments.

As lenders and investors grapple with these urgent challenges, many economists and industry experts are asking whether today’s social distancing measures will have lasting impacts. From a lender’s perspective, we’re already evaluating deals through a new lens. The aftermath remains unseen, but the current environment is raising several important questions about the future of all asset classes, including multifamily, office, retail and industrial.

Multifamily: How might the pandemic change where people choose to live?

While landlords are currently facing the very real and urgent rent crunch, ultimately we will emerge from this crisis in a very different place.

If the pandemic-induced recession continues for an extended period, will we see increased demand for rental properties as families downsize from single family homes? During periods of uncertainty, it’s not uncommon for households to prefer the flexibility of renting over owning a home.

However, the headlines about COVID-19 spreading in large apartment buildings in densely populated cities may scare enough people into rethinking what type of neighborhood and building they choose to occupy. The pandemic could ultimately lead to a “systemic flight from urban areas like New York to suburban areas,” according to a recent report from Moody’s Analytics.

The Moody’s report also suggests that as households become more concerned about working and schooling from home, those who can afford it may be willing to pay a premium for more spacious units. If that turns out to be the case, we could see rents rising faster for two- and three-bedroom units than studios and one-bedroom units.

Office: Will the shift to remote work continue to accelerate?

With office buildings closed, millions of white-collar workers are now working from home. As this great remote work experiment continues, will more businesses realize they can operate effectively when employees work from home, at least part of the time? Will it mean that companies lease less space per employee in the long run?

Early evidence suggests yes. A recent Gartner survey of CFOs found that 74% intend to move at least 5% of their previously on-site workforce to permanently remote positions post-COVID 19. And nearly a quarter of respondents said they will move at least 20% of their on-site employees to permanent remote positions.

Even before the pandemic struck, remote work was becoming more mainstream. Federal Reserve data indicates the share of the labor force that works from home tripled in the past 15 years. As more employees spend less time in the office, workplaces have evolved in response. Flexible workplaces with unassigned desks and large collaboration spaces dominate office trends, recognizing that even employees based in an office don’t need a desk 100% of the time, and spend some time working from home.

If these trends continue, it’s reasonable to expect that overall office utilization will drop. Yet at the same time, many workplace experts are questioning whether employees will want to continue working in dense, open office environments after the pandemic. Will people desire more personal space to protect their health? For example, crowded bench seating is unlikely to be popular when people return to their offices.

It’s too early to predict the full impact of social distancing on our workplaces, but it’s clear that office investors and their lenders need to carefully consider how such issues might impact future occupancy and rents.  Traditional formulas for calculating office space needs and usage will certainly evolve.

Retail: Will the pandemic hasten the shift from bricks to clicks?

The retail industry was already in the midst of a tremendous shift before the pandemic began, and we should expect that trend will accelerate well after social distancing ends. Quarantined at home, more consumers are becoming accustomed to the ease of ordering groceries and other goods with a few taps on a smart phone.

As more consumers shop online than ever before, will it intensify the need for all retailers to adapt to an e-commerce-driven retail market? There’s no reason to suggest otherwise. Even more complicated is the future of experience-driven retail, previously a booming sector that was replacing traditional stores in many malls and shopping centers.  After the pandemic, these experience providers will need to adapt to a public with many more questions and concerns about sanitation and disease transmission.

Lenders evaluating financing applications for retail centers will be scrutinizing the tenant mix even more carefully than before, looking more favorably on retailers that can survive the shift to e-commerce.

Industrial: How will supply chain pressures shift demand for industrial real estate?

Two large questions loom large for industrial real estate in today’s climate. First, if e-commerce trends accelerate, will it increase demand for urban warehouses to fulfill critical last mile shipping needs? Urban infill locations were already in hot demand before the spread of COVID-19, and it’s likely that the demand for space in major markets will become ever tighter, driving up valuations and rents even more in response.

Yet a larger question remains about the future of global supply chains as companies navigate the supply chain disruptions caused by social distancing measures and the economic downturn. The World Trade Organization predicts global trade will fall by 13-32% in 2020, a drop that rivals the Great Depression.

Once the economy starts to rebound, will more companies be tempted to shift manufacturing back to the U.S. in an effort to secure supply chains for future disruptive events? Or will they choose to further diversify supply chains in pursuit of the same goal? Depending which approach manufacturers take, we could see major shifts in demand for factory locations, ports and other industrial infrastructure.

As such, there are both positive and negative factors that will influence industrial markets; it will become even more necessary for each deal to be analyzed on a hyper-local level to determine the level of risk and reward.

Understanding the importance of reserves

Across all asset classes, one thing has become clear in today’s downturn: This crisis has been a wake-up call for many investors and lenders alike. Many borrowers have been caught without a cushion. In the future, investors who can reach into their own pockets – or the pockets of a few close co-investors – will have an advantage over pure syndicators. In the future, we’ll all look for more substantial reserves to prepare for the next crisis.

Visit the NAIOP Response: COVID-19 page for critical resources and knowledge to support you now.

Content and strategies shared on NAIOP blog posts are intended to provide information and insights to industry practitioners and do not constitute advice or recommendations. NAIOP and its blog post authors disclaim any liability for actions taken as a result of these blog posts.