In November, some experts worried that the U.S. economy might be teetering on the edge of a major financial storm. In recent months, banks that fear possible bankruptcies and defaults have restricted new lending and tightened credit standards. Federal Reserve officials, economists, and credit analysts suggest that a lengthy economic downturn that drives significant losses would undermine financial stability.
Companies like Barclays have already begun to adjust their thinking about how — and where — their employees will work. If commercial real estate needs decline, demand will fall, and so will property values.
According to one November 2020 report, commercial loan delinquencies have continued to rise. The four-week average of initial unemployment claims continues to hover at 100,000 above the highest level from the 2008 recession.
Certainly the corona virus vaccines have brought some relief. And as more people gain protection, some will revert to their pre-pandemic habits. But other changes — especially those driving pivots and accelerated adoption of telework as the rule rather than the exception — could negatively affect the value of office buildings, stores, hotels, and other commercial buildings.
Deloitte’s 2021 Commercial Real Estate Outlook paints a somewhat rosier picture. While the pandemic required that CRE companies modify and adjust operations, and the economy experienced a downturn, Deloitte predicts that “a vaccine and/or treatment will allow normal economic activity to begin to resume in mid-2021.”
A survey of 200 CRE senior executives that included owners/operators, developers, brokers, and investors across 10 countries provided insight into their abilities to weather the current economic situation — and drive recovery for future growth.
- Rent collections have remained healthy in some sectors because of leasing concessions/ higher tenant incentives
- Many CRE companies continue to struggle with digitizing business processes and defining digital workflows
- Nearly all expressed concern about cybersecurity and privacy concerns
- Most agreed that prioritizing nimbleness and enhancing agility to focus on improving tenant experiences remains critical
- More North American CRE companies (53%) have defined a digital transformation roadmap and consider digital tenant experience important
- Also in North America, 29% expect to decrease investment in technology in 2021 versus 28% who anticipate no change and 43% who expect to increase their investments
With a decreased demand for leased space, CRE companies have also prioritized how to contain costs through cost management and redefining value propositions. In North America, 47% expect a rental decline and 49% anticipate increased vacancy levels.
New health and safety measures required in office and other commercial spaces have driven up operating costs by approximately $19.40/ ft2 — about 5.8% of the annual cost of office rents in 2020.
Rental Growth & Decline Expectations Across Property Types
- Data Centers: 10% anticipate growth by 10% or more vs. 9% who anticipate a 10%+ decline
- Healthcare: 42% expect growth between 6% and 10% while 12% expect to see declines ranging between 1% and 10%
- Hospitality: 24% expect rental growth between 6% and 10%; 18% anticipate either no change or a decline of 1% to 5%
- Industrial: Between 24% and 21% of respondents expect rental growth between 1% and 10% versus 21% who expect a decrease between 6% and 10%
- Multifamily: These rents are expected to grow between 1% and 10% (according to 47% of respondents) while 40% of respondents anticipate a decline ranging between 1% and 10%
- Retail: 31% of those surveyed anticipate rental growth between 1% and 10% while 44% think rents will shrink between 1% and more than 10%
- Offices: Only 20% of respondents expect growth between 1% and 10%; 41% expect rental growth will decrease between 1% and over 10%.
Volatility Will Continue into 2021
CREA United member Pete Rosas, Senior Business Banker at Capital One says the volatility is a sign of the times. “We’re seeing market swings and that has certainly had an effect on the CRE market. We’ve received requests from owner-occupied businesses for mortgage payment deferments because of COVID. These people can’t sustain their revenue. But for the most part, it’s still been pretty strong.
“Most of our business customers have been able to make their mortgage payments. There’s a small percentage of customers who haven’t been able to pay and who’ve had to close their businesses,” he says. “Those loans went to default and the proceeds of the sale have gone to pay off the debt.”
Rosas says that when business owners build in the real estate costs into their expenses, there’s less risk of failure to make payment. “With investment properties, especially in retail,” he says, “we’ve seen some deficiencies and bad debt. But that’s more on the investment side than the occupied side.”
The new administration has worked to help shore up struggling businesses and their owners. “They announced in December that anyone with an SBA loan as of March 2020 would get a three-month payment waiver. And with industries even more impacted, like restaurants, those payment waivers are good for five or six months.
“The finance and banking industry has gotten creative, waiving some fees because of the current situation. Internally, we’re open to allowing customers to opt for deferment, and we’ve been flexible on terms. And the SBA will cover monthly payments up to $9,000/ month for three to six months, depending on the industry,” he says.
Real estate is based on collateral, but when banks see valuation changing, they become concerned. “They want to know the collateral is strong,” says Rosas, “but no bank is in business to collect collateral. It’s not in our best interest to not work with business owners. We do want to make sure banks are profitable and collecting payments but we also want to offer terms and payment programs designed to help owners survive a struggling market.”
Another CREA United member, Bill Schmid, Vice President of Provident Bank’s Healthcare Financial Services Group, says, “I don’t think that — unlike previous economic downturns — banks will be hurt as badly. For the most part, Banks have a strong capital position, limited loan losses and money to lend. The second half of 2021 should be more robust tied to the economic benefits associated with the roll out of the vaccine(s). We are seeing medical projects that were previously put on a Covid-hold being resurrected to take advantage of the low interest rate environment. We continue to see strong demand for medical since it has held up better than most industries.”
He says, “Banks have benefitted from the PPP program, and even though loans weren’t geared toward CRE, they did help the tenants in different sectors and buildings. SBA loans definitely helped reverse or defer the slide.”
“The EIDL loan program [an SBA program historically used to provide economic assistance for companies and businesses affected by natural disasters] rollout encouraged businesses to come back [during 2020]. It’s a very helpful government program that offers low, long-term interest rates and low payments,” says Schmid.
It’s too soon to predict definitively what the CRE market will look like by the end of 2021. However, with the vaccine rollouts increasing and more people gaining access to protection from the coronavirus, brings hope. Will the shift to working from home remain — and thus potentially keep rents down and demand low? Only time will tell.