Markets remain chaotic amid economic and public health challenges resulting from the pandemic.
“In the midst of chaos, there is also opportunity” – Sun Tzu, The Art of War
2020 has been a year like no other in our lifetimes. The coronavirus pandemic continues ravaging globally--public health, the economy, sports, and yes, commercial real estate. We would like to send our thoughts and best wishes to everyone who has been affected, and express our gratitude to all of the healthcare workers who are risking their lives every day for the rest of us, as well as other essential workers – grocery stores, delivery drivers, airline workers, etc., all working to keep life as relatively normal as possible for the rest of us.
Despite the terrible impact to employment and certain sectors of the economy, capital markets and CRE activity has remained active largely due to Fed action and low interest rates. Liquidity in the debt markets initially was tight, but has now begun to loosen up. Regional and local banks have been very active, while life insurance companies are being highly selective, and CMBS is struggling (9.6% delinquency rate as of July, according to Trepp Analytics). Where the current situation differs from the Great Recession is the severe and uneven impact to hospitality and retail, as well as the glut of equity capital present in the market right now to support pricing. Another noteworthy difference is that pre-pandemic underwriting was more responsible than in the mid- 2000s, with stronger underlying fundamentals, so defaults have been less widespread.
In terms of pricing, assets that were under contract before the pandemic began have, from our perspective, seemed to have continued to close at their pre-pandemic prices, although transaction volume and speed are down. We are seeing some price cuts, particularly on retail and hospitality assets, but generally most sellers do not (yet) seem willing to adjust pricing to reflect current headwinds and risks to rent rolls.
While this may change for the right opportunity or as pricing adjusts, Industrial and Multifamily are Nordic's current focus for new acquisition opportunities.
Industrial properties have continued to perform well, with strong cash flows for underwriting, and the heavier reliance on, and growth in, e-commerce is driving additional demand for warehouse and industrial space. Industrial remains the strongest sector with a heavy volume of new development, acquisitions and deal activity.
In the Multifamily space, the Federal Reserve stepped in early with CMBS purchases, which averted a liquidity crisis, and allowed interest rate spreads to tighten. Rates are now historically low and capital is plentiful, though some agencies are requiring 6-12 months of debt reserves. And, while it seems that the multifamily market should be worse, collections continue to be surprisingly strong.
Next, with Office workers everywhere adjusting to working from home, everyone is wondering about the post-pandemic office market. While vacancies will rise in the next year, the longer term impact to office occupancy is uncertain. Offices offer in-person collaboration, foster productivity and company culture, and are not going away, but the overall need for space may decline.
Hospitality and Retail are feeling the most pain in CRE. Given the decline in travel and entertainment, collections are way down, vacancy is up and increasing numbers of loans are in default and/or forbearance. Some will move into workouts or be handed back to the lenders in coming months and the impact will be felt in these sectors for some time.
We are cautiously optimistic but there are still many potential pitfalls and risks ahead. In our view, the avoidance of the worst-case economic outcomes are largely due to the economic support and liquidity provided by the federal government, and the quick and effective response of many world governments in controlling the virus. While the system is better capitalized now than during the Great Recession, there could certainly be further economic decline, especially if the virus drags on well into next year, and the lack of a second stimulus could jeopardize liquidity and lead to a landslide of evictions and defaults in residential mortgages and consumer debt.
Overall, Nordic believes that CRE will be very challenging over the next 6-12 months, but those who remain diligent, disciplined and are creative could emerge in a stronger position than before the pandemic. As difficult as the Great Recession was, many successful firms, developers and entrepreneurs arose from that challenging period.
As always, we will continue to be diligent in our underwriting and remain conservative in our approach, maintaining our focus on capital preservation. We thank you for your time and attention and should you have any questions, comments or concerns please don’t hesitate to contact us.
Sincerely,
NORDIC REALTY PARTNERS