COVID-19 CRE Impact Differs by Markets
- Shorter leases will experience greater challenges.
- Multifamily markets are local.
- The COVID-19 CRE impact includes market volatility.
The COVID-19 CRE impact is not yet fully clear. But in a March 19 webcast, Victor Calanog, the head of CRE economics at Moody’s Analytics underscored that the outlook will vary by property types and geographic locations.
Shorter Leases, More Immediate Impacts
The hotel industry, having shorter leases, will likely be hit hard at the outset, said Calanog. To stop the spread of the virus, businesses and entertainment venues have closed their doors. State and local governments are encouraging people to stay at home. The cancellation of business and personal travel is heavily impacting geographic markets which depend on the leisure and hospitality sectors. “Expect markets like Las Vegas, Orlando and New Orleans to be at greater risk,” Calanog.
Co-working leases have shorter terms and fewer tenants compared to more established companies. With office space, the economist noted that New York, San Francisco and Seattle have the largest shares of WeWork leases. Calanog opined that large companies are less likely to renegotiate leases for their headquarters compared to co-working arrangements. However, industry watchers should keep in perspective the footprint of flexible offices. Moody’s Analytics, REIS and CompStak documented the following in total office inventory: WeWork leases amounted to slightly over 1.8% in New York, approximately 1.7% in San Francisco and slightly under 1.5% in Seattle.
Employment and job growth reflected in office spaces will eventually affect multifamily markets. Industry experts have analyzed data through February. They are still gathering information on the coronavirus impacts starting in March.
Transaction Market Volatility
Investors have put deals on hold. Quarantines have prevented on-site inspections and standard due diligence, according to Calanog. Financial markets have become more volatile and borrowers are renegotiating loans, seeking lower interest rates.
He listed three historical events when the market affected transaction volume:
•Fall of Lehman Brothers (the fourth quarter of 2008)
•EU debt crisis (the third quarter of 2011)
•U.S. presidential election (the fourth quarter of 2016)
During these three periods, volume fell anywhere from 20% to 40% in a single quarter, said Calanog. But prices actually did not fall in 2012 and 2017 and transaction volumes recovered pretty quickly. However, Moody’s Analytics Deputy Chief Economist Cristian deRitis emphasized the coronavirus situation is complex and driven by factors outside the above-referenced events. A full-blown, protracted recession will extend the recovery period, he said.
Covid-19 CRE Impact on Multifamily
With REIS data, Moody’s Analytics looked at construction, vacancy, net absorption and rent growth. In early February 2020, the industry was expecting more than 300,000 new multifamily units nationwide. Calanog pointed out that was the highest figure in more than 20 years. However, he stated with a severe pandemic, new construction would be slashed by over 30% due to project delays and cancellations. In that scenario, about 170,000 new units across the country would come online in 2020.
Calanog stated a pullback in demand would prompt national vacancy rates to rise in a severe pandemic to 5.9%, and up to 6.6% with a protracted economic slump.
“it is important to note that the pullback in new supply actually acts as a positive countervailing effect capping the rise in vacancies,” he said. The economist opined that the market will not reach the historic high of an 8.1% national vacancy rate, which occurred during the 2009 recession, because multifamily fundamentals have been steady over the past decade.
Multifamily Markets Are Local
With a protracted economic slump, Calanog projected effective rents on a national level to fall by 2.8% to 3.9%. However, real estate is local. Economists have determined oversupply will tend to create more distress in geographic markets when demand pulls back abruptly. Recent historical records of rising vacancies and moderate rent growth point to markets that will face greater difficulties in a downturn.
New York and San Francisco have experienced stable vacancy rates but also volatile rent growth. With a protracted economic downturn, “New York vacancies are expected to rise by 160 basis points, 5.5%. But effective rent declines are projected to decline by 5.4%,” Calanog stated. “Similarly, San Francisco apartment vacancies are expected to rise by only 190 basis points, to 5.9%. But effective rents may fall by as much as 10.8%.”
Moody’s Analytics also predicted the top five markets likely to experience the most significant increase in vacancies in 2020 would include Tuscon, AZ; New Orleans, LA; Greenville, SC; Charlotte, NC; and Tacoma, WA.