Unlike past economic challenges, COVID-19 is having an immediate, widespread impact on the CRE industry across the globe. Learn how and why this is different, along with our take on what the post–COVID-19 recovery could look like.
The human and business impact of the COVID-19 pandemic continues to unfold globally. The rapid pace at which the pandemic is spreading and global actions to curtail it are having an unprecedented impact on the way we live and do business. While it is too early to fully understand the impact of these events, history can serve as a valuable source of information as we look forward.
Over the past century, external shocks such as an epidemic or a pandemic followed by an economic downturn have had an immediate to short-term impact on commercial real estate (CRE) asset prices, but minimal influence on transaction activity. However, the CRE industry recovered from these events at varying paces: While event-oriented downturns showed a quicker rebound, longer-term events, such as the 2008 recession, resulted in a more protracted recovery (figure 1).
As a rule of thumb, the industry has historically lagged the broader economy by six months in terms of experiencing the effects. But the expansiveness, depth and unprecedented reach of this pandemic has started impacting the CRE industry much sooner.
Unlike the 2008 economic downturn, the CRE industry was in a strong position before the onset of COVID-19. Balance sheets, capital availability, and liquidity were healthy; companies could manage their debt maturities to longer positions (figure 2).
In our 2020 commercial real estate outlook, which was based on a summer 2019 global survey of 750 CRE C-suite executives, nearly three-fourths of respondents expected capital availability to increase in 2020. Along with this, the US CRE markets continued to maintain global attractiveness, according to the AFIRE 2020 International Investor Survey released in early March.1
Since the second week of March, when COVID-19 was declared a pandemic, spreading globally and, particularly, across the United States, financial markets have declined sharply. The S&P 500 and Russel 2000 declined by 13 percent and 29 percent year to date as of April 15.2 The US 10-year treasury yields declined by 127 bps to 0.6 percent over the same time period.3
Rather than the typical lag, the CRE industry was affected immediately. This was because trade activities and occupiers’ businesses were shut down (figure 3).
How is the pandemic impacting tenants' businesses? The evolving economic situation has had a significant influence on property owners, brokers, developers, and proptechs. Here is a breakdown of the impact on CRE subsectors.
With REITs, there has been varied impact across property types based on the pandemic’s influence on tenant businesses. As of April 15, the Data Center REITs index was up 34 percent year on year, while retail and hotel REIT indices were down 48 percent and 53 percent, respectively (figure 4). Broadly, the immediate leasing risk is softened for REITs because they have long-term lease contracts. However, leases associated with the most impacted segments have immediately felt pressure because tenant businesses and liquidity have been affected. In addition to base rents, percentage rents, which are calculated as a proportion of sales volume, are significantly impacted by business shutdowns.
As buyers and sellers take a wait-and-see approach and CRE deals are delayed, most brokers feel the effects. Even property touring activity has declined considerably in the current environment.11 For instance, US CRE transaction volume declined 27 percent year on year in March.12 In early April, most realtors reported a decline of over 30 percent in buyer traffic.13
Developers’ project timelines and cash flows are affected due to the slow pace of activity and a halt in certain types of construction, including new developments.14 A recent contractor survey revealed that more than one-half of US construction firm respondents halted or suspended projects and more than two-thirds experienced delays due to a shortage of materials and personal protective equipment.15 Project sites that are still active have to adhere to guidelines on social distancing and frequent cleansing of common areas and construction equipment.16 Further, the Fannie Mae Home Purchase Sentiment Index (HPSI) declined 11.7 percent in March to 80.8, its lowest level since December 2016, indicating a potential decline in new home sales.17
There is no immediate decline in PERE investments, due to their nonpublic status. Currently, investors are, for the most part, focusing inward by helping portfolio companies manage costs and liquidity.18 To manage risk and allow for opportunistic plays, allocations may shift. Some investors could increase focus on more resilient assets, such as those supporting the digital economy. Others are expected to look for valuation plays in gateway markets or to invest in distressed assets.
The impact on proptechs varies by the type of products and services they provide. Coworking/coliving/holiday rental spaces have seen an adverse impact; users are unlikely to return to a short-term lease model in the near future.19 However, proptechs that offer digital solutions related to property and building management might fare better, as CRE companies could rely on technology to manage operations and interact with tenants.
The US government and Federal Reserve have taken multiple measures to respond to the impact of COVID-19, some of which impact the CRE industry. With rising selling pressure and illiquidity concerns in the agency commercial mortgage-backed securities (CMBS) markets, the Fed provided short-term financing to investors.20
Further, the federal government passed the CARES Act to boost cash flows and liquidity. The act includes several tax and business spending provisions that can be leveraged by CRE companies; it increases bonus depreciation, utilises net operating losses from prior years, and allows companies to obtain cash refunds for carryforward of minimum tax credits. For more detailed insights on regulations and potential benefits, please refer to Deloitte’s recent report, COVID-19 stimulus: A taxpayer guide.
Compared to the epidemics, pandemics, and economic downturns over the last century, COVID-19 has been unique in its global reaction and reach. Entire countries, regions, and cities have instituted shelter-in-place orders or have been locked down. This abrupt change in the way we work has required mass remote working, a complete lifestyle change, and has created a fair amount of fear. These converging factors, which may prevail over a sustained time period, will likely continue to influence occupiers and end users of real estate in unprecedented and unique ways, which is expected to have implications for the CRE industry.
Based on three economic scenarios laid out by the Deloitte Economists, the US real GDP growth could be -5 percent in a best or mild case scenario and -10 percent in the worst or severe case scenario in 2020 (figure 5).21
According to Deloitte’s The heart of resilient leadership: Responding to COVID-19 report, a typical crisis plays out over three time frames: respond, when companies deal with the present situation and manage continuity; recover, when companies learn and employ strategies to emerge stronger; and thrive, when companies prepare for and shape the “next normal.” To respond, recover, and thrive, each CRE organisation will have to chart its own path based on the pre-COVID-19 state of its business and decisions and actions made since then. Below are a few themes that may play out over the respond and recover phases and scenarios for the thrive stage (figure 6).
Since the pandemic began, CRE companies have generally focused on addressing short-term liquidity issues, accessing and securing their facilities, maintaining tenant engagement, complying with governmental directives, and managing the virtual close of their financial information. Below are some of the steps taken so far:
As Deloitte’s Resilient leadership framework mentions, companies can start recovering by learning from the current pandemic and taking targeted measures to emerge stronger in the medium-term. To get their companies ready, the CRE C-suite can focus on the following:
Each CRE company is likely to prepare for the next normal, or to thrive, in a different way and over varied time periods, depending on their unique circumstances. Deloitte’s futurists collaborated with Salesforce to develop four potential future scenarios to help leaders envision and prepare for the next normal, which are outlined in Deloitte’s The world remade by COVID-19: Planning scenarios for resilient leaders. When reviewing these scenarios, CRE company leaders should consider the following questions as they plan ahead:
The Deloitte Center for Financial Services, which supports the organisation’s US Financial Services practice, provides insight and research to assist senior-level decision makers within banks, capital markets firms, investment managers, insurance carriers, and real estate organisations. The center is staffed by a group of professionals with a wide array of in-depth industry experiences as well as cutting-edge research and analytical skills. Through our research, roundtables, and other forms of engagement, we seek to be a trusted source for relevant, timely, and reliable insights. Read recent publications and learn more about the center on Deloitte.com.