Steven LarsonCRE – The Counselors of Real Estate recently published an article entitled “The Coronavirus, the End of the Cycle, and U.S. Commercial Property Markets: Early Thoughts.” The article provides excellent insight into the current headwinds that the economy and more particularly, the real estate industry, are facing from the perspective of an economist. Below is a summary of the article, with my own commentary added.

As the United States (and the world) hunker down for at least the next four to eight weeks of stay-in-place orders and rising COVID-19 infections, it is clear that the current pandemic will create at least a short-term recession across the globe. Economists and analysts have been saying for the past two years that our growth engine was nearing the end of its cycle, but no one predicted this would be how it goes down. The most important questions, from an economic and a real estate perspective are: How long will our lives be upended? When can restaurants, stores, hotels, and small businesses get back to normal? How will landlords, tenants, borrowers, and lenders mitigate losses and work together to avoid widespread eviction, foreclosure, and bankruptcy? Will the Fed’s actions give banks the confidence and the credit needed to lend? And ultimately, what structural changes await us at the other end of this pandemic?

From an economic perspective, mass layoffs in many industries combined with sinking consumer and business confidence will have a significant effect on spending in the next couple of quarters. As of this writing, Congress just passed and the President has signed a $2 trillion stimulus package (the CARES Act) that may help to reduce the economic impact on small business, as it contains an aggressive forgivable loan program that is designed to help small businesses meet their financial obligations and keep their employees on the payroll over the next few months. For more information about the CARES Act, click here.  In the meantime, many Americans are trying to figure out how to survive the next few weeks or possibly months with reduced or eliminated income. Unseen are the effects that stay-in-place orders will have on the supply chain-side of the equation. However, in some states, the number of “essential businesses” are far greater than you would imagine (at least Ohio thinks lawyers are essential!).

Short Term Issues

From a real estate perspective, there are both near-term and long-term consequences of this pandemic. As April 1 approaches and rent becomes due, thousands of landlords and tenants have been vigorously reading their leases and analyzing their options. Clauses often overlooked, like force majeure, take on a new importance as many tenants have been forced to shut down and may be unable to meet their rent obligations. As tenants fail to make rent payments, come May 1 landlords may struggle to meet their debt service obligations or worse, fail to meet their debt service obligations AND fail to satisfy their financial covenants. Landlords who have tenants who were forced to close will need to work closely with their lenders to get in front of any potential defaults.

Business interruption insurance initially provides a glimmer of hope to many businesses, but many insurance policies specifically exclude outbreaks and pandemics – it is of course important to review your own insurance policies regarding any potential recovery. In the short term, it will take the cooperation of tenants, landlords, and lenders to find temporary solutions, or the courts (once they open again) will be jammed for years working through all of the eviction, foreclosure, and bankruptcy suits. Worse, though, would be the empty store fronts and thousands of failed businesses that could not navigate these unchartered waters if all parties involved are not able to work together.

In the real estate sector, the most vulnerable in the near-term are assets with travel-related uses, such as hotels and flex-office space owners. Business travel is limited to only the most essential and vacation travel has ceased almost entirely. And, although not a significant industry in Northeast Ohio, for flex-space owners, tenants sign extremely short-term leases and the easiest overhead for those tenants to chop will be rent.

Apartments may experience a drop in demand as tenants lose income or jobs and are forced to move back in with mom and dad. As apartment leases expire, tenants may seek cheaper options like finding additional roommates or moving away from the downtown core of higher rents and smaller spaces.

Retail owners and tenants will suffer a lot of pain in the coming months until consumers feel confident (and have permission) to leave their homes and start spending again, assuming they have the money to do so. Slim margin businesses like restaurants may not be able to weather the storm and will lead to an increase in bankruptcy filings.

The office and industrial sectors are less likely to see short-term impacts, but nonetheless may see rising vacancies as companies downsize. Niche markets, such as student housing, are also seeing an immediate strain as students are forced to move home and may cease paying rent. Owners of senior living facilities may face serious financial strain if COVID-19 makes its way into one or more of their facilities.