Were a commercial real estate (CRE) investor to have closed their eyes in March and kept them shut until December, they might have breathed a sigh of relief. The springtime’s gloomiest headlines have mostly not come to pass, due to a combination of investor flexibility, business and consumer ingenuity, and government aid. While certain sectors of the CRE market continue to face varying degrees of uncertainty, the turn of the calendar offers hope that the acute impacts of the COVID-19 pandemic will soon be lifted.
Although the U.S. enters 2021 amid the most severe surge in the COVID-19 pandemic yet and a decelerating economy, it is difficult to ignore the optimism that comes with closing the book on 2020. Pfizer and Moderna have already begun distributing their highly effective vaccines, and Q1 could bring approval of one or more additional inoculations. The rollout of these vaccines offers promise for the end of the pandemic and a return to normalcy at some point in 2021. This applies to the CRE space as well, although it remains to be seen what a post-pandemic “normal” looks like for property markets. Over the next three months, focus will be on bridging the economy to reopening as we all await widespread vaccination.
From an economic standpoint, Q1 figures to be challenging. After GDP grew by 33.4% annualized in Q3, the economic recovery showed signs of slowing in November and December as the pandemic raged.1 Retail sales fell by -1.1% in November, the largest month-over-month drop since April, as consumers dealt with new restrictions and colder weather.2 Labor market improvement slowed in Q4, culminating with 140,000 jobs lost in December, mostly in the hotel and restaurant sectors, and weekly jobless claims have crept upward, albeit modestly.3 It is clear that the economy heads into 2021 with little momentum and a “double-dip” recession is possible in Q1, although the latest stimulus bill should provide a needed boost. A $900 billion bill passed in late 2020 provides direct payments and support for unemployed individuals and small businesses, and it will be a key factor in helping avoid economic scarring while awaiting widespread vaccination. A unified Democratic federal government could lead to additional fiscal stimulus, though this remains highly uncertain.
From a market standpoint, 2020 finished as the least active year for the CRE market since 2012.4 After a robust start to the year, the pandemic drove Q2 transactions to levels not seen since the Global Financial Crisis (GFC). Deal flow has picked up somewhat since June, thanks in large part to the industrial and apartment sectors, which have comprised 60% of total volume since the onset of the pandemic. The market has been generally hesitant to provide liquidity in sectors that are either under immediate pandemic-initiated financial strain (hotels), hold longer-term demand uncertainty (some areas of office) or both (retail).4
The lack of transactions has made the impact on property valuations difficult to gauge, though it is important to point out that a dearth of deal activity did not inhibit CRE prices from declining consistently throughout 2008 and 2009. The difference between the two crises has so far been stark, to a large extent because a significant portion of activity during the acute period of the GFC was concentrated in distressed assets. In Q3 2020, only about 1% of total sales were in distressed assets, which has helped limit the impact on market valuations.4 Many property owners and lenders have been viewing this crisis as sharp but temporary, and thus mindsets have been geared toward getting to the other side rather than selling at a steep discount. Ultimately, CRE prices climbed 5.4% in 2020, though dispersion among sectors is wide.4
Debt markets have had a large hand in avoiding a glut of distressed sales. While delinquencies rose rapidly in 2020, lenders were quick to offer forbearance and loan modifications to give borrowers breathing room during the pandemic. Around 7.6% of CMBS loans remain delinquent, down from a peak of 8.7% in June.5 Balance sheet lenders show much less in the way of loans on nonaccrual, though reporting differences make it difficult to gauge delinquency for banks and insurance companies.6
We see reasons for both caution and optimism for CRE capital markets in 2021. The first quarter is generally light on transactions, historically representing only 21% of a given year’s volume, and economic fundamentals may be relatively weak to start the year.4 Additionally, once vaccines are rolled out, owed amounts for forbearance and reserves could cause some overhang. However, we see gradual progress in Q1 leading to a robust recovery later in the year. Effective vaccine administration should remove much of the near-term uncertainty, while ultra-low yields and an abundance of capital should drive investors into CRE assets. This should present opportunities for lenders of all sorts.
While this is meant to be a Q1 outlook, it is difficult not to look beyond to what lies ahead next year. The first quarter may be challenging for everyone, with the pandemic still surging, the economy decelerating and hyper focus on news around vaccine distribution. CRE investors may take some solace in the fact that markets have remained fervently forward-looking throughout this crisis. Significant challenges remain for certain property types, and even once most of the populace has been vaccinated, the market will have to gauge how the pandemic may have permanently changed the use case for many properties.
However, we go into 2021 with a hopeful outlook for the CRE market as a whole. “Waiting on the World to Change” may be an apt motif for Q1, but thankfully, one of the other lines from that John Mayer song – “We just feel like we don’t have the means / To rise above and beat it” – should not apply for the whole of 2021.