Roughly a year into the COVID-19 pandemic in the U.S., the commercial real estate (CRE) market continues to recover from an unprecedented dislocation. A strong pace of vaccination in the U.S., combined with aggressive fiscal stimulus, has brightened the outlook for economic growth and the CRE backdrop. While risks to the outlook persist for certain property types, we expect to see a broad improvement in both fundamentals and transaction activity during Q2.
- Q1 saw significant progress in vaccine distribution, lifting GDP estimates for 2021.
- Property prices continue to rise, though transaction activity remains somewhat muted.
- We expect a recovery in CRE fundamentals, especially for the most impacted sectors, to begin in Q2 and accelerate during the summer months.
Entering 2021, there were signs of optimism around vaccination and fiscal policy support, but an air of uncertainty still permeated the economic outlook. Vaccine distribution had barely gotten off the ground and the country was experiencing its worst surge in the pandemic to date. Fast forward just three months, and the future looks markedly brighter. After a slow start, the pace of vaccination continues to ramp; roughly 100 million people have received at least one dose of a vaccine, and the daily rate has improved to 2.5 million doses per day.1 At this rate the U.S. could near herd immunity by the end of summer, allowing a return to something resembling normalcy in Q3.
The federal government continued to support the economy through the vaccination period, passing the massive $1.9 trillion American Rescue Plan Act, the third installment in what now amounts to nearly $5 trillion in COVID-related fiscal aid. The bill included $1,400 checks to most citizens, expanded unemployment benefits, extended aid to states and localities, and money for vaccine distribution and school reopenings. The combination of this powerful fiscal thrust and a vaccine-led reopening have induced some remarkable economic estimates—the Bloomberg consensus estimates for U.S. GDP growth in 2021 and 2022 sit at 5.7% and 4.0%, respectively, while the Fed expects 6.5% and 3.3%. Both projections would get GDP back to its pre-COVID trend level by the end of 2022.2
U.S. real GDP
Source: BEA, Bloomberg Finance, L.P., as of March 31, 2021.
A turbocharged economy should help boost CRE fundamentals that were hit hard by the pandemic. Vacancy rates across most property types increased in 2020, with industrial the only exception. Rent growth also stalled for the most part—retail rents declined -2.6% as more shopping moved online, while apartment revenues fell -1.7% as apartment owners offered concessions to attract tenants.3 Impacts varied widely by geography, with the general rule being that less expensive second-tier cities experienced a more muted hit to fundamentals than gateway cities like New York and San Francisco. Broadly, we would expect vacancy and rents to begin to normalize over the coming year, although it remains challenging to predict what durable changes to space usage the pandemic will inspire going forward.
Transaction activity in the CRE space came out of the gates slower in 2021. After a relatively strong Q4, volume totaling $46.6 billion in January and February was more in line with June–August 2020 levels. We presume the anomalously active Q4 was attributable to a combination of sellers capitalizing on vaccine news excitement and a classic year-end deal blitz. Q1 is typically the lightest-volume quarter of the year, and we would imagine some sellers are holding off to see whether they can drive a higher price once economies reopen more fully and properties see cash flow return. Given the amount of capital available, we could see a rush of deals over the next two quarters as strong economic forecasts actually come to fruition.3
Property prices continue their relentless march upward, climbing 1.9% through the first two months of 2021 after rising 7.2% throughout a tumultuous 2020.3 We have not seen a surge in sales of distressed properties like the one that decimated property values in the wake of the Global Financial Crisis (GFC). Instead, capital availability and a sense that fundamentals should recover rapidly post-pandemic have allowed property owners to retain troubled assets. Additionally, the pandemic has driven a wedge between property types, boosting price growth in some sectors (e.g., industrial, multifamily) while sapping it in others (e.g., retail, hotel).
Outstanding mortgage growth
Source: Federal Reserve financial accounts, as of December 31, 2020.