Commercial real estate outlook

Q2 2021: Into the starting gates

Riding on growth optimism in the broader economy, we expect to see improvement in both CRE fundamentals and transaction activity during Q2.

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April 5, 2021 | 30 minute read

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.

Key takeaways

  • 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.

  • Our World in Data, as of March 31, 2021.

  • Bloomberg Finance, L.P., as of March 31, 2021.

  • Real Capital Analytics, as of February 28, 2021.

This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.

Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.

All investing is subject to risk, including the possible loss of the money you invest.

Matt Malone, CFA

Managing Director, Real Estate

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