Despite an ongoing pandemic and economic recession, valuation gauges for the commercial real estate (CRE) market have remained impressively resilient. We offer three key factors that have contributed to this seemingly paradoxical reality. Additionally, we analyze how the durability of property prices informs prospects for future performance.
- Overall CRE property values have remained impressively resilient in the face of the pandemic and economic recession.
- Sales of distressed assets, which can send broader market values downward, have so far been missing.
- Government support has been crucial in buttressing the economy and has made the COVID downturn fundamentally different from previous recessions.
- These factors have turned the normal CRE cycle on its head, and investors should consider the impacts on the next expansion.
At its core, commercial real estate is a cyclical market. Demand for property is directly correlated with economic activity, including personal consumption, business investment and travel. Consequently, while the magnitude of any decline will vary based on a variety of factors, CRE property prices generally go down during economic recessions.
Just as it has been in so many ways, the COVID-19 crisis is turning out to be an exception to the rule. Major gauges of property values continued to rise in 2020 despite an extreme economic dislocation and mobility restrictions that have had outsized effects on certain types of activities. Both indexes that use a transaction-based price formula (such as the RCA CPPI) and those that use appraisals (NCREIF ODCE Index) indicate that property values have remained impressively resilient, while Green Street’s more forward-looking metric initially declined but has since partially recovered. Indeed, if you were to look at 2020 performance data without context, you might ask whether there was a recession at all. Some have used this resilience, along with the incredible performance of U.S. equity markets, as evidence that financial markets have become increasingly untethered from the real economy. We posit that there are unique factors that can help explain the valuation dynamics in the commercial real estate market during this unusual “cycle.”
Valuations have remained resilient during COVID crisis
Source: Real Capital Analytics, NCREIF, Green Street Advisors, Macrobond, FS Investments, as of December 31, 2020.