One thing that buyers and sellers can agree on these days is that there has been a reset in property values across many sectors and geographic markets. Yet the sticking point that continues to stall transactions is determining exactly how much of a discount should be applied.
Pricing is relatively transparent when the market is gliding along with stable conditions, which makes it which makes it easy to gauge values. “The disconnect right now is that values have fallen much faster than pricing, but we’re not observing it yet because there has been a huge falloff in transaction volume,” says Anthony M. Graziano, MAI, CRE, chief executive officer at Integra Realty Resources (IRR).
Industry pricing indices have held up so far, but experts caution that is a reflection of many pre-COVID-19 deals getting completed along with some stabilized assets changing hands. They expect those indices to move more dramatically once lower-quality and distressed assets start trading.
According to the latest Real Capital Analytics CPPI for July sales, the U.S. National All-Property Index showed year-over-year price growth of 1.5 percent, which is down from a pre-COVID-19 pace of around 7 percent. Industrial has proved to be the most resilient with year-over-year price gains of 8.3 percent, while apartment pricing dipped from an annual pace of 10 percent prior to COVID-19 to year-over-year gains of 6.9 percent in July. Retail and office both reported erosion in average annual prices, falling 2.8 percent and 0.9 percent respectively.
Yet there is clearly some lag in the data that is compounded by the sharp drop in deal flow. The CPPI index was based on July property sales, which was down 69 percent compared to July 2019, according to Real Capital Analytics.
There are other factors that have helped prop up pricing over the past six months, notes Graziano. Number one is the liquidity in the market. Second has been a powerful blast of government intervention, including Fed rate cuts and the fiscal rescue package enacted by Congress in the spring. In addition, many owners also went into COVID-19 in a strong position following what had been a long-running growth economy, meaning they are not feeling pressure to sell, he says.
Certainly, there are some exceptions in property sectors and outperforming assets that are not being discounted, notably in industrial logistics and data centers, as well as some multifamily and self-storage properties that are proving to be more resilient to the negative effects of the economic crisis. For other property types that have taken hits as a result of COVID-19—including retail, lodging, office and student housing—pros are left sifting through market data, industry analysis and anecdotal examples of transactions to underwrite assets.
Graziano estimates that office values have declined between 5 percent and 20 percent, hotels between 30 percent and 35 percent and retail between 25 percent and 40 percent. Those properties that are seeing the bigger discounts are due to some type of systemic vacancy problem or shutdown, or a capital infusion will be required after purchase to stabilize the asset.
In addition, an IRR analysis of prior recessions shows that it takes about 24 months for values to hit bottom. If that trend holds in the current cycle, it would put the bottom into 2022, which would mean more runway ahead for values to erode further.
Public REITs offer some clues
Some investors are looking to the public markets for clues on how pricing has shifted. The Green Street Commercial Property Price Index shows that the all-property index is 10 percent below pre-COVID-19 levels with pricing that varies widely across property sectors. Those sectors that have seen the biggest declines in property values year-over-year through August include malls, down 28 percent, lodging, down 25 percent, strip retail, down 14 percent, and student housing, down 11 percent. The only two property sectors that continue to show price appreciation are manufactured housing, up 10 percent, and industrial up 7 percent.
“Public REIT pricing is a good average, but it is a very dangerous thing to generalize that discount across the board,” says Charlotte Kang, national practice leader, hotels and hospitality at JLL. In the hotel sector, for example, one end of the spectrum is economy/limited service and extended stay hotels that have proven to be more resilient because of essential workers and transportation professionals who have sustained demand. At the other end of the spectrum are big group hotels that cater to corporate meetings and events that are still experiencing sharply lower occupancies and revenues due to the postponements of nearly all large corporate events and industry conventions.
For example, one recent hotel transaction that involved a property that was under contract for sale prior to the COVID-19 outbreak recently closed at a 5 percent discount to pre-pandemic pricing, notes Kang. So, there are those hotel properties that are seeing only slight or modest discounts depending on the property and market, she says.
One factor that could potentially support hotel values is the amount of capital waiting on the sidelines to jump in and acquire properties. Investors know that for hotels located in markets that were strong before COVID-19 and had a very good story, if they don’t act today, the opportunity may be snapped up by someone else, says Kang. “There is a lot of capital that is willing to buy at the right price for the right asset,” she says.
Understanding the story
Transparency in the CMBS market also is providing some insight into how values are moving. There have been a growing number of adjustments to lodging and retail loans. For example, Trepp recently noted that the value of the Mall of America in Bloomington, Minn., dropped 17 percent from a pre-COVID-19 value of $2.3 billion to $1.9 billion.
However, it is difficult to generalize shifts in values. “Across the board, the change in values is different for every single property and every asset class, and there are so many factors,” says Thomas Edwards, global president for valuation and advisory services at CBRE. For example, anything on triple net lease industrial are the least impacted whereas multi-tenant retail has probably been the most impacted and all of the other asset class are in between, he says. Additionally, single tenant retail and grocery-anchored centers are holding their values better than some other types of retail.
Even the best-of-the-best retail properties have had some minimal decreases in values whereas the class-C malls and neighborhood centers with a lot of mom and pop local tenants may have seen values decline by 15 percent to 20 percent, notes Joe Miller, MAI, MRICS, executive vice president, valuation advisory services at JLL.
In the absence of retail sales comps, JLL’s valuation teams are digging into cash flows and looking at collections or signed deferment agreements on a tenant-by-tenant basis on retail assets. They are not modeling in any repayment of back due rents for March through September. On most multi-tenant retail properties, JLL also is running increased vacancy, collection loss and no rental rate growth in the first two to three years in a 10-year analysis, notes Miller.
In addition, valuation experts are engaging in conversations with market participants to get a real understanding of how different property types are faring. “That is 101 valuation expertise. When there is a lack of transactions happening in the market, you really have to force it out by talking to the market participants,” says Edwards.