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In the Short Term, CRE Will Take a Hit. But Real Estate Economists Advise Investors Not to Panic

“Right now, expectations call for a fairly quick rebound, which means holding through may not be too painful.”

As the impact from the measures to stem the spread of COVID-19 takes hold of virtually every sector of the U.S. economy, real estate economists are revisiting their predictions for 2020 made at the beginning of the year.

Just over two months ago, industry economists were saying 2020 activity should largely mirror the level seen in 2019. But with the coronavirus outbreak, those predictions are changing. Several economists and researchers declined to comment for this article, opting to wait until the situation becomes clearer to provide their 2020 outlook. However, NREI was able to talk with Michael Knott, head of U.S. company and sector research at Newport Beach, Calif.-based Green Street Advisors, and Andrew Rybczynski, managing consultant at CoStar Portfolio Strategy, about their current outlook for the rest of this year. Here are their responses.

NREI: What is your outlook for the 2020 U.S. commercial real estate market?

Michael Knott: We now have a painful freeze in social and economic activity that has likely pushed the U.S. into recession. What’s happening now will really hurt lodging, seniors housings, and retail. Industrial is still likely to perform well, but supply chain disruption is an issue. Self-storage has too much new supply, but demand is typically resilient.

Andrew Rybczynski: We expect the commercial real estate market to feel ill effects from the coronavirus fallout. Hard data on commercial real estate and the job market does not yet bear out reason to worry, but soft data, like the consumer sentiment index, is falling. There is an expectation that the job market will experience a soft patch, which tends to affect household formation, consumer spending, and business growth. Those affect, in respective order, multifamily, industrial, retail, and office. Of these, retail looks to be the most vulnerable, as Americans seem to be practicing “social distancing,” which will particularly hurt businesses that rely on physical presences of people in high concentrations. No property type is impervious, though.

Hospitality is particularly exposed. The data already reflects a decline in occupancy and slowing revenue. It is still unclear how much travel will be skipped because of coronavirus, but canceled sports events and conferences indicate that the shock could be very meaningful.

NREI: Do you think the U.S. can still expect a positive influx of foreign money into U.S. commercial real estate?

Michael Knott: Investment demand for U.S. real estate is likely to remain healthy, although we are likely to now have a period of slow transaction activity, so it may not show up for a while.

Andrew Rybczynski: It’s too early to say what the effects of coronavirus will be on capital markets in U.S. commercial real estate, but past experience indicates that foreign money will pull back in the face of global fears. Investors will reassess where their money can most efficiently be put to work and fear causes growth prospects to be recalculated.

NREI: What are some tips for investors for this upcoming year?

Michael Knott: Recent events serve as a good reminder that access to capital is important when volatility spikes and uncertainty abounds. Also, having a strong awareness of differences in economic sensitivity among property types is important in establishing a risk framework.

Andrew Rybczynski: Don’t panic. Uncertainty creates environments where transaction flows slow and pricing and yields become cloudy. It seems likely that transactions will at least temporarily slow down, and BBB yields, which tend to lead cap rates, have already expanded as uncertainty grows. Worries about the job market may create fears that rent growth will slow considerably, which would necessarily require higher cap rates to meet returns investors deem necessary. 

Right now, expectations call for a fairly quick rebound, which means holding through may not be too painful, but the end of the virus’s spread is not in sight, and a rebound won’t happen until the virus at least seems contained.

NREI: What is your biggest concern for this year?

Michael Knott: That growing construction pipelines that seemed manageable become too large if demand takes a hit from a corona recession. Widespread social distancing, retail closures, if mandated, could have lots of nasty side effects among retailers and landlords. Retail real estate, especially malls or big-box power centers, remain a point of concern.

Andrew Rybczynski: No comment.

NREI: What are your favorite and least favorite sectors for the rest of 2020?

Michael Knott: Overall, we prefer niche sectors to primary. Thus, we still like manufactured housing and single-family rentals. Among primary segments, we like industrial and apartments. We still stay away from malls, lodging, and office.

Andrew Rybczynski: We do still believe that the secular drivers behind industrial will allow it to hold up well. Hospitality is already suffering, and retail is most likely close behind. All sectors are likely to suffer to some degree as GDP is expected to deliver below initial expectations. Much depends on when or if the virus gets contained, and at this stage experts seem unsure what that timing looks like.

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