COVID-19: Research Update X


Will McIntosh, Ph.D
Global Head of Research

John Kirk, CAIA, CCIM
Senior Director, Research

Mark Fitzgerald, CFA, CAIA
Executive Director, Research

Karen Martinus
Senior Associate, Research

Chenchao Zang
Senior Associate, Research

Jane Zheng
Associate, Research

August 12, 2020

As the economic and real estate conditions continue to evolve in the wake of COVID-19, it has raised plenty of questions among market participants. The following includes several of the issues that we have contemplated in recent weeks:

What does the record decline in GDP suggest about the economic recovery?

Gross Domestic Product (GDP) contracted by 32.9% in the second quarter – three times larger than the previous record low set in 1958. The collapse in output was primarily a result of weakness in two critical areas of the economy: consumer spending and business investments. Consumer spending fell 34.6%, while business spending declined 49% during the period. The collapse in consumption was driven primarily by lockdown restrictions in April that forced consumers to stay at home. The second-quarter data reflects the most severe period of the pandemic, but the economy has already rebounded from these historic lows as states began reopening in May and June. While economists generally expect a substantial improvement in third-quarter GDP, the recent resurgence in virus cases remains a headwind to the recovery.

How vital is fiscal policy to the economic outlook?

Despite roughly 49 million unemployment claims between mid-March and the end of June, real disposable income spiked by 44.9% annualized during the second quarter, and the personal saving rate hit a record-high of 25.7%. These figures underscore the increasingly important role that fiscal stimulus from Congress has played in sustaining households, particularly lower-to-middle income families that have been disproportionately impacted by job losses. Congress has yet to pass legislation that extends many of these benefits. While President Trump’s recent executive orders may temporarily provide financial relief to those in need, millions of households could suffer a steep decline in income until a stimulus bill from Congress passes. The federal stimulus has been vital in supporting consumption during the past few months. Without this support, and with the virus still far from being contained, Capital Economics argues that consumer spending could collapse again, possibly sending the economy into a double-dip recession.

What can we expect from CRE returns over the next few years?

The NCREIF Property Index (NPI) turned negative for the first time since 2009. The NPI reflects investment performance for 8,652 commercial properties, totaling $696 billion of market value. The total return for the second quarter was -0.99%, falling from 0.71% in the first quarter. The total return turned negative for the quarter as the capital return (change in value net of any capital expenditures) of -2.00% offset the net operating income (NOI) return of 1.01%. Both rent and NOI growth rates saw the most significant decline since NCREIF started collecting data, which goes back to 1978 for NOI and 2001 for rents. However, the underperformance is heavily skewed toward retail and hotels. For example, in the second quarter, NOI increased for office, was flat for industrial, was down 4% for multifamily, down 32% for retail and down 146% for hotels. If the economic outlook holds, and a gradual recovery continues into 2021, the general expectation is that core real estate should rebound accordingly. A recent consensus forecast survey from PREA, suggests that total returns will remain negative for 2020 (-4%) before reaching 3.6% in 2021 and recovering to the long-run average of around 7.6% in 2022.[1] However, commercial real estate will likely experience a surge in capital flows as the market recovers given its relatively attractive attributes (e.g., healthy cash flow, potential inflation hedge, and appreciation opportunity), which could moderate returns over the next few years.

Are there signs that transaction volume (i.e., price discovery) is improving?

Commercial real estate sales volumes collapsed in the second quarter, as the economic disruption from COVID-19 stifled transaction activity. Real Capital Analytics reported a 68% decline in transactions, as volumes plunged to $44.7 billion in the quarter. The pandemic has made it challenging for investment sales due to the economic impact, the effect on consumer behavior, and the demand for space. These conditions make it difficult to underwrite future income streams, assess property values, and determine appropriate pricing. However, there are signs that the market is starting to heat up. Last week, for example, JLL announced that it is seeking buyers for more than $12 billion worth of apartment buildings. Multifamily assets, in particular, were resilient in the previous downturn, and rent collections have been relatively healthy during the pandemic. Thus, the rise in for-sale apartment properties may prove to be a critical test for the transaction market. Ultimately, the second half of 2020 will likely reveal further price discovery as potential buyers and sellers grapple over what properties are worth in today’s environment.

Notable Real Estate Updates

  • Office: A recent report from Green Street forecasts office demand could fall by 10% to 15% in the coming years as a result of expanded and long-lasting working from home policies. However, the article also cited the trend toward de-densification might offset some of this reversal. We agree that there will be greater flexibility in the work environment going forward. However, the majority of U.S. office leases are eight years or longer, according to an analysis by Moody’s credit rating agency, which suggests that office tenants are unlikely to abandon these contractual obligations. However, in the near term, the amount of available sublease space is on the rise. CoStar estimates that 147 million square feet are available for sublease, up 29% since the first quarter of last year. The increase in available office supply comes at a time when demand for office space is moderating, which could impact rent growth given that subleased space is currently being offered at a 10% discount, on average, compared to direct listings.
  • Multifamily: Renters are eyeing additional preferences according to a recent NMHC survey. For starters, tenants are inquiring about the HVAC systems, mainly due to awareness around air quality control because of COVID-19. Renters also rank larger units high on their preference list, particularly for tenants working from home. Some landlords have even tweaked some of their model units to highlight a desk set-up or work-from-home arrangement to attract new tenants. Lastly, balconies are in even higher demand, given that people are generally spending less time outside. It is unclear if these features will remain a top priority after the virus is contained. Still, in the meantime, both tenants and property owners are adjusting to the current environment.
  • Industrial & Retail: Retail-to-industrial property conversions are gaining momentum across the country. A recent report from CBRE found that over the last three years, 13.8 million square feet of retail space has been converted to approximately 15.5 million square feet of industrial space. The report indicates that 59 such projects have either been proposed, completed, or are underway since 2017. Underperforming retail sites have become attractive last-mile locations, as they tend to be located near population centers, have utility connections, and ample parking with various points of ingress and egress. While some of these conversions are big-box stores with clear heights that are compatible with industrial use, less functional designs are typically demolished and replaced with modern warehouse facilities. This trend will likely accelerate due to the glut of retail bankruptcies combined with the exponential growth in e-commerce during the coronavirus crisis.


On a positive note, the pace of new virus infections nationally slowed for the first time in seven weeks during the week ended July 28. On the other hand, the virus is far from contained at the regional level. The number of new weekly cases in the South is comparable to those experienced in the Northeast at the onset of the outbreak, and the West region is on the rise as well. Similarly, the pace of new infections is increasing again in the Midwest, where the virus had once seemed contained. These conditions suggest that the Coronavirus will continue to be a headwind for the economy over the coming months, particularly as local restrictions remain in place, and consumers worry about venturing into public areas. The upside, however, is that it appears that by deploying practical measures (e.g., frequent handwashing, social distancing, wearing masks, and self-quarantining when necessary), the virus can be contained without reinstating full-blown lockdowns. Indeed, there remains significant downside risk to the outlook, but the economy will likely continue on a gradual recovery through the second half of 2020.


[1] Pension Real Estate Association Consensus Forecast Survey of The NCREIF Property Index Q2 2020



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