By: Max Snider, Contributor
Effects of COVID-19 on the U.S. Commercial Real Estate Market
In the earliest stages of the COVID-19 global pandemic, it was unclear what the future would hold, because the level of contamination and severity of the virus’ effects were unknown. While much of the virus’ medical effects remain unknown and the risk of relapse looms, the country is now in early stages of reopening and a mere glimpse of the future is possible.
Part of the difficulty in assessing the future, is that this type of economic crises is unprecedented. An all-but-complete lock down is akin to point blank shutting down an economy and the scale and time horizon of the current shock has never been observed. Lockdowns represent, therefore, a shock to both supply and demand. Several trends are clear.
1. Interest Rates will Remain Low
In his latest iteration of forward guidance (an official statement about the future policy objectives intended to clarify expectations), Federal Reserve Chairman Powell announced that interest rates would remain near zero. Real estate investors sitting on piles of dry powder should rejoice. With low interest rates, this should make refinancing properties and investing in new ones with high levels of debt worthwhile. Low interest rates in the near-to-medium term are likely to compress cap rates, signaling a potential increase in commercial real estate valuations.
2. Total Debt will Continue to Increase
Global corporate debt hit $74 trillion in May (note that global GDP is roughly $120 trillion), while US nonfinancial debt rose 11% to $55 trillion. This all-asset class encompassing rise in debt is startling. While this may be startling for policymakers, real estate investors should feel confident that their ability to continue to finance housing investments is unlikely to be impeded in the near future.
3. Capital Markets will be Highly Liquid
With the Federal Reserve injecting nearly $6 trillion into capital markets and legislators in Washington looking to pass their second multi-trillion-dollar plan, capital ought to continue to be in abundance. Moreover, the Federal Reserve has already signaled their willingness to do “whatever it takes” to keep capital in ready supply. This ought to signal to investors that capital will remain freely available to those who need it, including real estate investors.
Yet, each of these macroeconomic trends primarily concerns investment and financing. Perhaps even more important, especially given the stability and the relative abundance of capital, is the operations side of these investments. Domestic housing prices have plunged, leading to some concern on the capital appreciation front, however, this presents a prime opportunity for buying. Moreover, rental vacancy rates have steadily declined from around 10% a decade ago to 6% today and have remained stable even during the pandemic. This suggests a meaningful trend: despite the pandemic, renters will continue renting and staying in their home. Much of the population has managed to bring their work home, leaving only the lowest-paid individuals jobless. This is a major consideration for investors.
Thus, despite the pandemic and the disastrous effects for many people, real estate remains a relatively safe investment in the near-term. Long term, the picture is far less clear. Given much of the population’s ability to continue to work from home, the ramifications for commercial leases is unclear: will this result in a 30% decrease in office space, because fewer people need to work from an office, or will it result in a 30% increase in office space given that the health effects of working in closer quarters is now better known? Whatever the case may be, this trend will not likely become clearer for another 12 to 18 months or whenever a vaccine becomes readily available.
About the Author: Max Snider is a graduating senior at Brandeis University in Boston, MA with degrees in Philosophy, Politics, and Economics. He is currently the Vice President of Operations for the Brandeis University Investment Club with experience in the Energy, Healthcare, and Real Estate verticals. He also has professional experience in corporate development and private equity.