COVID-19 has significantly impacted the global economy as countries took sweeping measures to combat the spread of the virus. Halts in production, logistics activity, and consumer demand have had outsize effects on the globally intertwined supply chains many companies have built. Zencargo, a logistics startup, predicts supply shocks will generate $700 million in losses for the U.S. retail industry alone in the period from March 9 to April 20. This has led many supply chain experts to formulate risk mitigation strategies accounting for a variety of factors from labor costs, to capital investments. Many companies had one pain point in common: high supply chain concentrations in China. The effects of production halts are still being felt across many sectors. It is likely this crisis will force companies to assess the risk of reliance on one source for so many inputs and finished goods. One potential effect is the increased buildup of manufacturing and distribution capacity in the United States. A large-scale shift to domestic buildup has important real estate implications, particularly for industrial properties. From modifications to existing properties to entirely new development of custom facilities, the new demand could represent a strong opportunity to generate returns for investors that can lead and respond to these changes.
The COVID-19 crisis has brought significant stress to the commercial real estate financing market resulting not only from the obvious effects of putting the U.S. economy on hold, but also because commercial real estate and social distancing don’t mix.
The inevitable result will be missed rent, forbearance, and potential defaults by tenants. Landlords will need to accept this and work with tenants or risk sending tenants into bankruptcy. This will create unoccupied spaces in their buildings and destroy relationships with otherwise good tenants.
When crises hit, the biggest challenge in underwriting commercial real estate is in sorting out which issues are brief interruptions, and which will have long-term impacts on value (i.e. understanding the difference between a suspension of the rules and a changing of the rules). For example:
Topics: Market Update
“As the current coronavirus pandemic reaches a (hopefully) peak in the U.S. and the extent of the devastation to the economy comes into focus – 22 million unemployed, thus far, with downstream impacts to everything from retail sales, sporting events, the price of oil, and the stock market (regardless of a mini bull market in the past week or so) – we have begun to think about what the recovery is going to look like, which real estate segments will be the winners and losers in the “Great Lockdown,” and what is happening in the real estate capital markets? And so we asked our client base of real estate market professionals to tell us what they thought, in this special edition COVID-19 Real Estate Sentiment Survey.” (RCLCO Real Estate Advisors, 4/21)
In December 2018, RRA Capital conducted an annual mortgage broker survey to explore how interest rate pricing changes at different leverage points for a typical commercial real estate (CRE) bridge loan. The inspiration for this survey came from the desire to give borrowers the sharpest pricing we can at different LTV exposures by getting a better idea of current market pricing.
For the purposes of this survey, a “typical commercial real estate bridge loan” was assumed to be the following:
- Debt Assumptions: Acquisition financing, non-recourse, 2-year term
- Property Assumptions: General multi-tenant commercial property, class B, partially-stabilized, $15 million value
- Borrower Assumptions: Has experience in the product type, good credit, an acceptable net worth as limited guarantor and ability to accept leverage between 40%-95% LTV
- Market Assumptions: Well-located, infill location, in a stable secondary market
The below chart displays the survey results, which came from some of the most active mortgage brokers across the United States. The black bold line in the middle is what RRA extrapolated to be a good average rate (internally referred to as the “Yield Curve”). More specifically, the black line is the exponential trend line of the rate of change between the data points. And to control for some outlying data, any data points where either the rate of change or the rate of acceleration were more than two standard deviations from the mean of the sample were excluded.
Topics: Market Update
Periodically, RRA will provide a brief snapshot of what we are seeing in the commercial real estate market in order to educate our clients and investors. Q3 2018 represents a poignant time in which to kick this initiative off, as interest rates and uncertainty are increasing and interest in alternative investments such as CRE are continually on the rise.
CRE values appear to be peaking but it’s not looking like a bubble as leverage remains conservative and the economy is healthy. The fundamentals are good but few are expecting large further increases in rent and values. Transaction volume is down and it will be interesting to see if there are enough compelling investments out there in order to put the sizable dry powered raised to work. The rising interest rate environment can have both positive and negative effects on CRE and we are watching this closely. Investors looking for additional security along with current income are finding a fit with CRE debt.
Topics: Market Update