Distressed Sales From Pandemic Could Exceed Volume of Great Recession
As the country’s local economies start reopening after two months of mandated shutdowns to contain the coronavirus, the outlook for commercial property sales is starting to look a lot different than March and April, when sale prices were cut sharply and a record number of deals were canceled altogether.
The future also looks different than the current month, when mainly cash-flowing properties are being bought. Those deals will continue to get done, but so too will billions in distressed property sales.
CoStar estimates that there could be $146 billion in distressed sales in 2021 and 2022, if the future resembles base assumptions by Oxford Economics, a global forecasting and analysis firm. Those estimates could increase to $565 billion under Oxford’s more severe “moderate downside” forecast scenario based on higher unemployment due to the pandemic.
The projections could exceed what CoStar saw happen in 2008 after the onset of the Great Recession. CoStar recorded $176 billion of distressed sales over the following eight years.
The number of distressed sales went from about 3,600 in 2008 to a peak of about 25,500 in 2012, according to CoStar data. Transactions considered distressed included: auctions, deeds in lieu of foreclosure, foreclosures, bank-owned returned-to-lender sales and short sales.
The coming surge in distressed property sales may yet still be a few months away, however.
“Property owners are an optimistic lot and don't feel that their holdings have declined in value,” John B. Levy, principal of mortgage brokering firm John B. Levy & Co. in Richmond, Virginia, told CoStar in an interview. “And there has been precious few [COVID-19-induced] sales.”
In addition, neither investors nor lenders want a cascade of trouble, Levy added. Three-month loan forbearances have been common practice since April on monthly repayments.
“They wanted to give people time to think their way through this because the coronavirus outbreak came so quickly,” he said. “There has been this feeling of 'Let's cooperate and see if we can get through this.'”
With so few distressed sales processed, there has been little price discovery. It could be summer before there is meaningful new sales data, Levy said.
The Federal Reserve recently released its latest semiannual stability report that projected commercial real estate may undergo a “substantial repricing.”
The Fed declined to say how much of a repricing but noted property values were already elevated, which increases the risk of steep declines.
Historical CoStar data shows that when distressed sales flood the market in a short time period, properties are liquidated at prices not only much lower than their outstanding loan balance, but also much lower than the market value of similar properties in the same location.
Properties could sell at an average of one-third of their pre-coronavirus value, according to a CoStar analysis, which is similar in severity to the Great Recession.
Wells Fargo Securities forecasted a similar drop, 31%, in property prices this week based on changes in unemployment, gross domestic product and inflation.
State of the Market
Current sales volumes are smaller compared to February before the pandemic wreaked havoc on capital markets. The $15.1 billion in sales reported in April was down about 70% from February’s volume of $55.9 billion, according to CoStar data. That trend is continuing this month.
The properties trading now are generally the better quality, cash-flowing ones. That phenomenon is evident in sales pricing per square foot or per unit. Industrial properties are getting sold at per-square-foot prices 22.5% more than year-end 2019 rates. Office properties going at prices 26.3% higher; multifamily, 3% higher. Only retail property prices are down from the pre-COVID-19 prices, down 14.2%.
“In today’s uncertain world, assets [that] bring stability is what many investors want,” according to Rob Cochran, senior managing director of Cushman & Wakefield, in an email to CoStar.
Cochran led a team that arranged the $58.5 million sale of Corning Optical Communications’ headquarters, a newly constructed, Class A office building totaling 182,169 square feet in Charlotte, North Carolina.
“The quality of the asset, the tenant credit and the long-term lease were all drivers for the interest level and thus the pricing,” Cochran said.
Cushman & Wakefield heard from more than 150 interested buyers about the headquarters. The brokerage received 30 offers. The buyer, an affiliate of Crown Realty & Development in Costa Mesa, California, acquired the property and closed the all-cash transaction in three weeks.
Preparations for Next Stage
This week brought moves from several firms setting up to take advantage of property buying opportunities likely to come.
Brennan Investment Group, a private real estate investment firm in Chicago, said it launched an initiative to purchase industrial assets up to $500 million in effort to help companies “improve supply chain efficiency” and enter into sale-leasebacks.
"The desire to be ‘asset light’ is a key driver. This liberates new capital for our tenant and also increases the value of the tenant's operating business,” Robert Vanecko, a Brennan managing principal, said in a statement.
Using the Commercial Real Estate Solutions platform, Brennan plans to undertake both single property and multiproperty, multilocation portfolio acquisitions.
In Portland, Oregon, alternative investment fund manager Sortis Holdings launched its sixth investment vehicle, the Sortis Distressed Opportunity Fund, which seeks to capitalize on “once-in-a-cycle” real estate and business opportunities created as a result of the COVID-19 outbreak.
The Sortis team does not estimate a lengthy recession following the pandemic, but it does believe the crisis will have a deep enough impact on certain areas of the real estate market to create special situations.
“Our team and platform worked through the last recession to successfully underwrite and sell over a billion dollars of distressed real estate loans and assets from bank balance sheets,” Paul Brenneke, Sortis’ executive chairman, said in a statement.