Q&A: Real Estate Expert Predicts Impact of Coronavirus on the Market

The coronavirus pandemic continues to impact the economy at large, and the commercial real estate sector along with it.

In this exclusive Q&A interview with LoopNet, real estate expert Norm Miller reflects on the short- and long-term effects of the coronavirus pandemic on the commercial real estate sector.

Professor Miller is the Ernest W. Hahn Chair of Real Estate Finance at the University of San Diego (USD) School of Business and is affiliated with the Burnham-Moores Center for Real Estate. He has published numerous academic research papers, books, and articles for trade publications on housing, brokerage, mortgage risk, valuation, forecasting sustainable real estate, workplace trends, and other real estate-related topics.

LoopNet: What do you see as the most significant impact the pandemic will have on real estate markets, and why?

A: Rent reduction requests will be ubiquitous across all assets, especially apartments and retailers, and these will last perhaps two quarters. Those with means to pay rent, and those without the means, will all play the game of negotiating rental abatements to the extent possible.

Landlords will need to be forensic auditors of real business financial conditions in order to size-up the requests. Some properties will default, especially those that are highly leveraged or with first and second mortgages or mezzanine debt. The defaults will be highest within the hotel and retail sectors.

LoopNet: Which sectors of the market are most vulnerable, and why?

A: Hotels will be nailed, and many independent hotels will go into default. This is the one sector where we will see many distressed sales. The lodging sector already had the highest cap rates, but now, only those with deep pockets—or those willing to bring in new capital for a large future interest—will survive.

Retail will also be hit hard, but those tenants with hybrid e-commerce channels will weather the storm better and come out stronger when we return to normalcy. Some consumer habits will never revert to pre-virus levels. Online grocery shopping, for example, will be here to stay.

Telecommuting will permanently increase post-virus, and this will affect the office market. Vacancy rates could rise 3% to 5% as a result. Office rentals in stronger than average markets should be fine in the long-run, but those in weaker markets will simply weaken more as the result of a permanent shift by some businesses to remote work options.

Data centers and industrial last mile warehouses will prosper, while industrial facilities at ports will be dormant for a few months. Global supply chains may never return to normal, and the U.S.-China trade war will seem trite in a world where the U.S. is buying COVID-19 test kits and N95 masks from China.

LoopNet: What will the short-term impact be on property values in different sectors, and how long will it take for the market to recover?

A: I believe the analysis by Nuveen and Green Street based on real estate investment trust (REIT) prices—which we know lead commercial real estate prices—are reasonable estimates. But those estimates are from March 13, 2020, now an eternity ago in a marketplace that is changing every day. Keep in mind that the market will overreact, and prices will come back swiftly by early 2021.

Among the implied value changes from Nuveen and Green Street are data projections on these property values:

• Strong credit tenants +20%
• Data Centers +19%
• Industrial +1%
• Apartments -8%
• Strip Centers -13%
• Offices -16%
• Malls -19%
• Lodging -37%

Based on what we know as of April 1, 2020, with the CARES Act in the United States providing about $2.2 trillion in economic relief, these projections still look reasonable for average impacts for the balance of 2020. Read more real estate takeaways from the coronavirus stimulus bill here.

LoopNet: What projections do you have for potential rental payment and mortgage payment defaults?

A: Everyone leasing property is likely to ask for rent relief, and many landlords will provide some deferral of rents, while taking the opportunity to renegotiate leases. I expect rent relief to be greatest in the apartment and retail sectors.

Debt on apartments is likely to allow a moratorium that will defer mortgage payments for three months. Many counties have also delayed property taxes by three months and, so long as the shelter-in-place economy lasts no more than three months, the pain will be somewhat mitigated within these two sectors.

I see less debt relief for hotels or other properties, and none for properties financed using commercial mortgage-backed securities. Though banks and insurance companies will likely be willing to modify loans.

LoopNet: What will these defaults mean for property owners and financial institutions?

A: There are already many investors licking their chops looking for distressed properties, but most won't be interested in hotels unless it is to convert them to other uses, like micro-housing.

Big box sites, already for sale, will need to drop prices, and some will be able to accommodate last mile warehouses, food halls, medical clinics, self-storage, and even multifamily conversions.

I don't predict the same tsunami of opportunities that came out of the 2008-2010 financial crisis. There will be some distress among lower-tier apartments, and highly leveraged properties, maybe double or triple the past year, but nowhere near the levels of the last financial crisis in my opinion.

LoopNet: What relief actions should property owners and financial institutions be considering for tenants and/or property owners?

A: Renegotiate leases with tenants you want to keep. Simply “finance" the lease deferral a quarter or two, and try to get mortgage payments refinanced and deferred as well. Try to get property taxes deferred, too.

Lenders need to know the capabilities of borrowers, and landlords need to know the capabilities of tenants. Many tenants are financially strong enough to weather this market disruption, just as many portfolio owners can carry the debt on low loan-to-value (LTV) portfolios.

Learn more about how landlords can work with tenants during coronavirus here.

LoopNet: What other factors are important to consider?

A: Like in past recessions, cash is king. Those who went through past recessions are presumably financed more conservatively, and will ride this out. The biggest lesson is to have enough liquid capital on hand to endure out a three-to-six month setback in your business, whatever that is.

Also note that in the long run, given the volatility and risk in the stock market, pension funds and other institutional investors will likely want to increase allocations to real estate beyond the average targets prior to the virus onset. This will help keep yields lower than otherwise. Finally, with $2.2 trillion from the federal stimulus sloshing around in the economy, we will see inflation concerns rising by 2021. Real estate provides one of the best inflation hedges—one more reason why asset allocation to real estate may increase.