Last week, we commented on some of the differences between Wall Street and Main Street with a primary emphasis on the scale benefits enjoyed by some larger companies. This week we’ll pivot our focus to cover the pandemic’s impact on Main Street and specifically the real estate sector. As you may know, our firm has extensive experience investing in real estate which puts us in a good position to provide some perspective and convey what we have heard from real estate operators managing properties across the commercial real estate spectrum including multifamily, office, industrial, retail and hospitality.
Except for the well-known challenges in retail, real estate entered this year with solid fundamentals. Vacancy rates were low and there has been more disciplined construction spending than was the case entering prior recessions. For several sectors, April and May rent collections have exceeded expectations. This has been an encouraging sign for many of our operators within the multifamily, office, and industrial sectors. Other areas such as retail and hospitality have been most negatively impacted. Below we present a few high level comments and additional commentary on each sector if you would like to read more.
- Multifamily. Rent collections have remained above 90% and exceeded expectations so far. Consumer financial health is key for the summer months and the likelihood of further stimulus plays a significant role in the outlook for multifamily. We expect delinquencies to increase as unemployment remains high, but the lack of new construction for a time and the likelihood that first-time home buying slows may help support occupancy levels.
- Office. Rent collections have also been higher than expected in April and May. In the short-term, the length of the economic “shut down” will impact bankruptcy rates and presents the biggest risk, but long-term risks to office space requirements due to greater work-from-home preferences will battle with higher space-per-employee desires to define demand.
- Industrial. Recent trends that were already in place are accelerating due to the pandemic. Logistics-dependent businesses like Amazon and Wal-Mart have benefited which increases the need for warehouse and distribution space. Bankruptcies will be disruptive for suppliers and declining global trade is a concern, but overall we believe industrial investments will remain attractive and will be well-positioned during the recovery and beyond.
- Retail. Challenging trends for malls and other retail sectors due to shifting consumer preference toward online retailers have only been accelerated by the pandemic. This is not limited to small operators as national retailers are already starting to announce bankruptcy filings. Restaurants have also been hard hit and new experiential concepts in retailing have been shut-down. The outlook for retail remains challenging.
- Hospitality. Hotels were the hardest hit due to the pandemic. Occupancy has plummeted and the name of the game is survival. Currently, most hotels have been given flexibility from lenders, but the recovery will vary greatly based on the location and their revenue drivers. Whether a hotel is located by a university, corporate business center, airport, hospital, tourist attraction will directly impact the timing and extent of recovery.
Our current perspective is being formed fairly early in the process and much uncertainty remains. Over 30 million workers are unemployed, and vacancy tends to follow unemployment. Many of these workers believe they will be rehired within 3-6 months, but some jobs will not be coming back. There are many chapters ahead and the timing and shape of the recovery are large unknowns. Generally, we have been encouraged that collections have outperformed expectations. We certainly hope that the phased reopening of the states goes well. June and July will be important months that will indicate whether the economy can regain its footing without significant additional extraordinary stimulus measures. We will continue to communicate what we are seeing as developments unfold later this summer. If you have further questions, please contact a member of your service team.
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- Rent collections. We have been encouraged with rent collections for multiple operators that have said that May collections are ahead of April collections to date. Most operators have collected or expect to collect more than 90% of rents in April and May. In fact, for some properties, occupancy has increased as moving out has become harder.
- Leasing. Leasing activity has slowed somewhat, but many managers have been able to quickly adapt to virtual leasing and tours and electronic paperwork.
- Future. We believe that higher-than-anticipated collections were partly due to the significant stimulus passed by Congress including individual checks and also increased unemployment benefits. Looking ahead, if the recovery is prolonged and more stimulus or extended benefits are needed but Congress becomes gridlocked, tenants may then be unable to choose not to pay rent. Multifamily has a headwind with the lack of 2020 graduates that will be moving to accept first-time jobs. However, a deep recession will also make first-time home buying more difficult and that should support multifamily occupancy over the short term.
- Rent collections. Similar to multifamily, broadly speaking tenants and landlords are working together to manage the current situation. The vast majority of April and May rents have been collected to date. Typically, rents are due by the 7th-10th of each month. By the initial due date in April, rents were collected in the 80-85% range, but by month-end landlords had generally passed 90% which was higher than anticipated. For May, we’re hearing that collection rates have so far exceeded April’s, which is an encouraging sign. Requests for rent assistance have typically come from smaller tenants, especially those that depend upon clients, customers, or patients accessing the office.
- Leasing. There is a definite slowdown in leasing activity as touring activity has been halted and we believe this will likely lead to a decline in asking rents.
- Construction. For projects in progress, construction has been mixed as many projects have continued without issues, especially in states where construction was deemed an essential activity. Others, however, have experienced disruptions either due to local lockdowns, supply chain issues, or issues with permits or inspections as many local governments have closed.
- Future. We foresee the risks and impact on office proceeding in stages. Initially, the risk is that some tenants will go bankrupt or may decide not to come back to the office at all. However, the long-term challenge is that unexpected and unwelcome work-from-home test has taught many that they can reduce their overall office footprint. Yet a desire for more space per employee to allow for proper social distancing will counter this trend. In general, we see this outlook for this particular segment as complex and we will need to cover this in a few months as we learn more.
- The flip side of retail. Industrial is benefiting from retail’s woes (discussed below) as the demand for industrial and warehouse space continues to grow. This includes cold storage as online groceries become more convenient. Industrial most likely comes out of the pandemic in a stronger position.
- Current state. The sector has held up fairly well in early innings of the pandemic, but we expect pockets of distress to materialize as corporate and small business bankruptcies disrupt supply chains. However, there will also be growing sectors of the economy due to the pandemic and industrial is a space that is likely benefit.
- Future. New construction will probably slow over the short-term but demand should remain robust. We believe industrial will continue to be an attractive sector for institutional buyers. However, industrial real estate that is dependent on global trade will probably see a slowdown. Self-storage should also hold up well as it has in prior recessions. The low-cost nature of self-storage coupled with the fact that it is not greatly impacted by social distancing should help protect margins. Also, some areas have seen increased demand as college students or other individuals that have moved back home have needed additional storage.
- Exacerbated trends. Retail hasn’t caught a break in a long time, and this pandemic is only accentuating trends regarding ecommerce that have been in the works for years. One recent trend that has been hurt is experiential entertainment concepts such as ‘retailainment’.
- Opposite results. It has been a story of the haves and have-nots in retail. Malls and consumer power centers with big box clothing or sporting goods stores have been mostly closed or limited to only online purchasers or pickup orders. Large home improvement centers such as Home Depot or Lowe’s or necessary retails such as grocery stores have been able to stay open and have even seen higher demand over the last two months.
- Rent collections . . . and bankruptcies. Generally, smaller tenants and local shops throughout retail have been unable to pay rent in April or May. However, it’s not just the small stores suffering as several public retail companies have announced plans for possible bankruptcies.
- Future. Restaurants, which are low margin business to begin with, have tried to stay afloat with take-out and delivery options, but many will not survive under the current conditions. This will only accelerate the struggles for class C centers or malls that will probably not survive the crisis.
- Scale wins. Bigger is proving to be better in retail as large companies such as Amazon, Walmart and Target that are able to complement online merchandising with delivery and logistics strengths will continue to increase their market share leaving smaller retailers behind in their wake. Retail is becoming more of a warehouse and logistics business as the pandemic accelerates consumer behaviors that were already shifting.
- Occupancy. This sector has probably been the hardest hit during the pandemic. After several years of record profits, rates, and occupancy levels, hotels have been devastated for no fault of their own. Occupancy levels which were typically 75-80% have crashed to 20-25% for many hotels.
- Financing. Currently, most hotels are able to obtain flexibility form their lenders for up to 90 days. However, future distress in hotels is likely as a recovery may be more prolonged for certain parts of the hotel industry.
- Future. The path to recovery will look different whether the hotel is next to a hospital, university, corporate business center, airport, beach, or an amusement park. Conference center hotels that depend on business or other large events for revenue may lose that revenue for an extended time. The recovery will depend on the submarket and typical reason for a nightly stay. Hotels will likely experience a slower recovery.
In closing, we want to acknowledge that this information we are sharing, and our perspectives are being formed fairly early in the process of dealing with the pandemic. Much uncertainty remains. Over 30 million workers are unemployed, and vacancy tends to follow unemployment. Many of these workers believe they will be rehired within 3-6 months, but some jobs will not be coming back. There are many chapters ahead and the timing and shape of the recovery are large unknowns. Generally, with respect to real estate, we have been encouraged that collections have outperformed expectations to this point and pockets of opportunity remain.
We certainly hope that the phased reopening of the states goes well. June and July are important months that will indicate whether the economy can regain its footing without significant additional extraordinary stimulus measures or not. For that reason, we’ll continue to communicate what we’re seeing as developments unfold later this summer.
Disclosures: This is a general discussion of current investment themes, asset classes, and specific investment segments. The discussion includes our opinions and forward looking thoughts and analysis as of May 17, 2020 and is not a guarantee of future investment results. Actual client portfolios are often customized and do not necessarily represent an exact replication of, if any, allocation discussed. This commentary focuses on a wide range of economics and finance issues in order to educate you on the linkages between these topics and their impact on the overall economy and investment markets. The content of this presentation represents the opinions of Homrich Berg regarding these educational topics and should not be interpreted as direct investment advice or marketing of HB services. Information included is from sources believed to be reliable, but which have not been independently verified. Investing involves risks including loss of principal. This document does not constitute legal, tax accounting or investment advice.