Commercial Investment Real Estate Summer 2020 | Page 28

My outlook is that this capital will return
to the market in 2H2020 and 2021
in a hunt for yield, especially given that
bonds are yielding below 1 percent and
approximately half the public companies
have suspended dividends.
5. CRE credit metrics. Entities like
TREPP monitor the permanent loan
delinquency rates by property type and,
more importantly, the loans transferred
to special servicers (LTSS). CRE
credit metrics will deteriorate rapidly
throughout the rest of 2020 — especially
in hospitality and retail property
sectors — and identifying the peak in
those measures will identify the point
of recovery.
With these considerations in mind,
let’s look at major property type sectors to
see where things currently stand, where they
could go, and what metrics to monitor to understand
the direction of future movement.
MULTIFAMILY
Recently, I was shocked when I heard that 93
percent of all debt for multifamily properties
is held by government-sponsored enterprises
Freddie Mac and Fannie Mae. Additionally,
two-thirds of single-family homes are backed
by the government. Considering these factors,
it’s no wonder this sector has seen such
intervention from the federal government.
This approach is a direct contrast to
the government’s actions during the Great
Recession in 2007-2009. The response to
COVID-19 is more of a bottom-up approach,
where programs are designed to help homeowners
and renters, compared to 2009,
where money was dumped into the banks in
hopes it would trickle down to individuals.
Support for borrowers through forbearances,
for example, will keep people in housing and
make shelter-in-place efforts possible. The
unintended consequences of this intervention
will not be known for six or 12 months
when these programs end. How will landlords
and banks deal with the forbearance
balances (all due at once, amortized with or
without interest, and imposition of mortgage
insurance premiums if the new loan balance
is 95 percent or 100 percent)?
While workforce housing has received
ample assistance, the intervention for student
housing hasn’t been as robust. Universities
have had to rebate housing fees on a pro rata
basis for the spring semester, while private
student housing landlords are discovering
that many leases have “act of God” or “act of
university” provisions that allow students to
terminate leases early with statewide disaster
orders by governors.
Student housing multifamily faces
more stress than workforce housing. Look at
the 136 college towns with NCAA Division 1
football programs that may not see students
THE ONLY CONSTANT
IS CHANGE
return to campuses this fall. What happens to
student housing without the students? And
what happens to all the small businesses that
rely on busy campuses? More than a third of
the country’s 360-plus MSAs are college or
university towns that will face unprecedented
multifamily housing and economic instability.
Aside from differentiation between
workforce and student housing, demand
may shift from urban to suburban as young
professionals and urban renters opt to escape
population density and crowded public transportation
to the suburbs where they can work
remotely and find more affordable housing.
In broad terms, will multifamily in cities like
New York, San Francisco, and Washington,
D.C., which are reliant on public transportation,
see reduced demand?
In essence, will the office workforce
reject risk factors associated with urban environments
and choose to reside in the suburbs
using the newfound acceptance of work
via Zoom? The opportunity lies in suburban
areas, where Class B and C assets can be repositioned
quickly as valuable and desirable
properties with more affordable rents and
less density. Suburban assets with a walkup
design and ample outdoor and/or green
space in proximity to good grocery shopping
and carryout restaurants may be especially in
demand in 2H2020 and 2021.
OFFICE
Growing office demand in suburban areas
is going to go hand-in-hand with housing.
Major institutional investors are beginning
to see evidence of rejuvenated interest in demand
for leasing suburban office space, including
large corporations who already have
footprints in urban areas. Earning reports
from 1Q2020 included examples of company
CEOs commenting on just this point, talking
about “redundancy costs” to lease some level
of suburban space to support teammates who
no longer want to commute into dense city
environments or crowded high-rise buildings.
What will be the new normal for suburban
office demand? And what will become of
urban high-rise office towers in three or five
years when the larger corporate leases burn
off and companies can shed space to mitigate
these redundancy office costs?
Will the employee-to-office-space ratio
increase from its 2019 low of 150 to 195
sf per person? How will that impact rents
with tenants getting less utilization per employee?
According to a survey from JLL, in
2019, the average employee in North America
had 195.6 sf, down 14.3 percent from the
2018 figure of 228.2 sf. That type of density
is not economically viable at current market
rents given social distancing policies to help
improve public health.
Lastly, what becomes of the openspace
floor plan? Do we remove one-third
of the cubicles, migrate to a staggered work
schedule, or develop a different office model?
Something will have to give, at least until
we have a vaccine, and maybe even longer as
the workforce becomes more entrenched in
remote work.
Another element to consider regarding
office building assets is increased capital
expenditures. Office property owners are
going to face substantial capex costs that
involve removing cubicles and new floorplans
to produce more segmented, isolated areas
for workers. Common touch-point surfaces
will have to be modified — voice-activated
elevators, for example — rather than everyone
touching the same buttons.
Another factor that will become essential
in office properties will be contact tracing.
Tenants may be required to provide information
about employees to property owners or
managers. For example, say a handful of a
tenant’s workers travel to a hot spot, whether
that’s in an American city or a foreign country.
The tenant may be obligated to report
that activity to property management and
have those employees quarantine at home
and work remotely for a period of time. Occupancy
monitoring technology is coming to
the office sector and it, along with HEPA air
filtration systems and touchless surface technology,
will impact capex budgets.
Overall, with pressure to decrease density
and growing demand to work from home,
office real estate likely will be repriced. With
cheaper alternatives in the suburbs, which
can also minimize redundancy costs, the sector
could see substantial changes in tenant
preferences and locations.
RETAIL
Retail evolution was the retail industry’s focus
prior to COVID-19 with a migration from
a “shop and take home” model to an “order
online and deliver to me” model. But challenges
now include operational and occupancy
orders by state and local government
that impair retailers’ abilities to operate.
Can physical retail be economically viable
with new COVID-19 occupancy restrictions
that limit occupancy to 50 percent or 65
percent of pre-COVID levels?
And, if these occupancy orders remain
permanent, physical retail space will have to
be repriced. Rents will decline because hair
salons and restaurants will have less revenue
to pay rent. Traditional occupancy cost ratios
will be invalid and will translate to lower rent
per square foot. Lower rent will translate to
diminished overall value.
26
COMMERCIAL INVESTMENT REAL ESTATE MAGAZINE
SUMMER 2020