A Macroeconomic Outlook on the Impact of COVID-19 and It’s Correlation to Commercial Real Estate

Since COVID-19 was first diagnosed, it has spread rapidly across the globe, impacting over 200 countries and killing hundreds of thousands of people. The consequences of the pandemic, including forced closures, social distancing, and restrictions in distribution, have all had an effect on the global economy. The impact of the pandemic was prevalent from the start, and the expectation is that it will have an ongoing effect on our economy’s recovery. The avenue by which we can measure how drastically the global economy has been affected is to review gross domestic product (GDP) and unemployment statistics – Both of which have experienced a drastic shift over the past few months.

In the US alone, according the Bureau of Economic Analysis (BEA), U.S. Department of Commerce, the GDP fell at an annual rate of 5% in the first quarter of 2020, the biggest drop since the last quarter of 2008. According to the BEA, this decline was attributed to the “negative contributions from [personal consumption expenditures (PCE)], private inventory investment, exports, and nonresidential fixed investment that were partly offset by positive contributions from residential fixed investment, federal government spending, and state and local government spending. Imports, which are a subtraction in the calculation of GDP, decreased.”

Furthermore, in April 2020, unemployment rates jumped to 14.7%, the highest they have been since the Great Depression. This radical change was the direct result of the pandemic; more specifically, businesses closing and laying off their employees. Since then, unemployment rates have continued to decline, down to 13.3% in May and 11.1% in June; however, with the current rising cases of coronavirus and new shutdowns being introduced, there is no certainty that this downward trend will continue.

These statistics have been directly impacted by the shifts in the commercial real estate industry related to change in construction, decline in transaction velocity, and a change in consumer demands.

A Decline in Construction

According to a report released by Marcus and Millichap, retail completions during the first three months of this year dropped to 8.3 million square feet, the lowest quarter level since the year following the global financial crisis. In addition, multifamily is roughly 15% to 20% behind projections, and office construction declined by roughly 20% to 40%. Both new development and existing projects have slowed down because of shutdowns, stricter safety guidelines slowing the pace of construction, and delays associated with obtaining permits, property inspections, and receiving building materials.

This decline has had a direct impact on the GDP, which estimated that in 2019, the construction industry contributed 4.1%. Furthermore, although construction on homes continue, it is not enough to offset the losses the industry is experiencing.

The benefit that this brings to the investor is a potential to have rents remain stable. Unfortunately, with the ongoing challenges tenants are facing, vacancies are increasing; but if construction slows, competition will decline and it will provide more opportunity for vacancies to be filled.

Closures Impacting Investors Returns

Restriction on opening has been one of the most detrimental actions that is hurting the commercial industry. Businesses are struggling to pay rent, and due to the uncertainty of the spread of the virus, their outlook on profits is a mere guess. As a result, tenants are not paying rent and investors with debt are struggling to make payments. According to Trepp, a CMBS data tracker, the delinquency rate for property loans that were bundled into commercial mortgage-backed securities deals hit a near all-time high of 10.3% in June, a jump from only 2.8% a year prior. Goldman Sachs analysts expect the rate to hit a record 11.3% in July.

There were three major side effects related to closures. First, closures caused a spike in unemployment as tenants were no longer able to operate and were forced to let go of their staff. As a result, high vacancy and rent abatements combined with an overall uncertainty about the future of the market caused a drastic decline in commercial real estate transaction velocity. Many investors are weary to make a move until there is more stability in the overall markets.

Shift in Consumer Spending

According to Gregory Daco, chief U.S. economist at Oxford Economics, “There is a tremendous uncertainty and virus fear that is lingering and that is restraining people’s desire to go out and spend as they normally would.” In fact, spending in May declined by 13.6%, with June records still being analyzed. Furthermore, the actual spending habits of consumers changed; there has been a shift to value and essentials, a flight to digital and omnichannel, a shock to brand loyalty, and an increase in the homebody economy and the health and wellness industry.

This desire to save has resulted in a decline in sales for many stores; and, while we start to see operations and businesses re-open, many are remaining closed due to their inability to profit with such declining sales. For investors, there has been a flight to quality assets, especially in the retail sector. There has been an increase in demand for essential businesses, including drug stores and dollar stores. The current state of affairs, as a result, has left investors in a holding position while they wait the pandemic out.

The Bottom Line

The full impact of the pandemic will not really be known until the effects of the pandemic peak. There is no assurance that we will not experience another round of closures, which would be detrimental to those businesses that are already suffering and to those individuals who are struggling to remain employed. In addition, the decision on whether to extend the federal unemployment, which is providing an additional $600 a week to those collecting unemployment who qualify, will have a major impact on the GDP; if the additional funding is removed, it is anticipated that more Americans will be faced with financial uncertainty as we move forward.

As an investor in real estate you need to know how to respond. Read this article to know how as a real estate investor, we think you should respond.



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