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Effects of COVID-19 on Real Estate

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covid effects on real estate

With close to 3 Billion people living under some level of lockdown, most of whom are located in primary economic markets, it is safe to say the COVID-19 pandemic has seen a sudden and drastic economic effect throughout the global economy. The actual initial date of COVID-19’s entrance into Asia as well as the United States is up for debate. However, it is clear the world seemed to come to a screeching halt in mid-March 2020. Up to that point, the threat of the pandemic seemed to many to only be that, a threat. When the National Basketball Association (NBA) chose to completely shut down its athletic enterprise bringing in $8 Billion in annual revenue, the world seemed to snap into reality that this virus would be treated like nothing we had seen in a century. Following the initial domino fall of the NBA, businesses large and small followed suit, triggering an abrupt halt to the global economy as Q1 2020 came to an end. While the economic effects will be mostly blamed on the virus, we cannot ignore the trickle-down effect the suspension of business globally has brought to the world. With people working from home and many businesses shut down, the cyclical economic cycle has stopped. People are not going to work, therefore they are not pumping gas, consuming food at eateries (as they stay at home), not having to repair their car as they are not driving, not paying vendors as projects are on pause – and the cycle goes on and on. As of mid-May 2020, the actual cost is yet to be known and difficult to quantify, however by one expert calculation, the world has seen a cost in excess of $85 Billion in GDP, with this number looking to continue to increase. Governments have done their best to bail out economies as they can, however, this cost will have to be dealt with for generations, in particular in the United States where the $2.2 Trillion dollar tab rung up by the federal government is only continuing to increase.

From the perspective of the real estate industry, the cost has been significant. The current times have caused significant uncertainty. 14.7% of the United States economy has claimed unemployment, a drastic change from the pre-COVID historically low unemployment rates of 3.5%. Companies are laying off people left and right, while others have furloughed employees or held onto them only for the short period of time in which the government will cover their employee costs through the Paycheck Protection Program, and other short term bailout policies. This period has been a wake-up call to businesses that were previously operating heavily on expenses and employees. A silver lining to business owners will be an effect of efficiency creation and “trimming the fat” by relieving inefficient and unneeded workforces as well as expenses. Unfortunately, this new efficiency focus has resulted in companies taking a new look at the greater picture of their staff needs and real estate needs. Companies are asking themselves: How many people do we need? How many locations do we need? This has created action in terms of consolidation into smaller spaces, halts or complete shut down of expansion plans, and in some cases shutdowns of locations. Commercially this has hurt activity in many sectors. Residentially the higher end and larger space sales markets have shrunk drastically and the market as a whole has been hurt. Recently furloughed or laid off employees have hesitated to move forward with large financial transactions in their personal lives. Those still employed have seen more conservative spending across the board, hurting the upper-tier market but continuing to move the lower and middle markets.

There is a tendency for those outside the industry to basket the entirety of the real estate world into one segment, however the effects of the virus vary drastically by asset type as well as geography. All industries at a macro level have negatively been affected however retail and hospitality have been hurt the most. Some niche sectors within asset types have actually thrived and succeeded during these times.

Retail

In recent years, shopping has shifted significantly to online settings due to the so-called “Amazon Effect”. Apparel stores and other past shopping locations are few and far between as retail trends had shifted to services, fitness, and experience-oriented tenancies. Now that large and multiple person public gatherings have been banned, these locations have been operating on a small portion of sales through take out orders or shuttered altogether. There is a large unknown as to how consumers will react (or be permitted to react due to re-opening rules) to these settings when business resumes. Malls, who were already hurting nationally, have been further pushed to the bottom of the market as mall operators have only collected 15% of rent in April. This particular sector will likely hurt in the future as the enclosed environments only feed on the fears of virus spreading. Operating expenses will be higher due to increased cleaning measures but rents will be lower as they have already fallen as high as 13% in malls according to some estimates. Grocers have been some of the few retailers to actually thrive as they see a 50 year high in performance nationally.

Hospitality

Just after retail, the hospitality sector has been extremely hurt as business travel has halted as well as vacations. Prior occupancy rates hovering at 70% are now 0% up through 15% at best for many locations. Labor costs may be lower, however business expenses for operating a hotel are very expensive for real estate carrying costs, employee costs, utility, and HVAC. As a result, performance has been $0 or less than $0 in revenue. Industry experts see this recovery taking as long as 3 years to reach pre-COVID 19 numbers. On a positive note, extended stay locations have proved resilient as they are still generally profitable during these times.

Industrial/Logistics

The industrial and logistics sector have exhibited resilience during the outbreak as many of these occupants have been deemed essential and thus continue to operate. E-Commerce became a staple of tenancy in recent years and has only benefitted from this situation as people stay at home and increase their consumption of online goods ranging from clothes to groceries to small household items. As grocery online ordering has increased, refrigerated buildings have increased in demand with a limited supply.

Office

So far, office has been okay, however, the effects in the future will likely be strongly negative as companies realize they can effectively have employees work from home and/or operate their locations with a reduced staff – meaning a requirement for less or even no office space occupancy. Landlords have not been hurt yet, however industry sentiment is that they will.

Investment Sales

Investment sales have continued however much of this can be attributed to an extension of 1031 tax-deferred exchange deadlines, which have fueled sales in the near term. Many investment-grade assets, such as restaurant pad sites, will likely not be as sought after in the future as many predict investors will be more conservative in their investments, possibly shifting to non-real estate ownership of bonds, etc. Some sectors have increased in demand, particularly in e-commerce and grocery locations, which has thrived during the pandemic.

For those deals that have been fortunate to continue to move forward, actually closing on a transaction has been extremely difficult, particularly in April and May. With people working from home and courthouses closed, laws had to be changed and systems reorganized to permit title transfer online, electronic notarization, and other elements digitally. Some transactions have been unable to move forward at all as building walkthrough for appraisals or inspections have been unable to perform due to state or county regulations.

 

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