What’s next for CRE amid the Coronavirus Economic Fallout

July 9, 2020Market Dynamics
men shaking hands on top of two sky scrapers

During this third full week of April, commercial real estate companies are reviewing myriad requests for rent relief from all manner of distressed tenants. Responsible asset and portfolio managers are currently pouring over leases and financial statements in an effort to understand which companies are truly deserving of this relief. The resulting strain on cash flows is likely to have a few material and lasting side effects that need to be evaluated.

In all likelihood, net operating income will be lower for many assets in the short-term, especially retail heavy assets.Office laggards are expected to follow, with many traditionally solid tenants like white-shoe law firms already announcing pay cuts for both Associates and Partners. There is a rising tide of reduced rent collections in many sectors, and the time horizon for these reductions remains uncertain.So, in the short-run, cap rates could theoretically decline.The longer reduced rent collections last, the more likely we are to see asset values also decline, which will put upward pressure on cap rates.At this point, it is too soon to prognosticate on the net effect on cap rates, but if asset values deteriorate, mortgage servicing will become a growing threat to many commercial real estate companies.

With the U.S. Fed supporting agency backed mortgage securities (those created by Fannie Mae, Freddie Mac, and Ginne Mae) with an unlimited credit spigot, non-agency mortgage securities become riskier.That was the primary reason we saw many REIT stocks hit the skids immediately after the announcement. Suddenly, commercial real estate becomes a lot riskier due to the Fed’s intervention.Commercial real estate firms with high loan to value ratios on their properties could be at risk of default, with no hope, at least not yet, of federal intervention. This could mean many companies shed assets to avoid default.

For smaller operators, asset sales could be the only way short of raising new equity to remain afloat and shore up capital.Restructuring property level loans is likely to be a long process, with many lenders currently resource strapped. The one potential bright spot amid the unfolding economic crisis exists mainly for operators that own assets outright or for larger, well capitalized commercial real estate companies.For them, this crisis represents an opportunity to potentially pick up new assets and consolidate their position in the market relatively efficiently.