Pandemic Sends Commercial Real Estate on a Roller Coaster Ride
While summer fairs and carnivals are mostly on hold, 2020 has taken us on a wild ride as the COVID-19 pandemic whipsawed the global economy in the first half of the year. The U.S. economy crashed downward in March as shelter-in-place rules drove unemployment to record numbers, surpassing peak levels of the 2008 Great Financial Crisis (GFC) in just one month.
U.S. unemployment reached 14.7 percent in April, well above the 10.9 percent peak of the GFC. Including part-time workers who wish to work full-time (the U-6 rate), unemployment reached a staggering 22.8 percent in April. Real GDP fell by 5 percent in the first quarter of the year and by 32.9 percent in the second quarter of the year, the worst decline on record. Politicians scrambled to put a social net under the economy, again quickly surpassing levels of the GFC. The Fed balance sheet swelled by $3 trillion from March to May, more than double the amount during the GFC.
Interest rates first spiked as lenders underwrote unforeseen risk, then crashed globally as countries began to backstop their economies. U.S. 10-year treasury yields have remained under 1 percent since early March, the lowest rates on record.
But the U.S. economy has tools in place now that it did not have in the past. First, an e-commerce distribution network was already growing and was able to continue some level of retail service despite shelter-in-place rules. Consumers, however, changed their purchasing patterns, dramatically switching from restaurant purchases to groceries, dropping clothing and department stores and increasing purchases at hardware, building supply and garden stores. Overall, retail sales at general apparel, furniture and other retail stores (GAFO) fell by 29 percent from February to April, while electronic shopping rose by 19 percent.
Second, technology allowed many office workers to continue working from home rather than in the office. Even schools scrambled and finished the year with at least some level of education online. While only 24 percent of university presidents intend to have students fully return to campus in the fall, office building owners are prioritizing the implementation of new healthy building initiatives to welcome tenants back to the office. Fortunately, a multitude of technology firms have developed systems that can significantly improve the health and wellness of workplaces — beginning with pre-entry wellness checks, touchless entry, social distancing sensors, low-touch and voice-enabled kitchens, autonomous cleaning and improved air filtering, among other systems. Additionally, new cybersecurity, at-home network security, on-the-go human resources and remote collaboration tools are improving remote work productivity.
Just as quickly as the economy careened downwards in March, we saw a steep, but partial, recovery in May and June. The unemployment rate fell to 11.1 percent in June as 7.5 million jobs returned. The biggest employment improvements occurred in many of the hardest hit industries in the March to April downturn, including vehicle sales, apparel, furniture, and sporting goods retailing, dentists and hospitality. Transportation and oil remain the hardest hit industries. Retail sales followed a similar trend as total retail and food service sales increased by 27 percent from April to June.
Unlike previous recessions, the housing market has stayed relatively stable thus far. In fact, residential investment was one of the best performing components of GDP growth in the first half of the year, declining by only 1.8 percent in the second quarter as compared to a 23 percent decline in consumption of services and a 9.4 percent decline in exports. While single-family home sales volumes declined in March to May, housing values continued to rise, mortgage rates declined and delinquency rates remained low. New single-family home sales returned to January levels by June.
In the multifamily market, occupancy rates remained high at 92 percent for Class A and 94 percent for Class B. Class A occupancy declined by 50 basis points in second quarter of 2020, a function of two factors. First, new construction increased total stock by 2.5 percent in the first half of the year as nearly 200,000 new units were delivered, a peak rate for the market. Second, net absorption, while positive, was only 42 percent of the pace of the past three years. Comparatively, occupancy held stable in the Class B sector in the second quarter, declining by only 10 basis points. Class A effective rents decreased by 0.8 percent in the second quarter, underperforming Class B, which increased by 1.9 percent. The mortgage market also remains healthy as 98.1 percent of apartment loans were current as of June 20.
Going forward, the multifamily market will continue to face risks. Demand is likely to hold up better in the Class A sector as unemployment rates are highly correlated to educational attainment. In June, the unemployment rate was 16.6 percent for those without a high school degree, falling to 6.9 percent for those with a college education. Thus, tenants of the lower-cost, Class B and C properties may have a harder time paying rent going forward — particularly with uncertainty regarding federal policies to continue extended unemployment benefits. However, the Class A sector will continue to face the risk of excessive new supply, at least through the end of the year. While the construction pipeline is likely to slow dramatically until the economy improves, another 100,000 units are expected to be completed by year end. Construction jobs continued to rise for both residential and non-residential sectors through June. Markets in which multifamily inventory is expected to increase by 7 percent or more include Miami, Nashville, Boston, Charleston, Orlando and Charlotte.
Similar to the single-family market, sales of multifamily properties dropped dramatically through May, although pricing remained steady. Apartment sales volume declined by 81 percent from the previous year in May. However, the apartment sales volume of $3.1 billion was the highest of all property types, equivalent to nearly 32 percent of all property sales. Cap rates fell by 10 basis points year-to-date in the first half of the year, driving property prices up by 7.1 percent year over year in June, but down slightly by 0.3 percent from April to June. REIT prices increased by 5.4 percent in the second quarter but remain 28 percent below the October 2019 peak. Dividend yields at 4.0 percent in June declined by 21 basis points over the quarter but are well above the 2.8 percent level of October.
The path forward is not yet clear. While we hope to continue to ride the roller coaster up, several factors point to a slower recovery. First, the COVID-19 pandemic is not yet over. Recovery risk is further amplified by federal policy uncertainty and the ability of the pharmaceutical industry to create a vaccine and/or cure. Transportation, nursing home and oil jobs are still in decline. High unemployment rates will continue to put downward pressure on consumption of both goods and services, which will create contagion in other lagging industries such as government and education (with the loss of tax revenues) and technology sectors (for those dependent to some extent on advertising revenues). In the meantime, low interest rates are likely here to stay for a while, which should support real estate pricing if demand holds up. Eventually, the unprecedented support provided to the economy by the federal government will need to be resolved.
— By Steve Theobald, executive vice president and chief financial officer of Walker & Dunlop. Walker & Dunlop is a content partner of REBusinessOnline. For more articles from and news about Walker & Dunlop, click here.
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 In February 2020, restaurant sales ($54.1 million) were nearly equal to grocery sales ($54.8 million). Restaurant sales fell to $27.8 mil in April 2020, while grocery sales increased to $63.2 million.
 U.S. Census Bureau, Estimated Monthly Sales for Retail and Food Services, by Kind of Business.
 CB-Insights, “Reopening: The Tech-Enabled Office in a Post-Covid World,” 2020.
 Bureau of Economic Analysis
 U.S. Census Bureau and U.S. Department of Housing and Urban Development, New One Family Houses Sold: United States [HSN1F], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/HSN1F, July 30, 2020
 Class A defined as properties with a 4- to 5-star CoStar rating. Class B defined as properties with 25+ units and a 1- to 3-star CoStar rating. Source: CoStar.
 Mortgage Bankers Association
 U.S. Bureau of Labor Statistics
 CoStar U.S. Multi-Family National Report
 Unless noted, pricing and sales data provided by Real Capital Analytics. Pricing data based on the RCA CPPI index.
 Source: NAREIT
 John Hopkins University. After a slight improvement from April to June, U.S. cases spiked again in June.