We Probably Haven't Seen The Worst Of The Pandemic Yet In CRE

It has been nearly eight months since the coronavirus pandemic reached American shores, and in many ways, things seem like they're getting better for commercial real estate. States are loosening restrictions, so consumers are returning to restaurants and retailers, and workers are trickling back into office buildings.

But don't let down your guard yet; many CRE experts are predicting the worst pain is yet to come, and unless more federal stimulus or a vaccine hit the market in the next few months, the industry may see a larger wave of business closures, loan delinquencies and foreclosures.

Operators of hotel and retail properties have the shortest runways ahead of them before facing inevitable defaults and bankruptcies, data shows.

Nearly one-quarter — 22.94% — of lodging commercial mortgage-backed securities loans were delinquent at the end of September, according to Trepp Analytics data.

One-third of hotel asset managers report fears of imminent default, foreclosure or a forced sale of their asset, according to Hospitality Asset Managers Association's October survey of 100 members. About 60% predict a 50% to 75% decline in revenue per available room compared to budget for their entire portfolio, HAMA noted.

Some retailers also are on their last leg, and retail brokerage experts like Weitzman chairman Herb Weitzman predict the industry is just now at the front end of retail loan defaults and delinquencies.

Retail delinquencies associated with CMBS loans have been rising for months, from 7.86% in June to 14.76% in September, Trepp data shows.

There is a positive data point. The overall CMBS delinquency rate, inclusive of all asset types, dropped 10 basis points to 8.92% in September. But even that comes with a disclaimer. Trepp noted in its October report that month-over-month improvements in CMBS delinquencies should be analyzed against the backdrop of loans being listed current as a result of forbearances. Trepp reported $20B in private-label CMBS loans had received forbearances by September.

Heading into 2021, economists predict challenges to CRE will continue and maybe even escalate. The ability to prevent further bleeding across all asset types next year is dependent on factors whose outcomes are unknown. 

"I emphasize the word 'uncertainty' more than anything else," Moody's Analytics REIS CRE Economist Barbara Denham told Bisnow. "Two things remain unclear: One is when will we get a second stimulus package, and when will so many who are unemployed be able to pay their rent and [when will we] see more unemployment insurance?"

Denham said the commercial real estate market is in dire need of a second dose of federal aid, particularly with the initial Paycheck Protection Program running out, and since Congress has not brokered a second round of stimulus, the panic is on. 

"Without PPP, we are going to see a lot more [firms], especially smaller retailers and smaller businesses, going out of business; there are no two ways about it," she said.

Those business failures will leak into the landlord space as rental payments drop, making it harder for already struggling landlords to cover their own debts. 

CBRE Global Chief Economist Richard Barkham saw some positive signs in consumer spending last quarter but is skeptical of Congress' ability to pass a stimulus package, although he does believe one will be passed post-election in the first quarter of 2021. 

“The lack of passage of that bill is going to be a headwind for Q4,” Barkham said. “I think some of the retail spending strength that we saw in Q3 comes from transfer payments and unemployment benefits. Growth will slow up in Q4, and be a bit of a slog.”

The other outlier in the CRE market heading into 2021 is how fast scientists and regulators will work in approving and dispensing a coronavirus vaccine nationwide to create enough herd immunity to restore normal traffic patterns at every type of CRE asset, Denham said. 

The market can coast along and save tenants and landlords if a vaccine comes in the first part of 2021, she said.

However, a physician with the World Health Organization predicted it will take until 2022 to reach immunization levels consistent with a restoration of normal life, CNBC reports. 

Office has thus far largely held its own and seen limited distress and discount sales in 2020, but that may change soon.  

“There is capital available for office, but I think that probably at the moment, office buyers are looking for a little bit of a discount that office owners are not yet willing to offer and that in itself indicates that you don’t really have that much distress,” Barkham said. 

But there is enough disruption in office for economists to worry about the impact of people working from home and tenant failures in the coming year. 

Moody's Analytics REIS predicts the office vacancy rate will reach 19.3% in 2020 and then 19.9% in 2021, surpassing the 1991 record-high vacancy rate of 19.7%. Things don't get rosier from there; REIS predicts office vacancy will reach 20% in 2022. 

"We have seen a decrease in demand, and we have seen negative absorption,” Younger Partners Research Director Steve Triolet said of office. “Tenants are not sure they need as much space as they initially thought.”

That is leading to a spike in sublease listings in many office markets around the country. In Dallas-Fort Worth, where Triolet is based, there was roughly 6M SF of office space on the sublease market before the coronavirus hit. That figure quickly rose to about 9.1M SF by late September, Triolet told Bisnow last month. Last month, Uber, which just opened a regional hub in DFW last year, put 117K SF of it up for sublease. Retail struggles have also been hitting DFW's office market — JCPenney, Neiman Marcus, Pier 1 Imports and Tuesday Morning all occupy both corporate and retail spaces in the area, and all are turning space back over, including Pier 1 emptying out its longtime Fort Worth headquarters. 

While Triolet is not seeing an influx of distressed CRE sales in the market just yet, he sees 2021 as a possible turning point as the market begins to feel the impact of delinquencies, subleases and distress on asset prices. 

There are some bright spots in CRE and some reasons to be hopeful. Industrial has been the strongest through the pandemic and could even see significant price growth next year, Barkham said. He is also relatively optimistic about how quickly consumer spending in retail bounced back in recent months and in the third quarter.

“We don’t subscribe to the idea that retail is dead at all, but obviously there are some headwinds, and I think we are in a period of price discovery around retail,” Barkham said. “Clearly there are some solid areas, specifically grocery-anchored retail, but there are some other areas that have been a little bit challenged.”  

Economists overall stress there is some runway left for asset owners facing a financial squeeze, but time is running out. 

“We are starting to see a lot of distress in the CMBS and the lending market, so a lot of properties are behind on their interest payments and their mortgage payments for sure,” Denham said.

“The very big difference between this recession and the last one is banks are much better capitalized, so they can manage a few months without these mortgagees paying their mortgage for a little while. But, it gets to where at some point, they have to foreclose and they haven't yet, so that is why you are not seeing these short sales where banks have to sell their properties.”