As someone who has analyzed the commercial real estate market through three cyclical downturns, I can honestly say that there has never been a more challenging January forecast to write than this one. A year ago, I penned forecasts full of optimism about the continuing record economic recovery, strong property fundamentals, low interest rates and high levels of debt and equity capital.
By March of course, that all changed. In a CREW Network event shortly after the COVID-19 pandemic hit, CBRE’s Spencer Levy referred to the health crisis as a “shock of a different color.” Indeed, it was.
Barometers point to a turning tide in 2021
Now that the final quarter of a truly unusual year is in the rear-view mirror, there are slow and steady improvements taking root in 2021, despite the continuing challenge of the pandemic and myriad market risks.
The pandemic’s impacts were widely felt across the commercial real estate sector in the second quarter—from listings activity to due diligence and deal closings. The third quarter of 2020 was, by several notable metrics, a turning point in the commercial real estate market’s recovery from April-May depth of the downturn. Three barometers from LightBox lend support:
The 4Q20 LightBox Market Confidence Index, based on a broad-based survey of nearly 500 commercial real estate professionals across the U.S., reflected a growing sense that the market turned a corner in late summer as property listings increased and motivated investors moved ahead with deals. When asked to forecast what they expect in 1Q21, 22% indicated they expect a substantial increase in their CRE activity vs. 4Q20, a more significant 42% expect a slight increase and only 15% expect to start the new year with a decline.
Trends in commercial property listings is another metric tracked by LightBox based on activity by brokers and investors using its Real Capital Markets platform to buy and sell commercial real estate. After declining by 43% in April, commercial property listings were up a solid 73% in 3Q20 over 2Q20. By asset class, third quarter property listings activity was dominated by multifamily (29%), office (19%) and industrial (16%)—followed closely by retail (14%) and land (13%).
The ScoreKeeper model tracks trends in the volume of environmental due diligence, and its output is widely viewed as an early indicator for where commercial real estate investment activity is ramping up—or cooling down. Based on an analysis of activity in the 20 largest CRE markets in the U.S. in 4Q20, there are stark geographic differences in the pace of recovery. The results also provide an interesting predictor of where investors are likely to be focusing over the near-term. The accompanying graph shows the strongest year-end activity vs. 4Q19, and the metros that were particularly hard hit by COVID-19. A metro’s recovery rate will not only depend on the severity of the rate of infections but also its vulnerability to the hardest-hit sectors of real estate. Metros with a heavy reliance on hospitality, travel, retail and restaurants will recover more slowly than ones that are a big draw for technology firms or industrial investors, for example.
Waiting for the chips to fall
It is difficult to predict how the next few quarters will play out, particularly with the new wave of stimulus and COVID-19 vaccinations being distributed. Lenders are turning a critical eye to the loans in their portfolio to identify those most at-risk of default as they prepare for potential distress, dispositions and foreclosures, as well as staffing up with experienced workout personnel. Loans associated with the hard-hit hospitality/travel, restaurant and retail sectors will likely be the most vulnerable.
During every down cycle, distressed asset buyers wait in the wings for market values to bottom out before moving in to aggressively look for opportunities, and this one is certainly no different. While the size of the wave of distress remains to be seen, it is highly likely that the distressed cycle will play out in the next six to 12 months. Before then, the market will go through a “discovery phase” of determining just how deep the pandemic-driven property value declines will go.
The good news from the last two quarters of 2020 is that commercial real estate investors are comfortable looking at properties again. The not-so-good news is that COVID-19 cases are still rising even as vaccinations are being distributed. It’s important to remember that COVID-19 exerted an external shock on an otherwise healthy market, and that fact alone bodes well for its recovery.
Clearly, the market recovery cannot fully happen until the health crisis ends, and certain asset classes will fare better than others, as will certain metros. The path forward will be uneven, but there is a tremendous amount of capital on the sidelines poised to pounce when pricing is attractive to buyers. As the market trajectory of 2021 unfolds, we can take solace in the fact that investor confidence is improving as they move off the sidelines, listings are rising and property due diligence is now at its highest levels since the pandemic hit.
Dianne Crocker is a Senior Economist for LightBox. She delivers strategic data and analysis on property risk management trends to commercial real estate lenders, environmental due diligence consultants and other stakeholders in property deals.
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