ADDENDUM (March 25, 2020) to The Short-Term and Long-Term Effects of the Coronavirus (COVID-19) on Commercial Real Estate
Norm Miller gives an overview of Coronavirus
Thursday, March 26, 2020
by: Norm Miller, Ph.D.

Section: COVID-19 Updates

When will the virus peak out?  Based on the research presented in a REMI webinar by Patrick Finley and Vanessa Vargas, of the Sandia National Laboratories on March 23, 2020, titled “Epidemiological and Economic Modeling of a Pandemic” based on history, we can expect the coronavirus to peak out about 153 days after the initial spread with the last 20 days by far the worst. Using Feb. 9th as a starting date for the U.S., this would give us a peak in the number of infections around July 5th.  If the quarantine really works to slow the spread, that peak might come much earlier, as soon as sometime in early May, but not likely much earlier. This suggests our service economy will be significantly impeded for much of at least two and a half months. The infected death rate depends entirely on the availability of ventilators and could range from .4 percent to 2.0 percent in the worst case, depending on ventilator access. Fear and stress add to the death rate, especially for those with diabetes, asthma and other chronic health issues, and economic stress can add to the suicide rate.

How is the economy affected?  Approximately 50 percent of the workforce can work effectively from home. With some 20 million working in retail-related services, and delays in construction, and manufacturing we can expect from five to nine million people to lose their jobs, temporarily by the end of April. The two trillion in federal aid, along with some state and local assistance will help but not stop a recession.  Quarter two and three GDP will likely be negative. Deutsche Bank estimates the U.S. GDP in the second quarter at -13 percent Pantheon estimates it at -10 percent, UCLA estimates it at -6.5 percent, and Moody’s at -1.6 percent. Among the states hit hardest are Hawaii, CA, MI, NY and by metro, New York, Las Vegas and Boston. These states and markets will have larger economic shocks and require longer to get back to normal. Part of the reason for a short-lived recession is simply the economic uncertainty that delays so many decisions, from selling or buying a home, to travel, buying a new car or any discretionary type consumption.  Some businesses and households, especially those without health insurance, will go bankrupt and those smart enough to have significant cash reserves will be economic survivors. Every time we see layoffs, even with a short recession, not everyone is immediately hired back.  The economy will likely accelerate in early 2021 as delayed decisions are ramped up. Above average healthcare costs will continue for up to a year or more. Cruise ship travel companies may take several years to fully recover.

Specific impacts on commercial real estate: In addition to an increase in rental payment defaults, requests for rental concessions and some mortgage defaults, we can examine the recent REIT prices from mid-March to estimate the implied discount or premium for specific property types.  Based on figures from Nuveen presented at PREA, generated by Green Street, we see data centers, health care and some last mile industrial property increasing in value. In terms of other property types losing value as of the current date, are hotels (-37 percent), regional malls (-19 percent), offices (-16 percent), strip centers (-15 percent) and apartments (-8 percent) but as these are based on REIT prices, the declines are over-stated and many will rebound towards the end of 2020.  Those looking for distressed bargains will need to act fast and find some over leveraged owners without sufficient liquidity to ride this out. In the long term, we should see increase asset allocations to real estate which will lower long term yield requirements and maintain or increase values. Fundamental trends in retail towards e-commerce, and office sharing that lowered space per worker, which were all present before the virus will continue. The volume of sales for all commercial real estate will go down by 30 percent to 60 percent as the market freezes up during a time of uncertainty, during the second and third quarters of 2020, but should rebound significantly in the last quarter of 2020.
Norm Miller, Ph.D. is the Hahn Chair of Real Estate Finance at the University of San Diego School of Business and is affiliated with the Burnham-Moores Center for Real Estate. He is a highly-regarded expert in the areas of real estate, valuation, automated valuation models, data mining, real estate market forecasting, sustainability, mortgage risk analysis, sustainable business strategies, public policy issues, real estate financial market outlook, commercial and residential real estate trends, office space and workplace trends. He teaches in the masters in real estate program at USD. He has published a vast number of papers and has received numerous awards for his contributions to real estate.