Last week I wrote a post on the commercial real estate market and summarized my initial views on how this type of investment would be impacted by COVID-19 and the actions we are taking to fight it. You can see the post here. On Thursday and Friday I participated on several calls that discussed the commercial real estate market and its prospects for 2020. CrowdStreet, the real estate crowdfunding I have discussed before, held an excellent update for its members on Friday. I decided to pass along the key takeaways from last week’s meetings and provide my own thoughts.
Here we go…
Liquidity is critical for real estate investments in this time of uncertainty. Many investments are suspending cash distributions and stopping capital projects on properties until things get better. This could hurt investors that have become used to these quarterly cash distributions but I believe it is the prudent approach and will mitigate the risk of losing principal. Properties lacking liquidity or needing to refinance right now will be at greater risk of seeing losses to investor principal. Financing for most properties is a little dicey right now. Cash is king, especially if this thing gets worse before it gets better.
Also, I think most of these panels that I heard are assuming more of a V-Shape recovery for the economy. I will be discussing the possible types of recoveries from this crisis in another post but for purposes of this post a V-shape recovery is a probably the most positive outcome we can hope to see. Things will become more challenging for many investments, including real estate, if we see more of a long-tail U-shape recovery.
How Your Real Estate Investments Will Perform During the COVID-19 Crisis Depends on the Type of Real Estate You Own
The key take-away from both of these discussions was that some real estate will perform better than others during this time of crisis. Here is CrowdStreet’s view on how the major commercial estate types are handling the current economic downturn:
Real estate investments that are being hurt
Hospitality (think hotels)
This market is already heavily affected as occupancy rates are down to single digits. Some hotels have already closed and these assets could become distressed properties at some point. The debt market for hotel investors is basically on pause and unavailable to these investors. CrowdStreet feels this sector could be a possible buying opportunity in late 2020 or 2021 after things begins to turnaround.
I was interested in investing in a hotel through CrowdStreet before the current crisis but I ultimately did not pull the trigger. I believe it does have upside potential once properties see a big discount because we start travelling again. However, occupancy rates could be down for a period of time after the virus is gone if people have less discretionary income and consumer confidence remains low.
There was already a lot of supply for this asset class and there is even more excess supply due to the cliff-like drop in near-term demand. People will refrain from putting seniors into these properties until this thing has passed and potentially until there is a vaccine in place. Poorly capitalized operators of senior housing may ultimately fail which could create opportunities for stronger players in this market to buy discounted assets. The longer-term fundamentals still look good for this type of real estate due to the growing senior population and a slow-down in new projects and some defaults could create a better supply-demand relationship for senior housing in 2021.
Assets with Mixed Results
Retail (think shopping centers and malls)
I had been grouping retail properties into the loser category but I got a better perspective from CrowdStreet. The degree of suffering for a retail property really depends on the tenants in place at each property and how long people are forced to stay-at-home except for essential activities. Properties with grocery stores as anchor tenants are probably doing fine (think about how busy your local grocery store has been since COVID-19 hit) but under-capitalized retail properties with a major food and beverage tenant base, think local restaurants and shops, are likely facing issues that will become major challenges if the economy does not restart soon or if a Federal fiscal plan does not allow their tenants to bridge to the other side of this crisis. CrowdStreet actually sees opportunity here for a quick recovery when stores re-open but I am going to stay away from this space unless the operator is very well capitalized. One of their guests was actually pretty negative on this space. I could see some opportunities in retail REITs that have been hammered but that have the balance sheets to withstand the pain. Simon Property Group (SPG) comes to mind.
CrowdStreet sees the office properties performing fine if the properties have quality tenants with good credit and longer-term leases in place. Office properties may have short term issues if they are trying to get new tenants or renew existing tenants because they are seeing that many companies are holding off on entering into new leases for office space. I think you might have to look at the financial profile of the tenants before determining if a specific office investment is safe.
CrowdStreet also acknowledges that this period of working remotely could actually cause some companies to get comfortable with this model for its employees and reduce overall long-term demand for office space. This is very much hypothetical risk for these property types at this point and it is equally as plausible that some companies could see that remote working does not work for much of its employee base.
Industrial (think warehouses)
This type of property has done well the last few years and CrowdStreet leaned more positive on its views towards industrial properties during this economic downturn. Overall, values for these properties are holding up and industrial properties known as “last mile” properties are performing well since they are so important to getting online products to consumers in a timely manner. Last mile properties are those warehouses online companies like Amazon use as part of their distribution plan to get products to customers quickly. The values for these properties are actually spiking right now.
CrowdStreet sees weakness in many newer industrial properties that need to be leased up in the near-term.
Multi-family (think apartments)
Multi-family properties will be focusing on collections and high lease renewal rates over the next few quarters but overall this asset class is seen as resilient and in high demand by the lending community if the properties are occupied and generating existing cash flow.
The guest speaker who is an executive of a multi-family sponsor really broke-out expected performance by whether the property was Class A (think luxury apartments), Class B (think nice but more affordable apartments) or Class C (think low-end but most affordable). The speaker felt Class B properties were in the best shape because some Class A tenants would move down to Class B properties when their lease was up in order to lower housing costs and most Class B tenants were in better financial shape than Class C tenants so their collections would not suffer as much. These thoughts are based on how these different multi-family property classes performed during the 2008 financial crisis.
Assets with Positives Outlook
Here were the property types CrowdStreet was bullish on during this crisis. Be mindful, these properties are probably priced at a premium right now but the thought is the properties will continue to perform well regarding occupancies, rents, etc.
When people downsize they need to store their stuff somewhere and self-storage facilities generally perform well during recessions. These assets performed well during the last recession and are expected to perform here.
Manufactured houses are the most affordable form of housing in a country that has a huge shortage of affordable housing and limited new supply due to regulations. Manufactured housing was performing well before and will likely continue to perform well during this time as any vacancies should be limited in duration as people search for more affordable housing options.
These are properties that house things like the larger servers that are necessary for things like cloud computing. The long-term prospects for these newer types of real estate are very positive and these properties will probably not see any negative impact from the current environment.
How your real estate investment performs in the near-term will largely depend on the type of real estate and whether it has existing cash flows and low debt levels. If the economic recovery from COVID-19 takes more than a few quarters then you might have some real opportunities to buy discounted real estate. Buying them through real estate crowdfunding and working with experienced real estate sponsors could be a very successful investment strategy.