The Macro View
By David Grana
As we headed into the Easter weekend, I started getting concerned when the Bloomberg Television anchors began talking about their plants - yes, their plants - that kept them company while they presented from their respective New York City apartments. Last week, the deluge of data that hit the market forced them to shift their focus towards more pressing matters.
The massive 8.7% drop in retail sales for the month of March was to be expected, considering that 95% of the country has been on some form of lockdown and that non-essential businesses have been closed in most states. Suffice to say, the figures that came in last week did not disappoint our somber expectations. Sadly enough, neither did the jobless claims, which came in at 5.245 million. What’s really difficult to stomach is that the 22 million jobs that have been lost over the last four weeks have nearly wiped out all of the post-Great Recession gains.
This being earnings season, we’re starting to find out just how bad the impact of COVID-19 will be on companies’ respective bottom lines. The large banks were the first to feel the sting, with JPMorgan seeing profits decline by 70%. The bank’s CEO Jamie Dimon declared that the financial stress would mirror the one felt during the 2008 Financial Crisis, as he and his peers began to bulk up on loan-loss reserves in anticipation of forthcoming defaults.
Speaking of banks, the $350 billion Paycheck Protection Program that was supposed to provide rescue loans to small businesses ran out of funds last week, falling short of its intended outcome. A second stimulus plan was in the works, but failed to launch because of disagreements between congressional leaders. Time is running out for many businesses that may not be able to negotiate the terms of their loans with their banks, who themselves are fielding similar requests across their entire lending portfolio.
On a brighter note, nearly 3 million borrowers have been successful in getting mortgage relief, representing $650 billion, or 5.5% of active mortgages. However, servicers - the middlemen between borrowers and bond holders - are still on the hook and haven’t been given any respite. These servicers need to advance somewhere in the neighborhood of $2.3 billion per month to government-backed mortgage security holders and $1.1 billion per month to holders of privately-securitized mortgage bonds. Where that money will come from while lending is starting to tighten up is not quite clear. Chase Bank announced last week that mortgages will only be issued to borrowers with a minimum credit score of 700 and a 20% downpayment. This is important to note because this change is not relegated just to homebuyers. Changes to lending standards, such as these, will ripple throughout the financial ecosystem. Whatever type of loan that you’re applying for, if you can’t provide substantial equity up front, you may as well move on.
"Businesses and households are expected to retrench as we continue down a path of economic contraction."
Businesses and households are expected to retrench as we continue down a path of economic contraction. The International Monetary Fund’s World Economic Outlook projects a 3% decline in global output and a 5.9% drop in U.S. GDP. These figures were reflected in last month’s 6.3% drop in U.S. manufacturing output, which was the biggest decline since February 1946. Until consumption can expand beyond basic household goods, factories will need to be idle, lest warehouses start to accumulate mass amounts of outstanding inventory.
Late Thursday, President Trump and the Coronavirus Response Team announced the initial plans for the reopening of the economy. The emphasis was on testing and a steady drop in COVID-19 cases, at the discretion of the state governors, before opening could commence. Harder hit states in the Northeastern U.S., including New York, have already extended their lockdowns until May 15. How all this is going to play out has yet to be determined, but what we do know with certainty is that it will be a slow and steady process.
In the real estate world, more and more retail properties with 5% cap rates and 90%+ occupancy are showing up for sale, as owners look to cash in while the world is still on pause. “Essential business” and “well-established franchise” have become the new catchphrases in every broker’s vocabulary. Considering the recent retail sales figures and banks’ concerns for the coming months, one has to wonder if some of these businesses will be among the anticipated defaults over the coming months.
Commercial listings with details like these may become scarce in the post-COVID-19 era.
One issue that is less spoken about, but which may have some bearing on landlords and tenants are triple-net leases. One thing that we have yet to find out as we approach our slow and gradual opening is what this means for real estate operating expenses. There hasn’t been any clarity on what new regulations will be passed as a result of COVID-19, such as higher sanitation standards or tighter restrictions on building occupancy. The former could mean higher maintenance costs, while the latter is essentially a higher rent per occupant ratio. If this does become the norm, even if only until a coronavirus vaccine is developed, will that change negotiations between tenants and landlords? And what impact will this have on lease structures?
Who will be the financially sound tenants of the post-COVID-19 era?
As we approach the end of the month, there will be plenty of planning that states, municipalities, businesses and landlords will need to do in order to conform with the changes that are ahead. This will ultimately have an effect on everyone’s bottom line, which will be especially challenging in the economic climate that we have already entered.
The Micro View
By Pam Junge, CCIM
“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” Winston Churchill delivered these famous words in a 1942 speech at London's Mansion House just after driving German troops out of Egypt. The battle marked a turning point in the war. Have we also reached a turning point, the beginning of the end of COVID-19 in our great state? New normals continue to shape how we behave and maneuver in the world, and it’s apparent that some of these measures are here to stay, while more are bound to be revealed.
On Friday, President Trump unveiled the guidelines for Opening Up America Again. Unlike previous plans, it recommends that governors phase out mitigation measures when data, not dates, show progress. That data includes satisfying a specific downward trajectory in case numbers in a 14 day-period, robust testing and the ability to treat patients without crisis care. This three-phased comeback is a state-monitored plan to open up our economy and get our people back to work. Governor Sisolak has made it very clear that changes will be incremental and further insisted he won’t succumb to pressure from critics demanding reopening of casinos and nonessential businesses for short-term economic gain.
On Thursday, U.S. Senator Jacky Rosen (D-NV) announced that she has accepted an appointment by President Donald J. Trump to join the Congressional task force to re-open America. “Nevada is one of the states whose economy has been hit hardest by the coronavirus crisis,” Senator Rosen said. “We must work together, not only to overcome this pandemic, but to plan for what comes next. Our small business owners and workers are facing unprecedented challenges and we must work to alleviate the incredible financial strains they are experiencing. In the Senate, I have worked time and time again for commonsense, bipartisan solutions that put working families first. As a member of this Task Force, I will bring Nevada’s voice to the table as we work to protect the health and well-being of our country.”
Senator Jacky Rosen (D-NV)
Thank you, Senator Rosen, because by all accounts, the CARES Act Loans afforded in the stimulus package have failed Nevadans and small business owners, or rather, Nevada failed in implementing them. The entire event could be summed up as “failure to launch.” The Silver State, which has a population of almost 3.08 million, had 4,209 loans approved by the SBA, totaling $1.25 billion as of April 13. It’s the least amount of aid received by the seven states with populations between 2.9 million and 3.5 million over that time frame. According to the Wall Street Journal, Nevada also ranks near the bottom for loans per 1,000 businesses with fewer than 500 workers. The state’s congressional delegation has been critical of the program for using criteria that excludes small gaming businesses - an essential piece in the Las Vegas economic quilt. “Nevada small businesses that engage in legal gaming make up key parts of our state’s economy,” Rosen said. “These businesses should be given the same access to coronavirus relief as any other small business.”
So here we sit with unprecedented unemployment, very little financial assistance, and a phased rollout that appears to prolong our reopening for at least several more months. Let’s investigate how that’s affecting the Las Vegas property market.
As the world sits on pause, so follows the housing market. The opportunists are gone and we’re left with only those that have to move. The previous week brought another 805 houses on the market, however, year-over-year, we are down approximately 1,500 listings. This puts us at four months of inventory, with a little cushion before the alarm bells start to ring. Price reductions continue climb, with another 638 downward adjustments this week. This could be the reason that accepted contracts and closings came in strong and over-produced. The closing numbers undoubtedly speak to a relatively high amount of consumer confidence, despite living in a pandemic. While this is great news on the resale housing front, without being too pessimistic, we will know the overall impact and if values are declining by the end of the month.
As previously reported, large institutional buyers pulled out of the market in mid-March due to uncertainty, citing plans of re-opening with the economy. While their entire business portfolios are wrapped around the housing market and ancillary services, they are also feeling the pain of the pandemic. Opendoor announced this week that they had to lay off 35% of their staff - approximately 600 employees. Quite possibly, their comeback was optimistic and their business models need to be diversified. Ironically, this takes us full circle back to the title of this article, and the song by Black Sabbath with the same title, which was inspired by the fear of how "technology is going to completely take over the human race.” Computers were going to upend the home buying process. Companies like Zillow and Opendoor were supposed to lead a revolution in real estate by using algorithms to flip homes. However, A global pandemic brought those plans to a screeching halt. I suppose the iBuyer ZOO didn’t count on COVID-19. While Zillow alone accounted for a mere 2% of the national market share in 2019, these sellers will now remain in our local database of inventory, until a future in which these giants find the market and pricing tolerable again.
New home builders are not exempt from the pain of cancellations caused by buyers’ unintended lack of financial qualifications. In this arena, it poses a slightly different obstacle to the builder, since part of the allure of purchasing a brand new home is designing it to the buyer’s specific tastes and needs. Once that house has been through the design process, it’s likely less appealing to another consumer in that space due to restrictions on changes and enhancements. While builders are embracing virtual tours and social distance showings by appointments, sales are way down. The telltale sign of lackluster sales is always Realtor incentives, which are coming out in droves. While builders were pulling back on agent commissions and relationships going into 2020 with a thriving market, they are back and knocking on our doors again. It’s been rumored that a few of the larger land purchases for future home sites have already been defaulted on. It’s a gamble - take a strategic loss of earnest deposit and hard costs, now betting on lower land costs in the future and/or making the decision to re-size developments that will better fit the future needs of consumers and cut losses now. We will be watching for lapsed builder permits in the coming months as another economic indicator of this market sector.
While it’s difficult at this time to track local numbers, nearly three million borrowers, or roughly 5.5% of all mortgage borrowers, have taken advantage of mortgage forbearance. With cash running dry for a lot of families, we expect those numbers to increase in May. While every debt servicer operates slightly differently, it’s up to the borrower to ensure that they are agreeing to terms they believe they can comply with at the end of the forbearance period. Time is the mortal enemy for many right now. While mortgage services are under federal guidelines to cooperate with borrowers at all costs, eventually they will gain back their rights to foreclosure. Since they will be burdened with what some estimate to be three billion dollars in unpaid debt in just the next month, they will be forced into massive asset repossession through foreclosures. We’ll undoubtedly start to see this fallout in twelve months or so (post forbearance timelines), but the numbers are still anyone’s guess. Should the mortgage deferment backfire on Las Vegas, we could see a largely disproportionate amount of homes hit the market in a short amount of time, shifting the inventory quickly.
Those buyers that decided to wait to purchase homes, hoping for a better price, may have temporarily disqualified themselves due to reactive lending guidelines. With the financial markets in turmoil and creditors trying to find the balance of competitive rates and terms, coupled with the likelihood of how many people will still make their payments, the game has drastically changed. There are severe loan restrictions in the FHA and VA sector, calling for minimum FICO credit scores of 700. The Jumbo market is drying up and only processed with caution right now. Interest rates will remain low and those consumers with excellent credit and significant down payments and reserves can take advantage of these historic lows. This story will continue to unfold with more economic developments. As the economy heals, guidelines will eventually loosen in response.
If we had a chance to look into our future, we’d be paying attention to Macao right now. Macao and Las Vegas, respectively, rank as the largest gambling markets in the world. While most of Macao’s casinos were only in a 15-day shut down, by all accounts, their slow and methodical re-opening is anything but glitz and glamour. According to the Las Vegas Review Journal, “To gain entry, visitors were required to undergo a temperature check, submit a health declaration from a cellphone app and don a face mask — which casino employees also were required to wear. Once inside, players found half of all slot machines and table games sitting idle to maintain social distancing protocols. At some properties, a maximum of three players were allowed at baccarat tables that normally seat seven and are crowded by onlookers making bets of their own.
Guests at Macau casinos undergoing temperature checks.
Workers were tasked with wiping down each poker chip after it was handled by a player. Time will tell what it will look, feel and sound like when the casinos reopen in Las Vegas, but Macao’s experience may hint at what is to come and how a recovery could slowly unfold here. Though the two markets are very different, there are lessons to be learned as Vegas looks to return to the 24/7, glimmering disco ball of a city that it was.” The Wynn was one of the very few casinos that took proactive action before government mandates. To protect their workers and the public, they shut down and set in place a plan to pay all employees, including estimated tips, through May 15th. The closure is costing them an estimated three million dollars per day. They’ve also pioneered a well thought plan of re-emerging in a safe and sustainable way, leading the charge for the community’s main industry and largest revenue generator.
The dominoes fell and we traversed the eye of the storm. As the country rallies to gain ground and turn towards healing our economy and our livelihood, we have to wonder what this next chapter of adaptation will bring as we enter the end of the beginning. Be well and stay safe. We’re all in this together. #vegasstronger
How reliable is the market information that you are receiving right now?
Information is coming in daily from the properties that we track, but it’s still very early on in the process. We may not see Q1 numbers reflect the true nature of the situation at hand, because all of this started in the last two weeks of March and the quarter only ended on March 31. And during this time, we all had to pivot from trying to figure out how this pandemic was going to affect us to how we quickly we could start working from home. Everything has moved so rapidly.
In other words, although we are receiving the best information possible across the many property types we are tracking, so much of this situation is new and we need time to process data as it comes in. To paraphrase Stephen Hawking, the uncertainty means that it feels like we aren’t just rolling the dice about how this will all pan out in the future: we’re on our hands and knees looking for the dice.
"What remains to be seen is whether there will be a reallocation of households
as a result of COVID-19."
What has been the impact on multifamily real estate?
We’ve not seen a huge decline in the population, and because multifamily is a basic good, there has not been a notable shift. In addition, top line numbers, such as occupancy and rents, have not seen a major change. At some point, we wonder if we will experience a sizeable drop-off in the amount of information that we collect, but that hasn’t happened yet. Our regular market respondents could either be too busy to take our calls, or there is so much distress that they don’t want to give out actual numbers. If this happens, we need to adjust our statistical models to account for a greater proportion of censored data.
What can history teach us about the potential impact that COVID-19 could have on real estate?
After the September 11 attacks, the worst prediction was that Lower Manhattan and Washington, DC would be sites for future terrorist attacks and that businesses and residents would move out of these areas. That never happened, which leads us to believe that the worst case scenario is not necessarily always the one that we will see in the end.
In 1994, the Northridge earthquake in Los Angeles destroyed many multifamily properties, but instead of driving people away, it ended up increasing tenancy and rent growth. Mind you, this was at a time when there was an urban revitalization in LA and many other US cities, but it had the opposite effect of what most people would have assumed. In contrast, Hurricane Katrina had a very negative effect on the city of New Orleans. They ended up losing a third of their population, resulting in a massive decline in property demand.
What remains to be seen is whether there will be a reallocation of households as a result of COVID-19. In other words, will people living in one of the epicenters decide to move away from those areas? This may have negative effects for the areas that residents choose to vacate, but benefit some communities that are far removed from coronavirus epicenters.
"...I do think that multifamily will recover quickly, much like it did in 2008-09."
How might office real estate be affected?
One of the biggest shocks and lessons of this crisis is that many employees have come to realize that going into the office is not critical to getting work done. In fact, for many job types (but not all), it turns out that you can do just as well working from home. I think this realization will have an impact on the amount of square footage and the type of office space that companies will demand going forward. That said, there are many people out there that are looking forward to returning to their offices, being amongst their colleagues, and getting back to their routines. However, I should note that we are already in the midst of shrinking office demand. In the 1980s, office space requirements were calculated at 200-300 square feet per employee. With the transfer of many jobs offshore, and the shift to automation, that requirement is down to 125 square feet per employee.
As we look at the entire ecology of the built environment of specific geographic areas, we need to seriously consider what future developments will look like. If we assume that this is not the last pandemic-like scenario that we have to deal with, there is a possibility that we will start to see a self-contained ecology in the form of mixed-use developments. In other words, retail supporting multifamily, supporting nearby office space. Of course, this concept would have to accommodate the new norms in social distancing, but it has the potential to be a more advantageous than the current setup, where retail in a downtown district suffers because people are no longer going to their offices. Self-sustaining communities, such as mixed-use developments, create microcosms of highly functional city environments without the downside risks that we are seeing today.
With all of this in mind, I project that we will hear more about mixed-use developments, as well as a rethink of the communal use amenity in multifamily developments. These changes may include collapsible walls and dividers, and in-house daycare.
Do you see NOI being impacted?
There are surveys suggesting that only a fraction of multifamily tenants paid their rent in April. I think it’s safe to assume that NOIs are going to drop by a significant amount. I would estimate that these losses will be concentrated in Q2. This is because of the shutdown, as well as the record rate of economic contraction that we should be anticipating. The last record contraction was 10% in 1958, and we’re expecting a drop along the lines of at least 30% this quarter.
"Our worst case projection for the retail sector in the wake of the COVID-19 pandemic is for vacancies to rise past historic highs, ending 2021 at 14.6%."
We will see a combination of unemployment, unpaid rents, but weigh that against many places where governments have banned evictions. The movement of households will, therefore, likely be constrained: I don’t think many people will be moving, nor will they want to. This will be a zero-sum game leaving landlords with lower NOIs.
On a brighter note, I do think that multifamily will recover quickly, much like it did in 2008-09. This is in contrast to retail, which is going to struggle greatly.
"We feel that tenants such as Amazon, medical, pharma and trucking companies will be the most dominant in industrial for the foreseeable future."
What factors have led to the retail being under this type of pressure?
The recovery of neighborhood and community shopping centers proceeded at a slow pace after the Great Recession. Between 2002 and 2007, retail growth piggybacked off a strong housing market, which left an oversupply when the economy collapsed. Vacancies rose to a record high of 11% by 2011 and then declined at a grindingly slow rate, bottoming out at 9.9% in 2016. This rate had been on the rise since then, ending 2019 at 10.2%.
The second area that has had a major effect on retail is the rise of online commerce. The coronavirus outbreak may well hasten the shift away from dense physical retail to online ordering and delivery. In fact, the average annual effective rent growth of 2.7% from 2000 to 2007 dropped by more than 100 basis points for the period 2012 to 2019, to 1.6%. Our worst case projection for the retail sector in the wake of the COVID-19 pandemic is for vacancies to rise past historic highs, ending 2021 at 14.6%. Asking and effective rents at the national level are projected to decline by 3.7% and 5.0%, respectively, in 2020. They will continue to decline by another 1.5% and 2.0%, respectively, in 2021, based on the assumption that U.S. GDP will continue to contract through the third quarter of 2021.
Retail Construction, Net Absorption, and Vacancies (2000-2023)
"The more nimble warehouse distribution operators will do well,
especially with the shift towards online consumption."
Which property types do you see pulling through strongly in this recession?
The more nimble warehouse distribution operators will do well, especially with the shift towards online consumption. The increase use of online services, such as Zoom and Netflix, will result in higher demand for data centers, which are within the industrial family of assets. I also see retail centers that are anchored by grocery stores and pharmacies doing well. Pre-2008, these strip malls did very well, and they will see a revival, especially with the needs that people have had for these stores through the pandemic. All classes of real estate are going to take a hit during this downturn, however, these property types will likely feel less pain.
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