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Capital Alert

Bidding Good Riddance to an Unprecedented Year

December 18, 2020

Capital Alert

December 18, 2020

We’d like to close out our 2020 Cap Alert with three words: What a year. We are entering 2021 with a COVID-19 vaccine, and the presidential election is officially concluded. These certainties should help restore confidence and optimism about the year ahead. Still, the coronavirus pandemic fueled structural transformation across the industry, and we face several difficult quarters ahead. It will take time to assess the damage, particularly in the hardest-hit sectors, and to achieve full recovery. Here are some of the dynamics that emerged in 2020 and trends to watch in 2021.

There is a weight of pent-up capital looking for opportunity. When the pandemic erupted, the government-sponsored enterprises (GSEs) dominated lending as some banks, credit unions, life companies and CMBS moved to the sidelines. We saw the credit box tighten, banks retreat from new origination to focus on balance-sheet assets, and lenders across the board avoiding battered hospitality and retail assets. Borrowers faced higher debt coverage ratios, lower LTVs, higher reserve requirements and more intensive due diligence. The vaccine is inspiring some investors to jump back into the commercial real estate: malls and shopping center REIT indexes each soared about 40% in the five weeks following Pfizer’s vaccine announcement. But some lenders are likely to remain cautious as they sort through the structural impacts of the pandemic and wait to see how regulators will assess potentially risky real estate assets on their books.
Some lenders are likely to remain cautious as they sort through the structural impacts of the pandemic.
Casualties of the crisis are coming to light, and distressed sales may rise. With rent defaults choking off cash flow, 20 large real estate companies have filed Chapter 11 this year, according to a Bloomberg analysis, including two with more than $50 million in assets. CoStar Group estimates that fire sales could surpass levels seen in the global financial crisis, with some $126 billion in commercial real estate forced to sell at distressed prices through 2022. Meanwhile, distressed debt has risen 4 percent since the March peak, while the situation has eased in most other industries. More than 10 percent of CRE loans were in special servicing in November.

The pandemic created a Darwinian divide between winners and losers. Warehouses, data centers, grocery-anchored retail and life sciences outperformed, while malls and hotel assets were crushed and are now seeing values fall. Watch for some distressed assets to be repurposed to serve last-mile logistics.

Institutional multifamily assets held up in 2020 but a crisis is looming for smaller property owners. By January, renters could be as much as $24 billion in arrears, according to the National Council of State Housing Agencies (NCSHA), and most of that burden has fallen on mom-and-pop owners. The financial stress will be coupled with social disruption, as up to five million tenants face eviction when a moratorium by the Centers for Disease Control and Prevention expires December 31. At deadline, Congress was reportedly nearing a deal for another economic relief package that would include stimulus checks of $600 per person, $300 a week unemployment benefits and $330 billion in support for small business loans and vaccine distribution. For its part, the Federal Reserve voted to hold short-term interest rates near zero and said it would continue to buy $120 billion a month in bonds until employment bounces back. 

Central business districts are reeling from a confluence of trends. Downtown apartment rents fell in 2020 as residents, particularly those with children, decamped for the suburbs, and net completions rose. In the office sector, only 20 percent of workers have returned to downtowns. With remote work firmly established and companies looking to cut costs, some firms may choose flexible space over long-term leases, or shift headquarters to lower-cost regions. Bloomberg reported that Goldman Sachs was considering moving its asset management business to Florida, and Oracle is relocating from Silicon Valley to Texas. But don’t count big cities out yet: Apple, Facebook, Amazon, Microsoft and Google have expanded their real estate footprints at the fastest pace in a decade, and Google’s CEO publicly rejected the notion of permanent remote work. With midtown Manhattan office space experiencing its highest vacancy rate since 2009, some landlords are asking the city and state to make it easier to convert their properties to residential. Meanwhile, mass transit systems are facing catastrophic budget cuts, threatening the vitality of cities like New York. (That system’s CEO recently described the impact as “a once-in-a-hundred-year fiscal tsunami.”) While we anticipate downtowns will eventually bounce back, watch for both disruption and creative transformation in the interim.

The market will continue to be highly dynamic and fluid in the year ahead. With its unparalleled market coverage and extensive network of lender relationships, Marcus and Millichap Capital Corporation is prepared to guide clients to successful outcomes. We at MMCC wish you a healthy and happy holiday season and prosperous New Year.

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