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‘You Cannot Buy A Building Until This Is Over': Despite Stimulus, Chill Hits CRE Investing

In just one week, the coronavirus has turned full blown flight to safety for investors into much more of a wait-and-see approach toward commercial real estate.

Over that time, as the pandemic has spread and thousands of businesses have closed, the Federal Reserve has sprung into action, announcing $1.5 trillion in short-term loans, $700B in asset purchases, plans to purchase up to $1 trillion in commercial paper from companies and a slashing of interest rates to nearly zero.

But even with those measures, which imitate a playbook the central bank took months to unfurl during the last economic crisis and include a rate cut, uncertainty and the virus itself have suppressed investment for the time being, as have questions about how deep and long of a recession the U.S. economy now enters.

San Francisco

“We’re in a recession now that started probably a week ago or two weeks ago,” Ken Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at UC Berkeley, told Bisnow. “[Lower rates] would normally be a very good sign for commercial real estate because we typically have quite a bit of debt. But I’m afraid it doesn’t work this time.”

Rather than fueling widespread investment, lower borrowing costs are at best being met with mostly indifference, or the additional financing of multifamily properties, and at worst, they have increased concern from borrowers for all other property types, according to Principal Global Investors Senior Managing Director Indraneel Karlekar.

“If anything, it’s making people a little more cautious on what the economic outlook looks like,” he said.

In an increasing number of markets, investor inaction is less by choice than by law. Shelter-in-place orders, which are in place for around 7 million Californians in and around the Bay Area, and soon possibly all of New York City, will stop an indeterminable number of deals in their tracks, San Francisco-based Emerald Fund founder and Chairman Oz Erickson said.

In the Bay Area, with inessential business forbidden, appraisal work, building inspections and other due diligence necessary to close on a property have effectively stopped, according to Erickson.

“Until this is over, you cannot buy a building,” he said.

Mirroring the spread of the virus, a drop in U.S. commercial real estate deal volume would follow what early data shows through the first two months of this year for the Asia Pacific region and Europe, which saw year-over-year drops of 50% and 20%, respectively, according to new data from Real Capital Analytics.

On top of overwhelming uncertainty, lowered interest rates don’t seem to be helping much yet, because lenders have widened spreads and reset floors on a daily basis so far this week, Karlekar said.

Lenders are still quoting and closing loans, but there is a slowdown in loan origination, Newmark Knight Frank’s Debt and Structured Finance group said in a letter sent to clients on Monday.

In the two weeks following the Fed’s March 3 interest rate cut, commercial banks kept offering competitive rates with only slightly widening spreads, while life insurance companies became more selective, “not necessarily lowering the cost of debt thus far,” NKF said in its report.

Lenders more reliant on utilizing capital markets executions like commercial mortgage-backed securities or collatoralized loan obligations have become more hesitant because of price uncertainty, NKF Vice Chairman and co-Head of Debt & Structured Finance Dustin Stolly told Bisnow.

“There’s still a lot of price discovery in the CMBS market being attempted right now,” he said.

Stolly said that his team having closed on six loans in the last eight business days or so is a good sign, but both he and fellow NKF Vice Chairman and co-Head of Debt & Structured Finance Jordan Roeschlaub say transaction volume has declined.

“What we’re seeing is a little bit of a pullback with respect to certain lenders,” Roeschlaub said on Wednesday. “They’re not out of business, just a little bit slower to respond to potential opportunities and looking at what they have on their existing book and in the pipeline.”

President Donald Trump and Federal Reserve Chairman Jerome Powell at Powell's nomination to lead the U.S. Federal Reserve in November 2017.

Elsewhere, investors have carried on with a little more action. EquityMultiple Chief Investment Officer Marious Sjulsen said the crowdfunding platform has seen some of its usually active investors waiting for more clarity, but they are “still seeing deals get done.”

“They’re getting done with delays because the financing market is still trying to figure things out, but they are getting done,” he said.

Likewise, Bull Realty President Michael Bull has recently closed on a couple of deals and says he thinks a little more clarity about the virus and the federal government's response will revitalize investment activity, especially with rates now lower.

“Lenders might be spooked by everything,” he said. “But if they’ve got a larger spread, they’ll be more willing to do loans.”

Where there is more consensus is the prediction that already-struggling property types are on the precipice of inestimable damage. Retail and shopping malls especially are floundering. As of Tuesday, month-to-date returns on regional mall REITs plummeted 49.27%, much worse than the 19.39% drop seen from REITs in general, according to Nareit’s index of REIT sectors.

Lodging and resorts REITs have hardly fared better than retail, seeing a 47.88% month-to-date dip.

“Hotels, unless there’s something unique about them like an income guarantee, are effectively not financeable at this moment in time,” Stolly said.

Even though retail and hospitality have been hit the worst this month, uncertainty around where the coronavirus is taking economy has hit all of the commercial real estate sector, including industrial and residential, which have seen 15.73% and 15.26% month-to-date drops, respectively, according to Nareit

Glenfield Capital Managing Principal and founder James Cate, whose firm is still tracking assets it was bidding on prior to the coronavirus pandemic, said Glenfield has slowed down on transactions right now, as have many other buyers.

“Underwriting is going to change,” Cate said. “I’d be afraid of the person who is going to tell me exactly how they’re going to underwrite a deal today.”

Karlekar, who heads global research for Principal Global Investors, said hesitance abounds across property types and markets, especially in CMBSs and REITs.

“It’s very hard for investors to get a handle on how this is all going to play out,” Karlekar said. “[REITs] are pricing in a very significant and meaningful long-term recession in the U.S.”

“I think we’ve only just started seeing the beginning of social distancing in the U.S., and there’s really no precedent on how the economy behaves,” Karlekar said. “This is not a balance-sheet recession, this is not a financial recession, this is not a business cycle recession.”

Aside from more clarity on where the coronavirus goes from here, Rosen and other economists agree a fiscal stimulus is the next step toward mitigating the ongoing demand-side shock to the economy. 

Beyond that, ultimate relief to markets and households depends on much more than fiscal or monetary policy, Rosen pointed out. For now, he said he expects a 5% drop in annualized GDP growth in Q2 but is much less certain about what comes after. 

“It’s all dependent on biology rather than economics, and that’s frightening,” he said. “This is the most uncertainty that I’ve seen in my lifetime.”