IllinoisCRE Coronavirus response: How will real estate markets respond? Matt Baker March 13, 2020 Share on Facebook Share on Twitter Share on LinkedIn Share via email The novel coronavirus that causes COVID-19 has upended many systems around the world, from stocks to tourism to the convention industry. With this uncertainty hanging over the market, how will real estate investors respond in the short term? What might occur on the broader horizon? As quickly as the new coronavirus crossed China’s borders, the impact on the financial markets has been almost as swift. Fearing a bear market, investors directed their capital reserves to the relative safety of the bond market, resulting in the largest one-week stock market drop since the 2008 financial crisis. The Dow just had its biggest crash since 1987. A special report from Marcus & Millichap points to recent history as an indicator for how long and how far reaching this market correction might be—as well as the implications for the CRE sector. SARS, H1N1 and other recent pandemics also generated short-term market volatility. While it’s still too early to compare the full health impacts of COVID-19 with those strains, the markets stabilized in the range of three to six months on average during past events. In isolation from this new health scare, real estate supply and demand are largely in balance. It’s fair to assume that—barring a devolution into a far worse global health emergency—job creation and economic growth will both decelerate but remain positive. This should support real estate fundamentals and lead to a relatively stable outlook for the sector over the remainder of the year. The biggest real estate impact from the coronavirus will be in the hospitality sector as tourists cancel vacations and corporations curtail employee travel. The cancelations of conferences and similar large events will also hurt hotels’ bottom lines. Last year’s nationwide 66.2 percent occupancy rate was close to a record high; while the virus will almost certainly diminish performance, the sector may still stay above the 30-year average occupancy of 62.5 percent. Another asset class that could see poor performance in the short term is the already beleaguered retail sector. The trend for more experiential retail that has buoyed restaurants, entertainment venues, fitness centers and similar facilities may boomerang as the public avoids busy public spaces. Product shortages might also weaken store performance. Expect some retailers to hold off on expansion plans until activity levels bounce back. In the short term, the novel coronavirus will do little to drive down demand for housing, resulting in a continued favorable rental environment. At the end of 2019, multifamily vacancy rates in the U.S. stood at 4.2 percent. The addition of new Class A units may push that rate incrementally higher during 2020, but miniscule Class B/C vacancy rates likely will result in rent growth for those properties. The office sector should perform similarly over the next two to three quarters as it has in the recent past. A tight labor market and steady job creation are likely to keep office demand stable and we shouldn’t see much deviation from the 13.0 percent national vacancy average rate at the end of last year. Similarly, there likely will be little short-term impact to the industrial sector due to the coronavirus. There may be a reduction in the flow of goods out of China, but the Marcus & Millichap report expect this to pose little risk to the strong demand for industrial space. At most, some users may postpone commitments for large warehouse space as they evaluate economic conditions. This could delay absorption of new spec facilities in some markets. While we’ve been inundated with headlines about COVID-19—and its detrimental impacts on the equity markets—the virus is unlikely to have severe, long-lasting effects on the commercial real estate sector. Marcus & Millichap points out that falling interest rates will propel refinance and acquisition activity and despite lenders increasing spreads over the risk-free rates, quality investors have been able to lock in debt in the 3 percent range. Coronavirus-related uncertainty among buyers has meant that property values aren’t escalating, and cap rates aren’t compressing, so investment activity should remain stable despite a lack of confidence in the wider economy. All of these assessments are based on market responses to pandemics from the recent past, and the current situation with COVID-19. If consumer confidence levels plummet and/or stock market volatility swells out of control, the situation could be far different. However, the Marcus & Millichap report expects reduced but still positive economic growth even in the face of these uncertain times, sustaining the cycle and the underlying demand for real estate.