The Pandemic Effect: How Will Real Estate Be Impacted?

Pandemic Effect on the Real Estate Industry

It may not be fair, but even pandemics tend to benefit some people and segments of society while devastating others. COVID-19 will likely leave both the world, and the real estate industry, looking different than they did before.

Each and every day, I read various real estate predictions from different sources on what will happen. A continued factor to consider is that we don’t know what the future holds with the solution to the COVID-19 virus itself. There is no cure at the moment, which will most likely have additional impacts in the real estate industry.

At the moment, the economy is still being artificially inflated with massive government stimulus programs from the CARES Act, such as the PPP, EIDL, mortgage forbearance and unemployment, to name a few. When these programs end or get reduced, then we will all see the final results. As Warren Buffet famously said, “When the tide goes out, you see who is swimming naked.”

When a tenant is unable to pay the rent because its business or employer had been forcibly shut down by government orders to prevent the spread of an infectious disease that’s completely out of its control, who takes the financial hit? The landlord, the lender or the tenant?

Is the tenant still responsible for missed rent even though the enterprise had seen no business or very little during the involuntary shutdown? Will the tenant’s insurer pick up the check and classify the loss as a result of force majeure? Will the landlord just have to accept lower revenue for the period?

These are going to be complicated issues facing an untold number of tenants and landlords across the nation.

Industrial real estate was already in high demand before the pandemic struck, but with millions of people having been told to avoid going to unnecessary gatherings and limiting their trips to the grocery store, the demand for e-commerce deliveries has become so overwhelming, even giants Amazon and Walmart have been struggling to keep up. The companies are among those hiring tens of thousands of additional workers to fulfill e-commerce orders, and the trend is not likely to go away, even after COVID-19 has come under control.

Data centers are on fire. Most of the planet may now be stuck at home, but we are still using lots of data to work, shop, socialize, binge new shows and stream our workouts. Unlike malls and hotels, data centers have gotten an “essential business” designation. In fact, some data center facilities are now operating at the peak of their capacity, according to Data Center Knowledge. And with no clear end to shelter-in-place orders in sight as of yet, that extra demand for cloud storage is likely to continue.

“With fewer people being able to afford homeownership—loan applications to buy a home were down to 2015 levels.”

We are seeing explosive growth in demand for supermarket chains and, by extension, owners of grocery-anchored shopping centers. Supermarkets and drugstores are among the last places people continue to venture out to, especially as time slots for online grocery deliveries can be booked up weeks in advance for some providers, and common household items can be out of stock online.

It’s been a while since we’ve seen distressed real estate funds in the market, but it looks like they are about to stage a comeback. Before COVID-19, many private equity real estate investors had amassed substantial cash reserves that they were unable to use for acquisitions because property valuations remained at a peak for so long. Some of those investors now see an opportunity to pick up attractive assets on the cheap, including hotels and retail centers.

As U.S. commercial real estate properties deal with the fallout from widespread shutdowns and missing rents, expect to see investors in distressed debt and equity prosper. It might be a while before the opportunities emerge. Lenders are likely to give borrowers some extensions in the short term. But after the most acute phase of the crisis has passed, expect defaults to rise and with them, the opportunities for buying REO assets from banks.

If there is one thing pandemics prove, it’s that demand for medical services exists in good times and in bad. Some medical practices may indeed have been temporarily shuttered by shelter-in-place orders, but others—those offering services like dialysis and pregnancy monitoring—remain essential. Regardless, even if some medical tenants will be temporarily unable to pay their rents, real estate investors remain bullish on medical office buildings.

Regional malls have been in a downward spiral long before the arrival of COVID-19, but the pandemic will likely accelerate the demise of many retail tenants from several years to a few weeks or months. Before the pandemic, regional mall landlords tried to protect themselves from retail bankruptcies by signing on more restaurants, entertainment venues, fitness studios and beauty salons. Even if people can buy whatever discretionary goods they want online and are not excited by the prospect of visiting a Macy’s or a Gap, they would still show up to share a meal with a friend, see a movie or get a manicure or a haircut, the logic went.

With multiple retailers already facing bankruptcy filings, regional mall landlords are among those in the commercial real estate universe least likely to ever recoup their lost rents, and some may go down with their tenants.

Some of the hardest hit companies, at least in the short term, are senior housing operators and nursing home owners, in particular. Nursing homes were already facing difficulty maintaining their occupancy levels prior to the arrival of COVID-19. Part of the challenge for nursing home operators is that their residents are people the most susceptible to the virus—those older than 80 and with pre-existing health conditions.

“Regional mall landlords are among those in the commercial real estate universe least likely to ever recoup their lost rents, and some may go down with their tenants.”

Hotel operators are the first to feel the pain when people stop traveling and industry groups cancel conferences and conventions. Hotel occupancies in the U.S. have likely hit the bottom last week, at 22.6 percent, according to industry sources. Many operators, including Marriott International, Hilton and Hyatt, have had to furlough their staff. Depending on how long the pandemic lasts, hotel owners may find themselves facing the same dismal occupancy statistics and shortage of income for months.

On the one hand, multifamily housing owners are sure to feel a significant amount of pain in the coming months from missed rents, as millions of people have been laid off or put on furlough as the result of pandemic-related shutdowns. On the other hand, people will continue to need housing, and reduced revenue is better than none.

In addition, with fewer people being able to afford homeownership—loan applications to buy a home were down to 2015 levels, according to the Mortgage Bankers Association—tenants that under different circumstances might have become homeowners will remain apartment renters.

With most universities sending students home in a hurry long before the school year was finished, managers of student housing complexes have been grappling with who is responsible for rent for the remaining period. In the short term, the disruption is likely to leave a dent on the sector, which was already struggling with overdevelopment in some markets, slower leasing and rising loan defaults. The big question is whether students will be back on campus this fall or whether we’re looking at one more semester of virtual learning before they return.

Prior to the pandemic, the self-storage sector appeared relatively well positioned. There was strong demand from end users, though because of overdevelopment, especially in primary markets, rent growth was stalling. As matters stand now, self-storage REITs might benefit from their low leverage levels and limited sensitivity of self-storage demand in times of economic crisis. The pandemic will also limit competition in the sector, as construction projects stall.

The question is whether millions of newly unemployed and furloughed people will use the government aid they receive to pay their self-storage dues when they are struggling to pay the rent on their apartments. The investing content service Seeking Alpha argues that self-storage rents are “collateralized by the renters’ possessions” and tend to be very “sticky” during downturns.

But the world has not seen a downturn like this for at least a century and Inside Self-Storage expects that the industry is bound to see missed rents and renegotiated agreements. “The government’s disaster-relief checks aren’t likely to be used by consumers for self-storage rent. Bigger priorities like food, transportation and utilities are likely to take precedence,” it notes.

The single-family sector is still very much a wild card, since already more than eight percent of U.S homeowners, about 4.7 million households, have signed up for mortgage relief programs. This is up more than 2,000 percent since early March. When the pandemic hit, millions of listings where pulled from the real estate multiple listing services due to the uncertainty. This has created a short-term lack of supply issue and has resulted in increased single-family pricing in many markets. Pay attention to the migration patterns of people in the next couple years which will have a significant impact on short-term and long-term prices in various markets. The big question is what will happen when the economy stabilizes and the real story is revealed regarding employment.

With over 30 percent of Americans missing their housing payments in June 2020, I would expect a significant number of foreclosures over the next 12-18 months when the mortgage relief programs end. This factor alone will increase the supply of for-sale housing which will result in a drop in future pricing.

About The Author

Ken McElroy

Ken McElroy is the co-partner of MC Companies in Scottsdale, Ariz. He is the author of the best-selling books, The ABC's of Real Estate Investing, The Advanced Guide to Real Estate Investing, and The ABC's of Property Management. McElroy is also a contributor for The Real Book of Real Estate by Robert Kioysaki, and The Midas Touch by Donald Trump and Robert Kiyosaki. McElroy's fourth book, The Sleeping Giant, is dedicated to the new class of entrepreneurs who are emerging in today's economy. For editorial consideration please contact [email protected](dot)com.

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