USA Regional Real Estate 2020 features 17 states. The guide provides expert legal commentary on the key issues for businesses involved in the real estate sector, including finance, planning, commercial leases, construction, tax and the impact of COVID-19.
Last Updated: May 14, 2020
The United States continued to see a strong economy and an active commercial real estate market during 2019, the tenth successive year of a prolonged economic expansion. The real estate industry had continued strong sales performance with an increased desire to invest both domestically and across borders. A growing trend was a strong surge in demand for alternative real estate asset classes.
The demand was driven by shifting demographic trends (medical offices, student housing, senior care facilities), changes in consumer demands (distribution centers, self-storage, cold storage), as well as the evolving corporate landscape (data centers, life sciences and technology parks, co-working offices). These developments re-affirm the expectation that many of these alternative real estate sectors will continue to lead activity over the coming years.
In 2019, industrial and logistics properties led the way in large transactions in the US real estate investment sales market. There was an uptick in demand for industrial and logistics properties, due largely to demand from e-commerce tenants and from major institutions and investors in this asset sector. Meanwhile, with the traditional retail industry continuing its secular decline, we saw more online retailers open brick-and-mortar stores.
Owners of retail and office properties have started to rethink the ways in which they attract consumers. Many retail and office spaces are beginning to provide access to a wide variety of amenities and "full-service" hospitality-like facilities, and are revamping the services that they already have to offer. At the start of 2019, the office sector was considered a favorable asset class, however near the end of 2019, the office sector lost some interest in some US markets due to a shift in demand to flexible and co-working office space.
The hospitality industry continued to see slow but steady growth throughout 2019, owners continued to reinvent existing spaces and amenities to meet their guests demand. This has resulted in a robust and dynamic real estate market over the past year.
Despite the continued strength in the real estate market in 2019, uncertainty looms around the economy as we enter 2020. In 2019 and into 2020, there have been multiple geo-political and economic events that increase the risk of pushing the global economy into its first severe recession in 12 years; including domestic and international political conditions and the effects of the COVID-19 pandemic.
After a banner year in 2019, which saw total US transactions approach USD200 billion (a 24% increase over 2018), and with vacancy rates hovering near historic lows (sub 5%) the industrial/logistics sector was poised for another banner year in 2020 before the COVID-19 pandemic surfaced. Despite quarantine measures adopted across the country in March, industry watchers report Q1 of 2020 saw year-over-year net rents increase by 4.8%, and 34 million square feet of space was absorbed on a net basis, pushing vacancies down to 4.5%. While April saw very few tenants request rent relief, a significant increase in these requests is anticipated for May and in the future due to the continued COVID-19 quarantine.
Transactions continue to occur, at least those not requiring debt (which has been largely unavailable while the capital markets figure out how to price risk). The transactions that are occurring have been fueled by a continued strong demand for “last mile” distribution centers (as e-commerce continues to flourish, further aided by the government response to the pandemic), as well as an uptick in demand for cold storage facilities. Also providing a counter-weight to the effects of the quarantine is a near complete halt to speculative development not already in production.
Although only time will tell what the full impact of the pandemic will be on the sector for 2020, the lack of new inventory coupled with historically low vacancy rates will provide some tailwinds to help minimize rent erosion in this sector in the near term.
At the start of 2019, retailers hoped to see a possible retail sector flattening or even an upward tick of modest growth. This outlook changed as 2019 ended and the COVID-19 pandemic set in.
With the COVID-19 outbreak and the overall slowdown of commercial real estate, the retail sector was hit hard by the uncertainty and policies surrounding the outbreak, including stay-at-home orders and social distancing, that has put unprecedented pressure on retailers. Although the additional capital being provided in accordance with the CARES Act and other government programs may ease some of the pressure on retailers and employees, there is a growing wave of many major retailers withholding rent during the shutdown. The retail CMBS delinquency rate in April 2020 rose to 3.89%, higher than any other sector since the outbreak.
Trepp is forecasting an increase of up to 16% in the default rate on retail loans.
The office sector experienced little occupancy growth in Q1, with leasing activity dropping by more than 20% according to a JLL study. Legg Mason forecasted “[o]ffice property income [to] be minimally impacted [by COVID-19] in the near term” due to the length of most office leases and continued rental obligations, but that view is not shared by all. Many tenants have started to seek rent relief from landlords, lacking the ability to pay their rent. Further, new leasing activity for future occupancy will likely be limited by a shift to greater working remotely and the inability to tour physical properties due to state and local shutdown orders.
The foregoing may put pressure on the office loan sector, with Trepp forecasting that default rates on office building loans could increase to 4.3% in 2020. Although this default rate would be significantly lower than the increases expected in other sectors, retail and lodging in particular, a 4.3% default rate in the office sector could put significant pressure on the commercial mortgage-backed securities (CMBS) market, due to its large share of outstanding CMBS loans.
The COVID-19 crisis had an immediate and severe impact on the hospitality industry. CBRE reports that average occupancy rates were trending at or slightly below that of last year prior to the COVID-19 crisis. March and April saw large drops in the average occupancy rates which now appear to be bottoming out and stabilizing in the low 20s.
Hotel owners may face severe capital and liquidity challenges as occupancy rates remain low, group and venue bookings lag and global travel demand remains soft. American Hospitality and Lodging Association (AHLA) is reporting hotels are “on pace to lose more than USD500 million in room revenue per day” which means a loss of “USD3.5 billion every week”. AHLA also expects such losses to “further escalate as the situation worsens.” Although many US states are lifting or revising their stay-at-home orders in May, it remains to be seen if or when pent up demand for travel will result in an increase in occupancy rates. Revenue per available room may continue to be the challenge for hotels as they face low occupancy rates and increased operating costs associated with heightened safety and health precautions, such as continued deep and high-touch frequency cleaning costs and increased technology requirements to minimize social interaction.
Reinventing existing spaces within hotels, and re-thinking available or curtailed amenities to their guests will be an immediate focus of hoteliers and managers as they re-open, and throughout 2020 and 2021. Traditional food and beverage offerings will also be revamped and/or eliminated in some circumstances resulting in less revenue to the hotels. As hotels re-open and trend upward in occupancy, some furloughed and laid-off employees will be re-hired, however the low occupancy rates and RevPAR may require hotels re-think labor costs which may mean sustained job losses for the industry through 2020 into 2021.
Expect to see consolidation in the industry as smaller owners and operators with less liquidity are unable to sustain operations through the crisis. Larger, more cash rich companies will capitalize on the volatility and look to grow and enhance their portfolio opportunistically. HVS expects that with the “lending freeze, the transactions that are likely to occur will reflect capitalization and discount rates above historic averages, given the high level of uncertainty, as well as low-leverage or all cash transactions.” Continued widespread economic pressure in the overall economy may result in discounts to 2019 values, loan workouts and foreclosures in the hospitality sector.
As 2019 ended and leading into Q1 of 2020, the continued spread of COVID-19 caused US economic growth to come to an abrupt, grinding halt. There were broad and immediate impacts across the entire real estate market. Forecasts for overall impact of COVID-19 are mixed and long-term effects on real estate are uncertain and constantly changing. Retail and hospitality have been hit the hardest at the onset of the pandemic, and the office loan sector may also face challenges.
Conversely, the industrial and logistics sector has held strong due, in part, to continued growth in e-commerce, as well as an uptick in demand for distribution and cold storage facilities. The industrial and logistics sector may continue to feed off e-commerce’s absorption of the traditional retail industry and will remain a strong contender for project financing, equity investment and government dollars.