2020 was the year when time both accelerated and stood still. From a purely human perspective, crises and trauma are known to manipulate how we perceive the passage of time. For what unfolded in the real estate capital markets this year, one could say there is a similar effect. Moving from a mostly stable market at the beginning of the year to a blindsiding economic crash in March and each twisting and turning month thereafter, each sector of this industry was impacted in a different way. Some sectors, like single-family (both for rent and for sale) and industrial, appear to be emerging as winners, benefiting from trends that are accelerating their performance. Other sectors, such as retail and hospitality, are seemingly frozen in time, with their fates much more in question.
From the Beginning
It seems like an eternity ago, but the U.S. rang in 2020 with an economy that was incredibly stable. Nine years into a record expansion, unemployment was at an all-time low, and interest rates had retreated substantially from their cyclical high mark in 2018. All was well in the real estate capital markets, for the most part.
Fundamentals were solid across asset classes (aside from malls and some poorly-positioned brick-and-mortar retailers, which had been struggling for years). Even in cases where assets were struggling, a tidal wave of liquidity in the investor-driven debt fund space was readily available to provide a refinance lifeline to struggling assets.
Then March came, and everything crashed. Many real estate lenders pulled out of the market altogether, and the ones that did not widened their spreads to all-time highs in order to account for market uncertainty. There was a sea of red in the mortgage real estate investment trust (REIT) and debt fund spaces where several well-known players who were reliant on back leverage seized up and looked like they may not survive.
Just when things looked bleakest, the federal government began cutting checks to every American citizen. At the same time, the Federal Reserve began buying — or at least threatening to buy — any debt instrument that was not nailed down. Finally, the market began to stabilize to the point where it was functioning again.
Below is a summary of what transpired and where we stand with each asset class.
Hospitality: Deep Freeze
The capital market for hospitality assets was perhaps the most acutely impacted by the crisis since operation of underlying businesses went from healthy to a complete stop overnight. The market was not overbuilt or overheated on a nationwide basis, but the travel restrictions brought on by the pandemic brought hospitality to a screeching halt.
To say 2020 was a difficult year to obtain financing for a hospitality asset would be an understatement. A substantial level of distressed sale activity has not yet emerged, as lenders are mostly offering forbearance in the hopes that properties will bounce back once an effective vaccine or treatment is discovered. New debt is difficult to find and, to the extent that it is available, it is relatively expensive. Equity investors are mostly on the sidelines waiting for signs of distress before putting their capital to work. Little, if any, capital for new development is available as investors focus on potential dislocation in existing assets.
Retail: Deep Freeze
The struggles of the retail market in recent years are well-known. The space was already struggling from a combination of consumer shift towards e-commerce and over-leveraged private equity buyouts of individual retailers. The pandemic substantially amplified these issues while also hitting the darlings of the experiential retail sector (restaurants and gyms) especially hard.
Retail finds itself in the same position as hospitality. Debt is relatively difficult to come by unless it is very conservative, and equity is largely on the sidelines, waiting for distressed buying opportunities.
However, there are bright spots. Banks, life companies and commercial mortgage-backed securities (CMBS) originators are all still lending on triple-net (NNN) lease properties with “essential” tenants that have continued operating during the pandemic as well as strongly-performing grocery-anchored centers.
Residential: Accelerating in Some Places, Frozen in Others
When the pandemic hit, the predictions for both for-rent and for-sale housing were dismal. However, we have seen a very uneven impact in this sector. Expensive urban markets like New York and San Francisco are struggling, while suburban markets are flourishing. Single-family residential is benefiting from the enhanced consumption of housing, as a home now serves as an office, gym and school. Homebuyers have proven willing to make discretionary upgrades, and historically low interest rates are helping to drive buyer demand.
Financing for multifamily has stayed readily available as government-sponsored enterprises (GSE) kept the spigots running through the worst of the March panic.
Single family for-rent was already somewhat of a darling, and the pandemic only accelerated this trend as lockdown and work-from-home made people crave more space. But not everyone has the finances (or the desire) to become a homeowner, causing investors to allocate even more capital to the space.
The industrial sector had its foot on the gas before the pandemic, driven by increased consumer reliance on e-commerce. The shelter-in- place orders, followed by extended work-from-home policies and distance learning, accelerated the momentum to warp speed. Every 1.5% consumption shift from brick-and-mortar to online retail results in around 46 million square feet of net industrial demand. This, coupled with inventory growth to hedge against future supply chain disruptions, is a perfect recipe for rent growth and appreciation in a market that was already extremely tight.
It should come as no surprise that both debt and equity are still readily available for well-positioned industrial/warehouse real estate throughout the U.S. as banks, life insurance companies, private equity and private investors covet the space.
Office: On Ice
Perhaps the most interesting of all sectors is offi ce. So much about the trajectory of this sector is still surrounded by question marks. The big question is whether the past nine months or so of work-from-home will lead to a cultural shift in norms for white-collar workers. As of this writing, it appears to already be happening in the tech community, where employers are mandating work-from-home policies well into 2021. The impact of this on tech-dominated markets, such as San Francisco, is chilling.
While defaults have been few so far, sublease space is piling up in many big markets, leading to concern among lenders and investors. As one can imagine, this level of uncertainty is frightening, leading to a substantial decline in investment activity in the space. Debt is still available but generally at very conservative advance rates. Equity mostly seems to be looking for distress stories. Financing for new developments will be difficult to come by until the direction of the market is better understood.
Perhaps the broadest takeaway from 2020 is the relative stability of the real estate capital markets, despite the economic chaos. In the Great Recession, capital markets seized up across all product types to the point where properties with no performance issues became virtually unfinanceable because liquidity completely dried up. That most definitely has not been the case this year.
Yes, CMBS and investor-driven lenders have pulled back on their volumes, but, after the March panic, liquidity has returned to the debt market in a way that has (so far, at least) prevented a crash. Spreads have widened, and leverage has fallen, but the market is still functioning.
When it comes to new acquisitions, the spread between buyer and seller expectations is substantial, leading to a dramatic decline in investment sale volume as the preference in investment committee is to have a “distressed buy” label on any 2020 vintage acquisitions. At some point in the not-too-distant future, price discovery will occur, and this gap will resolve one way or the other. However, that resolution will be 2021’s story.
The story of 2020 from a capital markets standpoint is a year that started out stable, was rocked by a pandemic and has seen disparate impacts among product types — albeit with an underlying level of stability that has kept prices from crashing.
Adam Deermount is co-founder and managing director at RanchHarbor, an integrated commercial and multifamily real estate investment, asset management and capital advisory fi rm based in Newport Beach, California. With over 16 years of experience as a lender, investor and advisor within the commercial real estate and homebuilding industries, Deermount is currently developing RanchHarbor’s investment and receivership platforms.