With COVID-19 travel restrictions, social distancing measures and mask mandates consistently in flux, as well as the Delta variant of the virus gaining serious ground, commercial real estate’s recovery remains somewhat uncertain. Some fundamentals appear to be improving, helped by vaccinations, measured reopenings, some return to travel and outdoor entertainment venues that have been reinstated to partial or full audiences. The return to the workplace, even if mainly happening via part-time hybrid work models, is also a mild improvement for that particular asset class.
Despite the partial turnaround, however, there exists uncertainty alongside current and imminent signs of distress. In the finance arena, lenders are feeling a bit more comfortable financing the asset classes most impacted by COVID-19. However, their confidence is far from absolute as these assets will also be more susceptible to Delta variant impacts. Debt providers demonstrate much more interest in office and retail deals today as they now have an improved understanding of how these assets will perform. Deals they wouldn’t consider a year ago, they now find more appealing. Underwriting defensively is also helping them navigate and weather the challenges of today.
Hotel transactions, however, tell a different story. The pandemic hit this asset class harder than any other and the sector remains far from recovery. Hospitality distress was
recently measured by Trepp, which analyzed the impacts of the pandemic on hotel loans looking at year-over-year numbers for 2019 and 2020. Trepp’s research found that, in 2020, average net operating income and occupancy on lodging loans fell by 70.5% and 35.6% respectively, from the prior year. Despite that, debt has in some instances become available for certain hospitality deals. However, lenders are shying away from fixed-rate loans. Borrowers show no inclination of wanting to get locked into 10-year loans with lower proceeds. Hence, floating-rate, shorter duration loans are commonplace, and this may remain the case for some time.
The conduit side of the business is picking up somewhat. Demand for bonds remains strong and lenders are demonstrating willingness to transact. Spreads have tightened and COVID-19 reserves have relaxed. However, volume is still a concern. With these lenders competing with Freddie Mac and Fannie Mae programs, volumes could increase due to caps put in place by the agencies. These could result in borrowers turning to conduits for debt solutions, potentially creating a volume spike.
What’s happening with the agencies is also noteworthy. Central to much of this is the recent dismissal of FHFA Director Mark Calabria by President Biden following the June 23 U.S. Supreme Court decision in Collins v. Yellen. The replacement of Calabria indicates a marked shift away from the former administration’s prioritization on releasing Freddie Mac
and Fannie Mae from conservatorship. Biden has signaled he is not in a rush to do so. The change in leadership likely means the FHFA will “continue down the path of promoting more and more affordable housing mandates and increased green mandates” (as expressed in a Trepp podcast) in alignment with the current administration’s values. The current posture of the agencies also reflects a push to grow the nation’s supply of affordable housing, which will likely equate to a future increase in apartment lending activity.
Multifamily, however is also still affected by eviction moratoriums. In June, the FHFA extended the ongoing freeze on evictions for properties backed by Freddie Mac and Fannie Mae through the end of September. Designed to provide assistance to renters, the third FHFA extension is undoubtedly hiding some non-performing assets. Once the moratorium clears, the industry is likely to uncover additional distress in this sector, which will unfortunately need to be worked out.
Finally, another issue impacting commercial real estate and finance is the new administration’s desire to roll back 2017 tax changes led by the previous administration that positively impacted 1031 exchanges and how capital gains were treated on real estate. If these current tax incentives are eliminated, investors may become less inclined to take the risks associated with real estate, slowing investment in the sector at large. While these rollbacks are not likely to pass, this effort is worth watching.
