The 880 page CARES Act was crafted during four contentious days of emergency Senate meetings. The financial world is still unpacking all of the aid packages aimed to help the country find its footing again after the economic slowdown caused by the COVID-19 response. The effects of the bill will be felt for years to come and will likely determine which sectors get the brunt of the losses from the shutdown needed to slow the spread of a deadly virus.
The property industry is likely to feel the brunt of this shutdown. Hotels were to first to feel the hurt as the world stopped traveling as the pandemic started to spread around the world. Then cities, states and countries started encouraging people to stay home as drastic measures were sought to slow the transmission. This has left many residential renters unable to pay their rents due to job losses and an extended (and unknown) period without income. Retail and office properties are also seeing renters ask for rent release, some evoking a force majeure clause in their lease contract and others likely going out of business altogether.
Now, help is on the horizon. The CARES act has been passed and funds should be dispersed in a few weeks. But will these be enough to help the property industry endure the shock it is about to suffer? The 3 trillion dollar plan that includes a one-time $1,200 payment and increases unemployment insurance will likely not be enough for every renter to afford rent. The slowdown will likely last long enough to push many businesses into bankruptcy, especially those with large lease expenses.
I asked Tim Savage, Clinical Assistant Professor of Real Estate at NYU Schack Institute of Real Estate what he thought would happen to commercial property values if a large number of renters were not able to pay rent for a short period. “If we think about real estate as an asset class its value isn’t entirely by short term rent rolls,” he said. “In the short run, we will see perceived values fall but this is a natural disaster not a financial crisis. This hasn’t affected the capital, it has just affected the human capital. The volatility and pause in transactions that we are seeing is just a reflection of uncertainty. In the absence of data all we have is uncertainty.”
The perceived value of real estate can often be best understood by looking at public market REITS and they have taken quite a beating. But, some have fared better than others. Brookfield Property REIT, a giant fund with a large mall and retail portfolio, is down around 50% of its market capitalization from the end of January. Bluerock Residential Growth REIT, one of the largest multifamily portfolios, is down about the same. Boston Properties, which owns mostly Class A office space in top tier cities, is only down around 30% from its highs. The industrial real estate giant Prologis is only down around 20%, the thought obviously being that the quarantine will strengthen the value of supply chain companies and thus industrial warehouses will not suffer the same kinds of losses as other sectors.
As part of the stimulus, the federal government has also issued a moratorium on evictions and granted mortgage forbearance to all federally backed loans (like those owned by Frannie and Freddy). This is similar to what the State of California did in 2008 and 2009 to help keep people in their homes during the housing crisis. Stuart Gabriel, Director of the UCLA Ziman Center for Real Estate, studied that policy during the recovery after the last crash. “We found that this was a very appropriate policy and it worked very well,” he said. “It mitigated the large-scale foreclosure that would overtake neighborhoods. It would result in severe downward movement in property value that would require further wright down.”
Keeping people in their homes and keeping those properties from having to be sold as distressed assets by the banks that lent on them are both necessary measures in the face of this impending slowdown. But the plan is far from perfect and some properties are not going to be provided the same level of relief as others. Many properties have private debt, although the thought is that those debtors will want to find agreeable terms as well in rather than having to put a foreclosed building up for sale in this catatonic market. Plus, these loans are packaged and sold as Commercial Mortgage Backed Securities (CMBS). Much like REITs, this makes them susceptible to market perceptions.
As governments ordered their constituents to stay inside and commerce in most parts of the world was reduced to a trickle, lending on new debt all but dried up. This put those with loans coming due in a tricky spot. Even with all-time low base rates, lenders are charging a premium to lend in this uncertain environment, if they are lending at all. One of the most important things that this new bill does is agree to purchase an “unlimited” amount of bond and security debt in order to stabilize the debt market. “The fed has stepped in as the lender of last resort,” Professor Savage explained, “this has calmed the debt market some, at least for now.” The debt relief has already helped the CMBS market a bit as the spread, the difference between the base rate and the rate lenders are actually offering, has dropped a bit over the weekend since the bill was signed.
Both professors had their concerns for the future. Professor Savage said, “The revenue shortfalls, which hit the equity tranche first, could be enough that investors will face a margin call on loans and have to inject more cash to get back to their LTVs.” This could lead some portfolios to sell off assets to pay their bills, leading to a firesale that would establish new price points for comparison, effectively pulling all property values down with it. Professor Gabriel is seeing signs that some are predicting that precisely this will happen, “We already see in the CMBS market that there is evidence that people are shorting it like they were with the RMBS market in 2007.”
The CARES act is a historically large relief package in the middle of a historically important time for the world. One of the silver linings of this pandemic is that all of us seem to be united against a common enemy. We know that we will all have to share the pain in order to beat this thing. But, the property industry might share a disproportionate amount of that pain, even with moratoriums and forbearance in place for what seems to be the foreseeable future.