Sobel & Co. LLC,  accounting firm livingston,  accounting firm livingston

Sobel and Co Secure File Sharing  Sobel and Co Site Search

Sobel and Co Client Portal Access  Pay My Bill at SobelCo

973-994-9494 Sobel and Co LinkedIn PageSobel and Co Facebook PageSobel and Co BlogSobel and Co Facebook Page

COVID-19 and its Effects on Commercial Real Estate

Print Friendly, PDF & Email

By now we all know that COVID-19 is an infectious disease caused by a newly discovered coronavirus.  It came to our attention in December 2019 when  clinicians in Wuhan, China notified public health authorities of a cluster of asymptomatic pneumonia cases, some with ties to a seafood market in the city.  Within weeks a novel coronavirus was identified and sequenced, with the sequence published online for use by other scientists and public health authorities globally.

The incredible impact that would be felt around the world could not have possibly been imagined in those first early days of awareness.

But unfortunately, it did not take long for the virus to reach the United States.  On January 21, 2020, the Washington State Department of Health (DOH) confirmed a case of coronavirus.  By the end of January, the Chinese government had taken the extraordinary step of quarantining the city of Wuhan, as well as neighboring districts and cities.

At the same time, the United States government imposed a two-week federal quarantine on 195 people who were evacuated from Wuhan, China and transported to a California military base.

By the beginning of February 2020, the coronavirus outbreak had killed more than 560 people worldwide, the majority of who were in China and infected more than 28,000 people in over 25 countries.  Close to 60 million people remained under lockdown in China, with three cities reporting over a thousand confirmed cases.  Despite all this, we believe no one could have imagined the World Health Organization (WHO) declaring a global pandemic on March 11, 2020. 

Although the significance and magnitude of this pandemic is still not fully known or understood, it does call to mind previous somewhat similar experiences with Middle East respiratory syndrome (MERS) and severe acute respiratory syndrome (SARS), two coronaviruses responsible for significant morbidity and mortality.

As of the writing of this article in July 2020, the statistics paint an extraordinary picture of our world brought to its knees experiencing more than three million cases of COVID-19 in the U.S., 11.6 million internationally and more than 539,000 deaths worldwide.  Along with the healthcare crisis, we are experiencing a global economic disaster with many companies and businesses ceased operations in compliance with national and local government restrictions. In fact, non-essential businesses have been closed for several months.  While stay-at-home restrictions are beginning to be lifted across the U.S., recent spikes in 35 states may cause a reversal of those guidelines.  As a  result of the closures, many businesses have already gone bankrupt, and there will likely be many more to follow.  The U.S. unemployment rate in June 2020 was 11.1%, up from 3.7% in June 2019. 

As the pandemic persists, new trends are emerging in the commercial real estate sector.

The disruption of business as usual on premises has led to the inability of numerous commercial tenants to pay rent, and many national chains have flat out refused to pay rent while their businesses are closed. This has severely hampered the cash flow of property owners, and put lease arrangements in limbo as uncertainty that these tenants will be able to survive grows the longer the pandemic lasts.

One of the most obvious changes is the role technology is playing regarding the enabling of virtual versus in-person interactions. Telehealth is a new tool that has gained in popularity in lieu of  personal visits with healthcare physicians. At the same time, Zoom, Microsoft Teams, WebEx and others are creating dynamic platforms for presenting information, participating in networking events, or attending nonprofit fundraisers. All of the marketing, branding and business development initiatives are being conducted remotely – putting a new spin on where business is conducted.

Uncertainty in commercial real estate continues to grow as business owners and senior leaders are discovering that staff working from home can be just as productive, if not more productive, than when working in their offices. This observation quickly led some to consider whether it is even necessary to continue supporting the amount of office space and related physical infrastructure they currently have.

These are just a few of the changes that have occurred in response to the shelter-in-place mandates which have already had a profound, possibly lasting, effect on many companies.

As the situation continues to develop, major national commercial real estate brokerage firms are feeling the squeeze.  When Marcus & Millichap’s CEO, Hessam Nadji announced layoffs of about 20% of its workforce as the coronavirus upends the real estate industry, he noted, “while this disruption is currently expected to be temporary, there is considerable uncertainty around the scope and duration.  The extent of the impact of COVID-19 on our operational and financial performance will depend on the duration of business disruption, which is uncertain and cannot be predicted.”

The cuts are the latest cost-saving measures in the brokerage world, where top executives such as Cushman & Wakefield’s CEO Brett White and CBRE’s CEO Bob Sulentic announced earlier in the pandemic that they would be taking reduced salaries while at the same time Avison Young in April announced forced pay cuts for some employees.

Reading between the lines, it is concerning that the market is indicating that the coronavirus may, and is perhaps likely to, catalyze a global recession. It has been more than 12 years since the last global recession and currently debt growth and valuations are at an extreme high. This adds a critical downside risk to the market.

Our informal anecdotal information demonstrates that in a very short period of time the market is showing signs of worry and fear.  As a matter of fact, many new deals are being put on hold because there is legitimate concern that the ripple effect to the commercial real estate market will result in a serious decline in real estate market conditions.  Finally, investors might also consider the implications of force majeure and the impossibility of performance due to government regulation on rent obligations and negotiations.

The overall message is that any astute investor should consider the potential impact of the virus on business and rents in making a decision to invest in commercial real estate.

Shrewd investors know that comparables generally reflect investment decisions and agreements made many months before the valuation date. True comparables should be based upon sales that are first negotiated at around the valuation date which are actually reflected in transactions that only occur many months later. 

Even if there is a vaccine for COVID-19 within the next year, the short-term impact on commercial real estate may be felt for years to come.   Many companies and their employees are learning that working from home can be a viable option for many, resulting in significant cost savings.  This will reduce overall demand for office space, as well as businesses, such as restaurants and fitness centers, who survive on office employees.

To quote Peter Rothemund, Managing Director at Green Street Advisors, publisher of the Green Street Commercial Property Price Index, “Price discovery is going to take some time, but something like 10% lower still feels where things will shake out for the average property. However, the range of outcomes is wide, so it’s dangerous to talk averages. Prices of properties with long-term leases to high quality credits, and/or those where underlying demand is largely unaffected, may see little change. Those where the income stream is more at risk will see larger declines, and where it’s most in jeopardy expect haircuts of 20%, or more.”

As the consequences of COVID-19 evolve over the coming months, we will be observing and tracking major behavioral changes from social distancing to use of technology to dealing with human resource concerns and office space requirements.  Along the way we will also share information with you regarding all of the changes taking place in the commercial real estate market.

Jordan Yuter, Sobel EAC Valuations

Jordan Yuter is licensed throughout the Mid-Atlantic states as a general real estate appraiser, and is a Member of the Appraisal Institute (MAI).  For more than 15 years, Jordan has provided exceptional real estate appraisals to Sobel EAC Valuations and its predecessor companies, EAC Valuations and Enterprise Appraisal Company.