CRE at a Crossroads

The coronavirus pandemic has put commercial real estate “at a crossroads,” said Yardi Matrix, Santa Barbara, Calif.

“COVID-19 has put enormous stress on commercial real estate,” said Yardi Director of Research Paul Fiorilla in the firm’s report, Stressed Out: Are Commercial Properties Close to Default?. “Many office buildings are nearly empty as people work from home, while retail and hospitality are operating at a fraction of pre-pandemic levels. National multifamily data is down only slightly from first-quarter peaks, but urban apartments are losing tenants and government support that has propped up the sector is in doubt.”

Government support and policies mandating forbearance have helped keep delinquencies down so far, the report said. “Whatever the short-term pain, however, it pales in importance against long-term property performance,” said Fiorilla. “Will tenants be able to pay apartment rents if jobs don’t come back and government aid doesn’t remain at current levels? Will corporations renew leases on large blocks of space if workers continue to be remote? Future cash flow depends on the answers to these questions. Loss of income could lead to increases in mortgage defaults.”

Fiorilla called property owners’ misfortune a lure for distressed investors, who were less active during the profitable 2010s cycle, as default rates of loans originated after the financial crisis were miniscule. “Now vulture funds are sharpening pencils in anticipation of increased delinquencies, although so far distress has been concentrated in hospitality and retail,” he said.

Yardi Matrix examined office and multifamily loan maturities and property performance in the 50 largest U.S. markets and found relatively few properties in those sectors in immediate danger. Potential distress appears to be concentrated in South and Southeast metros such as Dallas, Austin, Atlanta, Houston and Miami where significant new development and surging COVID-19 cases weigh on property fundamentals, the report said.

“Fundamentals have weakened only slightly in recent months, in large part because of trillions of dollars of government support for tenants and businesses and the implementation of forbearance policies by government and loan servicers,” Fiorilla said. “Properties that started the pandemic in good shape with strong demand drivers are likely to survive, but those with less solid fundamentals may have problems with distress if the recession is longer or deeper than expected.”

Fiorilla said the immediate outlook is not dire, “but the pandemic could create a long-term problem for the multifamily and office sectors if the economy doesn’t recover quickly or if there are profound changes to office use and residential trends,” he said. “The amount of distress–and opportunity for high-yield investors–depends on the course of the virus and whether policymakers implement effective actions.”