We have hit uncharted territory; the U.S. has never experienced a near complete shutdown of the entire economy so abruptly. The economic implications from the recent government imposed sanctions are far reaching for Commercial Real Estate. Not one aspect of CRE will be unaffected. The retail and hospitality sectors were some of the operations hit earliest with restaurants closed, movie theaters closed, malls and retail stores closed and hotels empty. The impact will be devastating to property owners as they experience serious cash flow stress from tenants unable to pay rent. This will lead to debt service issues for borrowers and ultimately loan defaults.
There will be longer term structural changes to all commercial space requirements. The retail and hospitality sectors are not alone in the decline in demand for commercial space. The requirements being laid out by Federal and State governments before business can reopen will impose unprecedented changes. This will lead to additional costs and many businesses will downsize or decide to not open due to the increased costs and declining revenue. Many companies are now making plans to operate with fewer people, in smaller space and becoming more efficient in their operations.
CRE prices more than doubled over the past decade since the GFC. Prices were at elevated levels prior to the virus and the economy was beginning to contract in 2019. As a result of the Fed maintaining abnormally low interest rates over the past two decades there has been a misallocation of resources and inaccurate valuation of assets. Because of COVID-19 things have suddenly changed and the financial mistakes of the past several years are being exposed. The demand and need for all types of CRE is being reevaluated by all users. The drop in demand and decline in Net Operating Income will mean a significant re-pricing of CRE going forward, assumptions on income growth, vacancy, lease up time and future sale prices are changing.