In a recent Trepp research report the consulting firm took a detailed look into how appraisals are determined. The shutdown of the economy has suddenly set all time records for unemployment, income and cash flow for businesses. The report looks at what the recent shutdown and soon to be closures of many businesses, including layoffs at large companies, will have on commercial real estate valuations.
“Market value is representative of a transaction where no exceptional factors influence the parties (buyers, sellers, lenders). The concepts of market value as previously defined do not contemplate how short-term occupancy and revenue declines caused by external factors, beyond the control of the owner/property manager, should be treated by the appraiser. Until the pandemic surfaced, many CRE property sectors were pacing above the previous year’s performance metrics. Employment and other market-level indicators such as interest rates and the availability of financing were favorable and readily available across all major metros in the U.S.”
According to Trepp, “the types of CRE properties whose values are most likely to be negatively impacted are hospitality, retail and apartments. Hospitality and retail properties have already had to face the immediate reality of lost revenue due to the pandemic. Hotel operators in hard hit areas have seen occupancies plunge from their stabilized 70% range into the high single digits, or in some cases, have been forced to close their doors all together until the crisis subsides.” Additionally, the report shows the percentage of hospitality properties that did not make their April mortgage payment stands at approximately 20%. Financed retail properties that did not make their April payment increased to 10%.
Conventional apartments are out performing hospitality and retail for now due to the government imposed forbearance programs providing a lifeline. However, with rising unemployment there will be increasing rent collection issues leading to increased vacancies and lower overall valuations.
According to Trepp, “In April and May, 354 apartment and office properties started missing payments on $7.1 billion in mortgages which only includes loans packaged into mortgage bonds. That is just the start as more tenants miss rent payments in the coming months, leading to an increase in mortgage defaults throughout 2020 and into 2021. There will be a large number of distressed commercial real estate assets.
Real Capital Analytics tracked over $462 billion during the Great Recession, that was ~13% of outstanding commercial mortgages at the time. They determined that valuations fell 35% erasing the equity in many properties. Lenders also saw significant losses and were able to recoup only 67% of defaulted mortgage value.