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U.S. Commercial Real Estate Cross-Sector Overview Amid Covid-19

Amid the uncertainty brought on by Covid-19, participants in commercial property markets are in an adjustment period. Green Street has been especially active, with recent meaningful updates for commercial real estate fundamentals expectations. In addition, our estimate of private market values feeding into REIT NAV estimates have been updated, and often reduced, to recognize the impact of the pandemic in many property sectors. Our analysts teamed up to discuss the changes they are seeing in each property sector, their most recent forecasts and insights on how to navigate the property market in today’s environment. This article summarizes our latest expert analysis for five commercial property sectors.

The social distance-induced recession is unlike any previous downturns and the effects have rippled through property sectors in ways that upend the traditional thinking on how sectors fare in a recession. Property sectors have unique economic sensitivity levels – as measured by swings in fundamentals – to a recessionary environment. In an ordinary recession, the negative effects tend to be most pronounced in lodging, office, retail, and industrial properties. By contrast, residential sectors – from student housing, to multifamily and senior homes – are shelters in the storm. Medical office buildings and self-storage also generally prove recession resistant. But in the coronavirus era, norms do not apply. Sectors like student housing, senior housing and skilled nursing have seen uncharacteristic, disproportionate negative effects, while most recession-sensitive property types have experienced even larger than usual declines, creating a challenging climate for property investors.

These trends have been largely reflected in the public market through REIT pricing, which dropped materially since the crisis began. Although Green Street has cut fundamental estimates and property values in most sectors, there remains good value in the public market at current prices, especially in the residential sector.

Single-Family Rentals

The middle-income renter that typically occupies single-family rental properties is currently disproportionally affected by the Covid-19 crisis. An avalanche of job losses could increase bad renter debt and delay rent collection. However, the situation seems rosy on the ground. Limited single-family construction, tightening mortgage lending and a sticky tenant base should insulate top-line growth. Thus, pricing power and occupancy is fairing quite well and Green Street is expecting meaningfully better operating results as compared to apartments. Both single-family rental and apartments, however, should outperform the average real estate sector.

Single-Family Rental Full Year NOI Forecasts
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Office

The geography of Covid-19 has not responded to clear patterns and its public health impact on various markets has been impossible to predict. Yet, so far, there are markets that are more impacted by the disease than others and markets that should suffer longer-lasting pain.  Coastal gateway markets, for instance, have been harder hit than Sun Belt markets and other non-gateway markets. From an office real estate fundamentals perspective, the impact of the disease, with employers either following lockdown orders or willingly keeping employees out of the office, has raised more questions about near-term rent prospects and rent-paying ability in New York metro than elsewhere.

But the big question in office is to quantify the long-term prospects for the business as the work-from-home experience has proven the near-term viability of a concept that few would have wanted to try of their own volition just six months ago.  There is a growing chorus of companies now suggesting employees will be allowed to work from home for long periods.  Investors need to assess the impact of a slowdown in demand caused by companies that allow a growing percentage of work from home to take place (some people home permanently, others a day or two a week) versus the likely reverse of a long-term densification trend that had packed more employees in less space.  The net near-term effect is a likely notable drop in demand for office space, especially urban office.

Health Care

Health Care has historically been one of the more resilient property sectors in a downturn.  But this is not a typical downturn and therefore expectations for much-greater-than-normal declines in occupancy are being baked into our forecasts in the senior housing sector (which is the health care business category most represented among public companies.) Senior housing tenants are particularly vulnerable to the virus, which has been causing pressures on both the move-out and move-in sides of the business. Increased labor costs have put added profitability stress on senior housing landlords.

The senior housing business is however waiting for a sizable demographic tailwind which should start kicking into gear in a few years from now.  Therefore, investors with a longer investment horizon should not fear this near-term turbulence.

Health Care Cash NOI Growth Index (2019 = 100)

Retail

Investors in the retail space have largely focused on rent collection in the second quarter as a proxy for the near-term pain the business would suffer. In the longer term, the more relevant period on which to focus, surviving retail concepts will drive occupancy levels and property values. Accordingly, understanding the different types of tenants among sub-property types is key to picking winning REITs in the sector.

Within the strip center segment, Green Street predicts that power centers will fare better than grocery-anchored centers. This is because grocery-anchored centers derive a large percentage of their income from small businesses and restaurants – a segment that should be particularly hard hit through this recession.

Green Street also expects a greater negative impact on malls than strip centers given their dependence on apparel sales. Department store bankruptcies are likely being pulled forward from the next five years to the next two, with Green Street now expecting over half of mall-based department stores to close by the end of 2021. This could trigger co-tenancy clauses for in-line tenants and accelerate the downfall of many malls across the country. Mall NOI should be approximately 20% lower than 2019 when the dust settles in a few years.

Industrial

Industrial fundamentals are traditionally sensitive to the economic cycle, but the accelerating prevalence of ecommerce during this pandemic has provided a nice buffer for the sector’s fundamentals. But it has only been a partial buffer as some smaller tenants in the space will struggle to pay rent in an environment where service businesses are being affected. Industrial demand is still tied to the health of the economy, but the sector should sufferhan others throughout this downturn. Green Street forecasts moderate market rent growth in this segment, driven by positive demand, negligible rent growth, and a somewhat disciplined supply landscape. 2020 same-property NOI growth results are unlikely to exceed 2019 while growth should bounce back in 2021.

Green Street Advisors regularly reviews sector and market-level forecasts as the landscape has changed quickly in response to this global pandemic. Learn more about Green Street’s views on the outlook for additional commercial property sectors amid the coronavirus-induced market uncertainty by listening to our full OnDemand webinar.

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