A Significant Milestone Towards Economic Recovery
U.S. markets have a renewed sense of optimism with the passing of a $2 trillion stimulus deal—the largest stimulus package in U.S. history. Coupled with recent steps taken by the Federal Reserve, these unprecedented actions are meant to stabilize and prevent any further damage to the economy.
Parts of the measure are aimed at providing relief in the form of loans to real estate sectors particularly hard hit by the emergency, especially hotels and restaurants. The bill would also expand small-business loans, allow many multifamily mortgage borrowers to receive temporary forbearance of payments, provide direct payments to individuals and expand unemployment insurance benefits—all of which are expected to benefit the commercial real estate industry.
In this article we cover the primary effects the stimulus bill is expected to have on the commercial real estate industry, the economic context of this recent legislation and what we can expect to happen over the coming months.
What the Stimulus Bill Means for Commercial Real Estate
According to the Commercial Real Estate Development Association, the legislation is expected to positively impact the commercial real estate industry through the following measures:
- Providing small businesses, many of whom are tenants, with $377 billion in loan assistance so they can keep employees on payrolls and continue paying obligations.
- Allowing a 5-year carryback of net operating losses (NOL) for non-REIT businesses for 2018, 2019 and 2020.
- Increasing the limitation on deductible business interest from 30% to 50% of EBITDA (earnings before interest, taxes, depreciation, amortization) for 2019 and 2020. Excludes from income the cancellation of debt related to new, emergency small business loans.
- Providing a technical correction to the Qualified Improvement Property (QIP) depreciation drafting error from the 2017 Tax Cuts and Jobs Act that resulted in a 39-year depreciation period for QIP, rather than making it eligible for immediate expensing. This correction is a top NAIOP federal priority and its inclusion is a result of our efforts over the last two years.
In addition to these real estate-specific items, there has been ample discussion on the bill’s highlight provision—a direct payment of $1,200 to many American individuals with income up to $75,000, $2,400 for married couples and $500 for the parents of each child they have under 17 years of age. These proposed payments will be given in full to individuals with adjusted gross incomes of $75,000 or below, and then are gradually diminished above that threshold, with individuals earning more than $99,000 ineligible for payment (these thresholds are doubled for married couples).
These measures are intended to help strained households cover immediate needs and will be further bolstered by expanded unemployment insurance and social safety net programs. The combined impact of these measures is widely expected to help renters and homeowners alike achieve more stability in their lives and make their monthly payments, although the extent to which these additional funds can be stretched will vary widely across submarkets. In order to ensure broader tenant support across the board, earlier this week the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, announced that they will give multifamily landlords a break on their loans on the condition that they do not evict renters low on money as a result of the current health epidemic.
With multiple protections for small businesses and working-class Americans baked into the bill, the end result is expected to bolster those most affected by the ongoing epidemic and keep the landlord-tenant flywheel spinning. And while the magnitude of the effects of these policies remain unknown, landlords, brokerages and real estate investors alike should find some relief in the stimulus package’s support for small businesses and independent contractors. As James Whelan, President of the Real Estate Board of New York, puts it: “there are specific aspects of the bill that will help real estate agents, brokerage firms, commercial tenants and small businesses begin the process of regaining their financial footing.”
What This Means For Commercial Real Estate Today
Even with the passage of this historic stimulus bill, the challenges facing the U.S. economy remain formidable. The proposed funding for state and local governments is seen as inadequate by leaders in some of the hardest hit regions of America, and over the past month the Dow Jones lost all its gains since President Trump was inaugurated in 2017. Furthermore, a record 3.28 million workers applied for unemployment benefits last week, ending a full decade of job expansion, and the national response to the COVID-19 encroachment remains uneven and decentralized.
On a macro scale, the sum of these factors point to a serious constriction of the U.S. economy for the next few months, although many sources expect a healthy national recovery to begin in the second half of 2020, as evinced in Cushman & Wakefield’s summary graph below.
So where does all this leave the commercial real estate industry today?
It’s worth noting that commercial real estate figures are typically reported on a quarterly basis and therefore the full impact of recent events on the industry remain uncertain. However, with increased volatility in the equities and commodities markets and the wide differential between real estate yields and government bond yields, real estate continues to offer a strong value proposition relative to many public market investment options.
This means that in terms of investment activity, a shift to defensive assets is expected as commercial lenders and individual investors alike remain in a phase of turbulence-driven price discovery. Although the impact of the COVID-19 outbreak has been most evident in the hospitality sector, several other real estate classes are potentially more resilient to negative market externalities and have less exposure to supply chain disruptions.
- Multifamily: While the continued trend towards higher-density living and shared living spaces potentially heightens the risk of COVID-19 transmission, this is a trend which is expected to continue, with new risk mitigation protocols and prop-tech developments. In situations like the one we’re facing, multifamily properties tend to have more defensive characteristics given ability to actively adjust rent levels to match market demand, and the fact that layoffs and pay reductions can potentially push some potential home buyers back into the rental market.
- Office: An extended quarantine period and the consequent increase in remote working are likely to reduce office utilization rates. However, this impact will be felt more acutely by landlords with exposure to short-term leases and property owners with long-term institutional tenants are expected to be able to weather the storm. More generally, there may be softer rental growth than previously forecast and in the long run the industry is expected to evolve to meet the needs of an increasingly fluid workforce.
- Retail: Local retailers operating on lower margins are expected to be severely impacted by the current epidemic, and while the stimulus bill takes ample steps to protect these small businesses, they will still be at risk due to prolonged operational interruptions. Larger retail chains and businesses that are able to quickly shift resources towards online fulfillment will stand a better chance of long-term success, and present conditions will expedite a broad shift towards more flexible, omnichannel retail models.
While there were some initial disputes about unemployment benefits and assistance to corporations which were expected to disrupt the House vote, the Senate bill was passed on Friday.
The level of relief you can expect from the stimulus bill is highly contingent on your personal circumstances, but the main takeaway should be that the bill takes a dual-pronged approach towards addressing immediate business and individual-level needs alike. With industry-specific benefits, direct payments to individuals, expanded small-business loans and an expansion of unemployment insurance benefits, the biggest concern over the past month—that the economic flywheel will creak to a halt as the bottom half of the economy drops out—is being remedied.
It should be noted that the negative impacts of the current health epidemic are not an indictment on the intrinsic value of commercial real estate, but rather part of a broader reflexive response to an unforeseen circumstance which saw asset value declines across the board. With institutions ranging from Goldman Sachs to Bridgewater projected an impressive start to the nation’s economic recovery in the second half of 2020, it’s important to continue focusing on identifying high quality investment opportunities rather than assuming a purely passive role or trying to front-run market expectations.
All commercial real estate projects you are considering need to be viewed through the lens of today’s rapidly evolving circumstances. We suggest that you take note of these specific characteristics:
- Income Stability: The less variable the contractual income, the less risk is involved. Examples of assets with relatively stable income include multifamily properties and office assets with credit tenancies and strong remaining terms.
- Operational Necessity: Assets which play a central role in maintaining core business operations will likely undergo less disruption. Examples include data centers and critical logistics facilities, but can also be extended to certain key service sectors including healthcare facilities and schools.
- Occupation Density: The higher the occupation density, the higher the risk of contracting COVID-19 and future contagions. While this naturally bolsters support for Tier 2-3 markets, occupation densities range widely even within individual cities and districts, and investors are therefore advised to take a more granular approach to their market research.
While many businesses across America remain shuttered for the time being, the initial shock of the market situation is wearing off as investors survey their holdings with more long-term clarity and the understanding that the current situation will eventually come to an end.
Many investors are now leaving the sidelines and looking for opportune ways to rebalance their current portfolios. In order to meet the needs of these investors, iintoo will continue to provide a steady stream of high-quality, thoroughly vetted commercial real estate deals ranging from a Midwest multifamily portfolio in a supply-constrained, economically resilient market to a commercial mixed-use property in the Bronx which is already 90% leased to long-term institutional tenants.
Our collective belief in the intrinsic value of commercial real estate investing is as strong as ever. If you believe that your current portfolio can benefit from increased diversification and exposure to the private market, feel free to see what we can offer you.