U.S. Real Estate
Commercial property transactions in the second quarter plunged 68% year-over-year, as transaction sizes shrank amid a sharp pullback in institutional buyer activity and entity-level deals were non-existent. Limited clarity around rent collections, rental rates, and growth prospects in the intermediate term is suppressing investor appetite, though signs that pipelines are picking up for property types that appear less impacted on a relative basis – such as industrial and multifamily – are emerging. Financing markets present an additional challenge to a recovery in transaction volumes, as some large bank lenders are effectively sitting on the sidelines, and all lenders are hesitant to finance asset classes with less certain recovery profiles, including retail, hotel, and office. While many COVID-19-related state lockdowns were lifted in June, a recovery in deal activity is not expected to begin until there is more stability around the economic reopening.
The Trepp CMBS delinquency rate rose to 10.32% in June, with approximately half of that number representing loans in the 30 days delinquent bucket. For context, CMBS delinquencies have already reached global financial crisis (GFC) levels in a span of just 3 months and are expected to rise further. An additional wave of maturity-related defaults is also likely. To date, lenders have largely accommodated defaults by forbearing from enforcing remedies; however, such cooperation will eventually cease, and recapitalizations and forced sales will likely ensue.
Nevertheless, generic comparisons to the GFC are misplaced. Superior balance sheets and capital structures and relative lending prudence distinguish this cycle, and those factors paired with the rapid response of the Fed and Congress resulted in liquidity being largely restored and damage limited, at least for the time being. The combination of a low growth and low rate environment is challenging the traditional relationship between interest rates and real estate. Shrinking economic activity is weakening property fundamentals, and recovery trajectories remain murky, particularly for hard-hit sectors like lodging, retail, and senior housing.
Publicly listed markets have been more focused on liquidity than cash flow and are hoping for continued stimulus adequate to make up for the economic impact of pandemic-related changes to the way people live, work, and play. To date, fiscal policy has done a reasonable job of replacing lost income but hasn’t comparably restored spending.
On the valuation front, the Green Street Commercial Property Price Index declined 11% from pre-COVID-19 levels. Meanwhile, the REIT market posted a sharp recovery, though company valuations imply that large corrections in private market property valuations are still to come. Listed REITs in core sectors ended the quarter at a discount to NAV of 14%, though NAV revisions remain likely. Green Street Advisor’s model, which tracks the relative value relationship between private real estate and fixed income (investment grade and high yield), pegged real estate at about 2% undervalued.
For more information on U.S. Real Estate, visit angelogordon.com/strategies/real-estate/u-s-real-estate/
Private commercial real estate pricing has begun to correct.
U.S. REIT valuations imply large corrections in private market property valuations.
Unlevered real estate has historically offered a return between investment grade and high yield bonds. Real estate currently appears slightly undervalued on a relative basis compared to debt.
The combination of development deliveries and a demand shock is expected to drive rent and occupancy declines.
New deliveries are at cycle peak and are expected to decline.