January 2021: Where are the deals?
When will the deals come? Where all the rock bottom prices? Where are the foreclosures?
This is probably the number one question that investors want to know. Well, we may be waiting a while to see these deals, if at all.
After the crash of 2008 (which was more 2010 for commercial markets), lenders tightened up on borrowing requirements. One such requirement was a higher DCR (debt coverage ratio) to assure lenders that owners could sustain more of a loss in a downturn of the market.
The rate of payoff at maturity of the loans will quickly return to pre-pandemic levels unlike the 2010 crisis that lingered for years. Hence the rate of default in commercial loans is expected to be much less this time. This coupled with the low interest rates means there is very unlikely to be a high number of distressed sales.
GDP (Gross Domestic Product) is predicted to return to pre-pandemic levels in later 2021; largely fueled by increase confidence now that the vaccine is being more widely distributed. This GDP growth is the highest in the southern and western markets; generally, the less regulated the state the higher the GDP.
The following show the highlight of the market, based on interviews of key market participants as well as information from sources such as Costar, CBRE, Walker Dunlop, Virginia Commonwealth University and researched additional information from Moody's, Freddie Mac other national information as well as extensive information from the Appraisal Institute and CCIM Institute.
- New job growth is expected to be slower (5 million job deficit) in 2021 as previous workers are returning to work.
- Optimism faded in late 2020 as the CARES act waned and businesses exhausted PPP loans.
- This renewed optimism is picking up in early 2021 as the vaccine is being distributed.
- Retail sales are outperforming services spending: this gap will likely remain through 2021. Most affected are services such as barbers, theaters, and hotels which are likely to remain stalled until later in 2021 when the vaccine is more readily available.
- CMBS (Commercial Mortgage-Backed Securities) underwriting has remained conservative since the financial crisis of 2008; this has resulted in fewer distressed properties. Higher DCR requirements will likely remain.
- Higher DCR requirements have allowed for owners to stay current on debt payments despite rental moveouts.
- Historically low-interest rates have allowed for loan payoff and refinance at the end of the term at a higher rate than immediately after 2008.
- Hotels will likely still find refinancing because of the long-term forecast (most predict the hotel market to return in 2022/2023) on a national level. Pockets of local areas may see a hesitance by local lenders for financing.
- Profit growth is expected to grow in 2021.
- New construction will be very slow in 2021 and beyond as it will be a while before new inventory is seen as needed in the industry.
- Those properties that are grocery store anchored or anchored with ‘necessity goods stores’ are in the best position for funding. On the opposite end, regional and mega malls are seeing a higher loan default as major anchors go under
- Single-tenant net deals are still popular due to the stability of the tenants typically in these sectors. The overall number of deals has risen from 42% to over 50% from the first to second half of 2020. This is expected to continue in 2021 and beyond.
- The CBD has especially suffered as two major categories of spenders; workers and tourists, have been largely absent.
- Many retail tenants are looking for shorter-term leases due to perceived instability, especially in malls.
- There is a major move to suburban office as the attraction to the downtown CBD market is lower; COVID has made CBD markets less attractive as factors such as high-rise offices with elevators and public transportation are deemed riskier. Still, the return will likely occur in the long term.
- Lenders are looking at CBD offices on a case-by-case basis due to the long-term historical stability of this sector.
- Richmond remains strong despite the pandemic due to the lower cost as compared to primary markets. In addition, the land abundance and number of large companies headquartering in suburban areas with lower-rise buildings has made the south and mid-west more attractive. These areas are pulling tenants away from primary markets that were hit hard by COVID.
- The pace of office leasing is likely not going to return to pre-pandemic levels; most of the transactions are in renewing. CBD will likely see higher rent losses.
- There is a substantial amount of subleases coming on the market; it remains to be seen how this will affect the office market however it will likely have an effect on the primary leasing sector
- Industrial properties are still considered to be the most favored property type among institutional buyers. Cold storage is especially attractive due to the need for grocery and other storage. Lab space is also in demand as this sector cannot work from home.
- Industrial saw a 97% collection rent in rents through the end of 2020; this is compared to 95% for office and 67% for retail.
- The eastern coast ports are especially in demand.
- In terms of multifamily, student housing is not expected to recover due to an extremely high amount of remote learning.
- The traditional higher rent per square foot has reversed course in some areas as more tenants are desiring larger apartments to be able to work from home.
- Still considered to be the most ‘stable’ sector due to there always being a need for rental housing
- Cities such as Richmond are especially attractive due to their affordability of rent compared to larger cities such as Washington DC
- Renters are desiring more outdoor amenities due to being ‘cooped up’ indoors for working from home.
Overall, 2021 is expected to make large strides back to what was normal before the pandemic. The speed and accessibility of the vaccine will dictate the speed of this returning to normal. Spending should increase and the number returning to previous jobs should boost consumer confidence, especially by the third quarter. Richmond is especially poised to be attractive for both investors and owner occupants. Don’t miss out by waiting for the crash that may never come-now is a great time to invest!
Heather Placer, CCIM, MAI, SRA, ASA
*All opinions are that of the authors and are on over 20 years of experience in the market as we well as interviews with local market participants and a wide variety of webinar and studies from national sources including but not limited to the Appraisal Institute, CCIM, Virginia Commonwealth University, Walker and Dunlop, Costar and others.