“If I had an hour to solve a problem and my life depended on it, I would use the first fifty-five minutes determining the proper questions to ask.” – Albert Einstein
This initial period of the COVID-19 pandemic has been marked with as much or more uncertainty than many of us have faced in our lifetimes. From questions about how the virus spreads and infects, to its lethality, to the timing of available treatments and vaccines, to the depth of its impact on the global economy, to the longer term changes in the way we as humans live, work and play, we have an endless queue of questions swirling in our minds. Then, there are the more granular questions that we as real estate people are asking about how to deal with the tenants and lenders in our portfolio today, and how should we be preparing for a time when we can go safely back to work? Finally, and most important, we wrestle with our own needs for safety, and the needs of our families, friends and community. We hope all of our investors stay safe through this crisis.
There is so much that is uncertain or unknowable in this environment. Therefore, in this update, we will address questions around what we are seeing at the property level for different asset types, and close with some key questions to think about going forward.
Our first observation is that property performance by sector is generally correlated with the length of the user’s obligation. The property types that have the longest-term leases will face less disruption than those where users have more flexibility. At the short end is the hotel guest who makes a daily decision about whether to commit to a room. Apartment leases are a little longer, generally a year, and industrial and office buildings have long term leases for the most part. The outlier in this analysis is the retail sector where long-term leases are in place, but only 50% of tenants paid their rent in April. In this environment, the unfortunate reality is that landlords wear the risk of their tenants’ businesses, and as we all know, few retail businesses across the country are open.
Hotels have been one of the most severely effected as both domestic and international travel have ground to a halt, and by some estimates as many as 20% of the hotel rooms nationally have been closed. The best performing part of the hotel sector is extended stay which as a group is maintaining a higher occupancy than the balance of the hotel sector, but this is only a small comfort. While recognizing that recovery is a way off, forward looking investors are looking hard at this space.
Multifamily owners across the country waited with great anticipation to see who would pay rent for the month of April and breathed a sigh of relief when almost 90% of tenants paid. May and June collections will be more telling. Both Maryland and the District of Columbia have COVID-19 related prohibitions against evictions and rent increases. It remains to be seen whether this incentivizes tenants to opportunistically withhold rent payments. Apartment rents are down slightly and are projected to fall further. To offset a drop in collections, we are seeing landlords giving up on rental increases and pushing to raise occupancy. On the good news front, people still need a place to live, and there remains more debt capital available in this asset class than others due to the participation of the GSE lenders. As a result, the sector may be better positioned to weather the storm.
Industrial and office buildings have longer term leases for the most part. The tenants in these spaces face potential legal jeopardy if they decide to break those contracts, and most would only do so if it were a matter of survival. April rent collections on average were in excess of 90%. We expect this figure to drop in May. If a tenant asks for relief, and has applied for stimulus funds, some landlords are providing short term deferrals and accruing the deferred rent. Lender approval is a part of this process and most banks are providing some deferral and accrual features to their borrowers. This has not been the case with securitized lenders, and it remains to be seen how these loans fair.
As we emerge from lockdown, office workers will need to know that their work environment is safe. Recognizing this, owners and property management companies are working through cleaning and distancing protocols. The last several years have seen a steady reduction in square footage per employee. Now, major tenants are looking at their footprints to determine how to configure space to allow for social distancing. This could lead to new leases requiring more space per employee and would create an instant increase in demand. On the other hand, teleworking has worked better than many thought during this crisis, and tenants believe this will be a larger part of their program going forward. This sentiment would likely reduce the square footage needed. The answers to these and other post-pandemic questions will determine the workplace of tomorrow and the future demand for office space.
The one product type which has remained consistently strong during this time has been industrial, as more products are being shipped directly from the warehouse to the consumer. E-commerce was growing rapidly before the crisis and is now accelerating, capturing an ever-larger share of total retail sales. While we have seen some weakness in small bay industrial, high bay and bulk storage remain sought after by tenants and investors. As the economy recovers, e-commerce should continue to capture a larger portion of retail sales. Brick and mortar retail has been moving to “experiential retail” and that trend will need to accelerate to draw a wary shopping public away from the computer and back to the store.
The objective in fighting the pandemic is to halt its exponential spread, and the challenge to our personal and work lives is to adjust to a world where change is accelerating throughout the economy and everyday life. We hope by searching for the right questions we remain resilient and flexible in facing the new tomorrow and emerge ready for the opportunities that recovery will present. Please stay safe.