From a small northwestern observatory…

There is a lot of attention on the owner-occupied housing front, with costs/prices skyrocketing and affordability tanking. However, COVID has had complex and somewhat unpredictable impacts on the commercial real estate (CRE) market.

First to set the stage, commercial lenders became much more conservative after the 2008/10 debacle, even though most of that was felt in the residential sector. Non-performing commercial real estate debt was a manageable 0.86% among the nation’s 325 largest banks at the end of 2020, albeit up from 0.41% at the end of 2019. By comparison, at the peak of the previous recession, this stood at 8.6%. Banks have largely focused on lower-leveraged loans and kept higher reserves. Indeed, the lack of distressed inventory has put distressed buyers in a position of having too much money chasing too few deals. Distressed buyers are hoping for discounts in the 30% range, but having to settle for 10% to 18% discounts.

Even in the non-distressed arena, there is a lot of capital (both debt and equity) in the market. Surprisingly, a lot of this is coming from debt funds, which leverage returns by getting an equity slug on top of the dent. As of early May, 2021, there were about 130 such debt funds in the market place chasing fewer and fewer deals. By the end of 2020, CRE sales had fallen by 32% from 2019, according to Real Capital Analytics. In the month of January, 2021, sales were down 58% year-over-year. Among the investments of choice, save sectors (multi-family, industrial, self storage) are getting even better terms than they were pre-COVID. However, lenders are asking more detailed questions now about minutia such as collections and tenant financials. Nonetheless, there is money to be had, even for distressed deals, and while banks are holding out for 60% – 70% LTVs on construction lending, some borrowers are getting as much as 90%. Some development companies are finding success raising equity for pipeline deals, rather than traditional property-by-property investments.

One of the more interesting twists has been the movement of foreign investors from major markets into smaller markets. In 2011, for example, 76.9% of foreign investment in the US was in Top-10 markets, according to a recent study from Marcus and Millichap. However, thus far in 2021, this has declined to 58.5%. More striking — in 2011, about a third of foreign investment went to one city, New York. Today, only about 10% of such investment is flowing into The Big Apple. Not surprisingly, that same study finds that retail and hotel investment has declined precipitously, while multi-family and industrial have taken up the slack. Interestingly enough, office investment has varied widely over the past five years, down somewhat from 2019.

Much of this information came from two great studies in the current edition of Real Estate Forum, one by Erika Morphy titled “An Abundance of Liquidity” and another by Erik Sherman titled “Distressed Real Estate Doubles But It’s Still Not Enough for a Buying Spree”.