The Only Constant Is Change

The COVID-19 pandemic has upended commercial real estate, but market sectors have opportunities to bounce back amid difficult forecasts.

What a difference a pandemic can make to an economist's forecast. Earlier this year, the most influential topics in my 2020 outlook questioned if the longest economic recovery on record could continue; would the 2020 presidential election impact the economy; and how national and state fiscal health would affect the U.S. economy.

Considering how the COVID-19 pandemic is suppressing both the economy and state of commercial real estate, I'm reminded of a humbling quote from Winston Churchill that all economists should note, because it recognizes the uncertainty in forecasting:

It is not given to human beings — happily for them, for otherwise life would be intolerable — to foresee or to predict to any large extent the unfolding course of events.

The two categories of data likely to reliably foretell recovery from this pandemic are corporate earnings and transportation metrics, specifically Transportation Security Administration passenger count and rail traffic. The transportation metrics tell us when goods and materials will start moving again and at what trajectory (i.e., demand) to influence gross domestic product. Corporate earnings, meanwhile, reveal important behavior — such as capex spending and layoffs/rehiring — that will influence re-employment and renewed demand for CRE space. This latter category, corporate earnings, grounds me in another piece of sage Churchillian advice that emphasizes behavior over words — or guidance statements in corporate earnings:

I no longer listen to what people say, I just watch what they do. Behavior never lies.

First, though, our real estate industry should prepare itself for both:

  1. More worst-ever economic reports on jobs, manufacturing activity, and GDP contraction.
  2. A W-shaped recession (aka a double-dip recession in which a second contraction in the economy occurs following an initial recovery).

The economic lift from states reopening businesses this summer will likely be followed by a contraction in the fall or winter into 2021, as holes not plugged from initial fiscal and monetary intervention will be revealed. What holes am I referencing? Some include the slew of bankruptcies to follow in leisure and travel, the retail sector, small businesses, and manufacturing — from autos and airplanes to equipment and housing. Some of this bankruptcy activity is already underway with announcements by rental car companies such as Hertz and Advantage. However, many more are expected as CARES, Paycheck Protection Program 1.0, PPP 2.0, and Main Street fiscal and monetary intervention programs wind down.

Before examining different property types in this COVID-19 environment, I want to examine some revealing resources and metrics that will most influence 2H2020 outlooks and answer the question: When will we know we are beyond the COVID-19 recession? There are five primary influences:

  1. Success of states reopening businesses and a relapse of COVID-19 in a sort of rolling hot-spot fashion until we have a vaccine. The Johns Hopkins University of Medicine COVID-19 dashboard tracks coronavirus cases by country, state, and MSA. Except for Alaska and Hawaii, cases continue to rise — and have increased from just under 900,000 globally at the beginning of 1Q2020 to surpassing 7 million the week of June 8.

    The U.S. has the most cases of any country by a multiple of 3.5 times, topping 3 million in early July, with outbreaks moving from the coasts to many Southern states.

  2. Employment and housing metrics. Does anyone recall when unemployment was below 4 percent era in 2019? Prior to the June jobs report, the Total U6 Unemployment Rate rose to 22.4 percent (and remained at 21.2 percent in the June, or double that of the Great Recession). Also, persons filing jobless claims from mid-March through May exceeded 40 million. Additionally, many of those unemployed were either delinquent in their mortgage/rent or already availing themselves of some sort of housing payment forbearance program. The percentage of homeowners with a forbearance agreement increased to a record 8 percent through May 2020, or eight times prior peak levels. Also, the ratio of homeowners who are delinquent in their mortgages doubled from the beginning of March through May, to 6 percent. The full impact of this kind of job loss has yet to be felt. It is being cushioned at some level by extended paid leave by companies, extended unemployment insurance benefits from the CARES legislation, and loan/rent forbearance programs. As these programs wind down later this year and into 2021, the true discovery process begins. Look to metrics like small business failures, bankruptcy filings, declining homes listed for sale, and increasing days-on-the-market (DOM) housing metrics for what lies ahead. Forget creating two million jobs in 2020 like we did in 2019 or 1.5 million new housing starts, as expected the beginning of 2020. Monitor when we return to just 300,000 jobless claims per week and hope the end of loan forbearance programs in spring of 2021 won't result in another housing foreclosure crisis.

  3. Transportation metrics. The TSA passenger count metric is the best overall measure of how the U.S. is recovering from COVID-19. If business and leisure travelers return to flying at levels near 1.5 million passengers a day, we are on a good trajectory toward full recovery. If, however, they stay recessed to less than one million passengers per day, the economy is not recovering to a level that will drive unemployment below 10 percent. Other transportation metrics, like rail traffic by the American Association of Railroads, will tell us not only when the supply chain is normalizing, but if demand is recovering and items like autos are once again moving by rail from factories to dealerships.

  4. CRE transaction activity. In 2Q2020, Real Capital Analytics began to show the decline, but some confusion remains as to what is driving it. Most assume it is declining demand. However, the quarterly mark-to-market accounting by pension fund investors may be the greater influence. By end of the second quarter, Pension Real Estate Association (PREA) reports that its members will have to mark their $2.5 trillion of CRE investments to market for the impact of COVID-19. This event is driving capital to the sidelines until they understand the valuation implications. They can then reallocate capital from hotel and retail to multifamily and industrial, for example. 

    My outlook is that this capital will return to the market in 2H2020 and 2021 in a hunt for yield, especially given that bonds are yielding below 1 percent and approximately half the public companies have suspended dividends.

  5. CRE credit metrics. Entities like TREPP monitor the permanent loan delinquency rates by property type and, more importantly, the loans transferred to special servicers (LTSS). CRE credit metrics will deteriorate rapidly throughout the rest of 2020 — especially in hospitality and retail property sectors — and identifying the peak in those measures will identify the point of recovery.

With these considerations in mind, let's look at major property type sectors to see where things currently stand, where they could go, and what metrics to monitor to understand the direction of future movement.


Recently, I was shocked when I heard that 93 percent of all debt for multifamily properties is held by government-sponsored enterprises Freddie Mac and Fannie Mae. Additionally, two-thirds of single-family homes are backed by the government. Considering these factors, it's no wonder this sector has seen such intervention from the federal government.

This approach is a direct contrast to the government's actions during the Great Recession in 2007-2009. The response to COVID-19 is more of a bottom-up approach, where programs are designed to help homeowners and renters, compared to 2009, where money was dumped into the banks in hopes it would trickle down to individuals. Support for borrowers through forbearances, for example, will keep people in housing and make shelter-in-place efforts possible. The unintended consequences of this intervention will not be known for six or 12 months when these programs end. How will landlords and banks deal with the forbearance balances (all due at once, amortized with or without interest, and imposition of mortgage insurance premiums if the new loan balance is 95 percent or 100 percent)?

While workforce housing has received ample assistance, the intervention for student housing hasn't been as robust. Universities have had to rebate housing fees on a pro rata basis for the spring semester, while private student housing landlords are discovering that many leases have “act of God” or “act of university” provisions that allow students to terminate leases early with statewide disaster orders by governors.

Student housing multifamily faces more stress than workforce housing. Look at the 136 college towns with NCAA Division 1 football programs that may not see students return to campuses this fall. What happens to student housing without the students? And what happens to all the small businesses that rely on busy campuses? More than a third of the country's 360-plus MSAs are college or university towns that will face unprecedented multifamily housing and economic instability.

Aside from differentiation between workforce and student housing, demand may shift from urban to suburban as young professionals and urban renters opt to escape population density and crowded public transportation to the suburbs where they can work remotely and find more affordable housing. In broad terms, will multifamily in cities like New York, San Francisco, and Washington, D.C., which are reliant on public transportation, see reduced demand?

In essence, will the office workforce reject risk factors associated with urban environments and choose to reside in the suburbs using the newfound acceptance of work via Zoom? The opportunity lies in suburban areas, where Class B and C assets can be repositioned quickly as valuable and desirable properties with more affordable rents and less density. Suburban assets with a walk-up design and ample outdoor and/or green space in proximity to good grocery shopping and carryout restaurants may be especially in demand in 2H2020 and 2021.


Growing office demand in suburban areas is going to go hand-in-hand with housing. Major institutional investors are beginning to see evidence of rejuvenated interest in demand for leasing suburban office space, including large corporations who already have footprints in urban areas. Earning reports from 1Q2020 included examples of company CEOs commenting on just this point, talking about “redundancy costs” to lease some level of suburban space to support teammates who no longer want to commute into dense city environments or crowded high-rise buildings. What will be the new normal for suburban office demand? And what will become of urban high-rise office towers in three or five years when the larger corporate leases burn off and companies can shed space to mitigate these redundancy office costs?

Will the employee-to-office-space ratio increase from its 2019 low of 150 to 195 sf per person? How will that impact rents with tenants getting less utilization per employee? According to a survey from JLL, in 2019, the average employee in North America had 195.6 sf, down 14.3 percent from the 2018 figure of 228.2 sf. That type of density is not economically viable at current market rents given social distancing policies to help improve public health.

Lastly, what becomes of the open-space floor plan? Do we remove one-third of the cubicles, migrate to a staggered work schedule, or develop a different office model? Something will have to give, at least until we have a vaccine, and maybe even longer as the workforce becomes more entrenched in remote work.

Another element to consider regarding office building assets is increased capital expenditures. Office property owners are going to face substantial capex costs that involve removing cubicles and new floorplans to produce more segmented, isolated areas for workers. Common touch-point surfaces will have to be modified — voice-activated elevators, for example — rather than everyone touching the same buttons.

Another factor that will become essential in office properties will be contact tracing. Tenants may be required to provide information about employees to property owners or managers. For example, say a handful of a tenant's workers travel to a hot spot, whether that's in an American city or a foreign country. The tenant may be obligated to report that activity to property management and have those employees quarantine at home and work remotely for a period of time. Occupancy monitoring technology is coming to the office sector and it, along with HEPA air filtration systems and touchless surface technology, will impact capex budgets.

Overall, with pressure to decrease density and growing demand to work from home, office real estate likely will be repriced. With cheaper alternatives in the suburbs, which can also minimize redundancy costs, the sector could see substantial changes in tenant preferences and locations.


Retail evolution was the retail industry's focus prior to COVID-19 with a migration from a “shop and take home” model to an “order online and deliver to me” model. But challenges now include operational and occupancy orders by state and local government that impair retailers' abilities to operate.

Can physical retail be economically viable with new COVID-19 occupancy restrictions that limit occupancy to 50 percent or 65 percent of pre-COVID levels? And, if these occupancy orders remain permanent, physical retail space will have to be repriced. Rents will decline because hair salons and restaurants will have less revenue to pay rent. Traditional occupancy cost ratios will be invalid and will translate to lower rent per square foot. Lower rent will translate to diminished overall value.

Traditional occupancy cost ratios will be invalid and will translate to lower rent per square foot. Lower rent will translate to diminished overall value.

A lot has to be sorted out, but until then, uncertainty in retail real estate is elevated, maybe as much as in hospitality. This uncertainty is exacerbated by the acceleration of retail bankruptcies and store closings that had already reached record levels in 2019, with approximately 9,000. The estimates for this year's closings range from 12,000 to 15,000 by retail industry insiders such as Coresight. As of June 5, Coresight reported 15 retailer bankruptcies in 2020 and 4,000 store closings, including JCPenney (154 stores in the near future), Pier 1 (450 stores), GameStop (320), Victoria's Secret (238), and The Gap (230), to name a few. 

While these e-commerce and industry pressures would suggest physical retail may be on its last legs, there is news to the contrary in 1Q2020 retail earnings. Walmart, Target, Home Depot, and other big-box retailers revealed that physical in-store sales rose in 1Q2020, before shelter-in-place orders took effect. Across the board, these large retailers reported 3 percent same-store comparable sales increases in addition to their double-digit growth in online purchases. 

The aforementioned big-box retailers figured out how to safely handle in-store purchases and process more “order online and pick up” in their parking lots and front-of-store areas that is now commonly referred to as “click it and pick it up.” Additionally, dollar-discount stores, like Dollar General and Dollar Tree, which rely entirely on physical in-store purchases, reported the largest quarter-over-quarter, same-store comp increases for the retail industry with 21 percent in 1Q2020. Physical retail is not dead, but the evolution that was underway has been accelerated by at least three years — especially in the category of online grocery. 

Finally, another big retail question from the pandemic is the future of experiential retail. Those retail spaces where consumers were doing something rather than buying products will face a more uncertain future as we emerge from shelter-in-place orders. Entities like Weight Watchers may have given us a clue in their 1Q2020 earnings. The company noted that it was able to pivot from a 75 percent face-to-face experience with clientele to a 75 percent virtual/online interaction during COVID-19. The company experienced subscriber growth and its highest customer satisfaction ratings ever. Looking beyond Weight Watchers, we see experiential can work in a digital format without a physical store or real estate. Experiential in a digital space can be successful, but it needs imagination and innovation. Some aspects will survive and thrive, like hair salons, but others may not mesh with new occupancy models that work against gathering in person or high density.

Total Passenger Throughput



Industrial warehouse has been the shining star in commercial real estate during the pandemic with metrics like 5 percent vacancy, more than 90 percent of rent paid by tenants, the fewest requests for rent forbearance, and net positive absorption. These metrics are not expected to change in 2H2020 and were affirmed in 1Q2020 earnings by Prologis and Monmouth MREIC where they highlighted record throughput. However, some wrinkles were identified in the supply chain during 1Q2020 that suggest even industrial and warehouse will undergo changes in the wake of COVID-19.

Just like commercial mortgage-backed securities had to be adjusted after the Great Recession, in what's known as CMBS 2.0, a similar evolution of the industrial and logistics sector will occur after COVID-19. This next generation of warehousing and supply chain management will have to tackle increased automation and a changing supply chain model.

First, the U.S. will likely retire the 1980s Japanese model of just-in-time inventory, which didn't work out so well during the onset of the pandemic. Instead, the goal will be supply-stock inventory — ensuring three or six months of additional inventory is available across all industry sectors, from automotive to personal hygiene, personal protective equipment, and pharmaceuticals. This system will be analogous to the national oil reserve. But where do we put this supply stock? It does not make sense to congest existing throughput e-commerce warehouses with inventory that is being held or on standby for the next crisis; rather, it will require different type structures and locations. Vacant malls, closed retail stores, and underutilized older warehouse space in secondary cities are potential cost effective and readily available options.

Supply stock in former retail is the kind of adaptive reuse that is practical and affordable. Supply stock will require we look at these alternative buildings and secondary locations, and local governments will be more accepting of the zoning modifications in use because it does not involve the same kind of heavy truck traffic as an e-commerce warehouse. Just such an example occurred in May in a suburban Atlanta submarket via the acquisition of a former Dave & Busters and former Havertys Furniture showroom for use as both last-mile fulfillment and supply-stock storage.

Regarding increased automation across the supply chain, Visual Capitalist conducted surveys of supply chain managers in May, documenting just how manual these systems remain. The COVID-19 pandemic has shown that complex supply chains can become fragile under public health crisis-type circumstances. As a result, companies around the world are now rethinking their warehouse and distribution systems, with automation taking center stage. The issues in need of automation range from warehouse handling (still only 50 percent is automated globally) to returns management (the least automated process).

Industrial CRE is going to experience continued demand growth in the coming years. Prologis, FedEx, Amazon, Walmart, Home Depot, and other dominant logistics companies have been the driving force behind the 200 million sf of warehouse space construction per year before the pandemic. That total may drop to 100 million or 150 million sf. Demand and new construction will recover, however, from increased e—commerce activity and a need for supply stock. Remember, we just accelerated the move to online of almost everything by three to five years due to the pandemic.

New warehousing facilities, though, are not going to be the same as those of previous years. Building a million-sf box is not the optimal model when a public health crisis can shut it down, thereby disrupting a company's entire supply chain. Industrial developments will likely become more varied in size and location.

Think about walking down the cereal aisle in the grocery store. You see variations in sizes from single-serve packages to larger family-size boxes. Industrial warehouses will have more variation tied to purpose, from central e-commerce fulfillment to last-mile or supply stock.

Overall CMBS Special Servicing Rate by Property


Leisure & Travel: The 'Other' L&T

Logistics and transportation comes to mind when “L&T” is referenced in CRE circles. But there is another L&T sector — leisure and travel — and it has been performing much worse during COVID-19. The 95 percent decline in air travel — from 2.3 million daily passengers through U.S. airports in February to an average of less than 100,000 in April, according to TSA, shows the pandemic's severe impact on travel-related commercial real estate. Another sign arrived with the April CRE loan delinquency data from Trepp, showing hotel CRE had the largest increase in delinquency during 1Q2020, rising from an average of 1.5 percent for all lodging loans to 2.7 percent. Trepp warned in its May CMBS delinquency report that deterioration in lodging loan performance would get worse, noting hotel occupancy rates were running below 20 percent, while liquidity from debt and equity sources had dried up.

The loan delinquency ratio is a lagging indicator — much like vacancy for other CRE property types. Once it is elevated, not much mitigation can be done — and then in come the loan workout teams. The indicator that reveals when loan delinquency is going to rise is much more insightful to investors. That metric for the CRE finance industry regarding lodging assets is LTSS, or loans that have transferred to special servicing.

LTSS is a forward-looking indicator. If April and May's figures are a harbinger, the leisure and travel sector is in for a bumpy ride. The percentage of overall CRE loans with a special servicer grew from 2.83 percent in March to 4.39 percent in April. Prior to the April servicer data, 2.27 percent of all lodging loans were in special servicing. In May, that ratio ballooned to an eye-popping 16.2 percent. The balance of loans in special servicing nearly doubled in one month, from $14.1 billion to more than $22 billion.

But two more clues show just how bad the environment is for leisure and travel. First, Real Capital Analytics revealed that there were a mere 10 hotel transactions nationwide in April. “We have never seen this level of illiquidity in the hotel market,” says Jim Costello with RCA. “It is effectively a frozen marketplace.”

Regardless, some level of travel will return, so what might the hotel experience of the future be like? In a May Wall Street Journal feature, Eventbrite CEO Julia Hartz identified some fundamental changes to come. “We believe smaller local events that are core to our business will resume earlier, and we think they will happen more frequently to satisfy pent-up demand,” she says. “When it's safe to gather again, we think that consumers will favor these local events over a larger more expensive episodic events, especially during a period of depressed consumer discretionary spend.”

A May feature by Business Insider includes some fascinating prognostications for hotel owners, investors, and frequent travelers, including:

  • Smaller, less dense hotel properties.
  • Motel-like exterior entries and corridors.
  • Contactless check-in and digital key systems.
  • 50 percent average daily occupancy.
  • Reduced or eliminated daily housekeeping.

Overall, amenities will be reformatted, removed, or altered. The Four Seasons began placing “Lead with Care” kits in each guest room that include masks, hand sanitizer, and sanitization wipes. Best Western, with more than 5,000 hotels worldwide, has removed “unnecessary items” like decorative pillows from guest rooms as part of its enhanced sanitization procedures. Finally, Hilton has done away with the pen, paper, and guest directories unless specifically requested.

Looking Ahead

Throughout this pandemic, I've stressed the need to be pragmatic but hopeful by looking up and forward. The tough times are far from over and, like Winston Churchill said, the unexpected will happen again and again. But I encourage all commercial real estate professionals to take a page out of the Greatest Generation, which was a part of the victorious effort in World War II. These people, whether our parents or grandparents, persisted in the face of war, the Great Depression, and public health crises to build the U.S. into a global economic powerhouse. While our challenges are unique, they are not unprecedented, so I hope we all put in the effort just like the Greatest Generation did before us.

For more from K.C. Conway, watch the "Leveraging Corporate Earnings Reports for CRE Analysis" webinar.

K.C. Conway, CCIM, MAI, CRE

K.C. Conway, CCIM, MAI, CRE, is CCIM Institute's chief economist. 

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