The Coronavirus and CRE with CCIM Institute Chief Economist K.C. Conway
With the COVID-19 coronavirus pandemic dominating headlines and impacting economies across the globe, commercial real estate professionals are feeling the effects on their communities and their businesses.
Considering the monumental concerns for public health and economic volatility, Commercial Investment Real Estate magazine spoke to K.C. Conway, CCIM Institute chief economist and director of research and corporate engagement at the Alabama Center for Real Estate. You can listen to the full episode below or wherever you listen to your favorite podcasts.
We've also included an edited excerpt of his conversation with Larry Guthrie, CCIM institute director of communications. Conway shares invaluable insights into what's next for the industry in the face of the pandemic, advice for practitioners on how to weather the storm, and methods to help future proof new investments.
Listen to the full podcast episode.
CIRE: This isn't the first epidemic we've had to deal with. There was MERS in 2012 and the 2009 H1N1 flu pandemic. Why is this one having such an effect on commercial real estate? And are we too far gone to stem the tide at this point?
K.C. Conway: Looking at my 401(k), I feel like the tide's gone out - but I think you ask a good question. We get these normal bad flu seasons, and then it seems like about every decade we get one of these serious viruses. But what's different here versus, say, the H1N1 back in 2009? One thing that is very different is our use of social media. We can know everything in more detail, more quickly, more fluidly than we ever have before.
So, when anything disruptive or bad happens, we're going to know everything about it, dissect it, and communicate it - whether we want to know about it or not. Social media has enabled information to really be shared much more rapidly.
A second thing, if you go back to 2009 and 2012, we were already reeling from a major financial and housing crisis. We may, honestly, have been more focused because of what was going on with the Great Recession, that the flu just kind of seemed like one more bad thing. This time around, we entered this situation in a pretty healthy economy and things going pretty well. A negative event probably was able to capture more attention and get more broadly communicated.
Look at what we just went through the last two years on the battles over the tariffs and trade deals. I think being much more globally connected in transportation, communication, trade, and shipping allowed something like this to travel globally much more quickly than maybe a decade ago.
CIRE: You brought up travel. Hospitality is taking some obvious hits in the short term and that asset class has been priced to perfection to begin with, so it wasn't in the best place to withstand any type of disruption. Looking ahead, what should folks in that sector keep in mind for future investments? Is there anything that they could be doing to try and create a safety net on the front end?
Conway: It's a great question, because the biggest challenge the hospitality, transportation, and tourism sector is facing today is still the unknown. We haven't seen this fully play out yet. I was trying to book some travel this week for May and June, thinking maybe things will be settled down, but I wasn't willing to take the financial risk in case things don't. I couldn't find travel insurance, though. It's all been removed from the market. That's going to prolong things further for hospitality
For those that own hospitality assets and invest in that space, you need to step back and reflect on what brought you to that property type. Why? Where were you going into this particular period? The market had near record revenues per available room, average daily occupancy, and rental rates. It had a good run, so we were probably priced to a point not able to withstand any kind of disruption. When I look at the floors, I start to go back and look at things like replacement costs. What does it cost per room to still put a new hospitality asset back to work? I'm going to look at those prices. Whether I'm a hospitality REIT, hotel owner, or I've got properties, I want to negotiate with my lenders for some debt restructuring. I want to have a good focus. What is the replacement cost? Because that's going to be a threshold. If I start to go way below there, then I know either I have more room to fight or maybe it's gone too far. I can't get out of it. But I think there's a long way to go; we still don't know the psychological hit to the consumer and the traveler.
CIRE: Looking ahead to the longer term - across the board in all property sectors - what do you see as the next wave of impact on commercial real estate?
Conway: My biggest concern is on the capital side, because it's always the bankers that tend to freak out - and they freak out because their regulators freak out, so it's not always the bankers' fault. It's usually what the regulator does. We can look back to what happened in the 2007-2008 financial crisis and how things locked up. It took a long time for the banking sector to realize what to do with commercial real estate and housing, so I would be watching that. I would be making an extra effort to be communicating with investment partners, whether they're debt or equity, as to where they are and what they're thinking. I'd be looking at my capital structure. Do I have enough equity to ride out three months, six months, or a year?
Is there an opportunity with these low rates right now where banks are still willing to keep your line of credit active, extend it, or give you a new one? Maybe it would be prudent to draw down that line of credit to have the cash handy to be able to weather a longer storm. I think the next impact is really going to be on the capital side. I think we're going to see a pretty good spike over the next 90 days in CMBS delinquency rates. We've got down to record lows, but I think that's going to revert. I think the next property type that takes it as hard as hospitality is retail. Retail was already coming off a lot of distress. We had 9,300 store closings last year. We already had 2,000 store closings announced in the first six weeks of the year before this blew up. We're going to see a stratification between two types of retail. If you're in the retail sector and you own or invest in retail, begin to really think about segmenting your retail between that which is more consumer staple-oriented. By that, I am thinking of a Costco, a Walmart, a grocery store - because even if we're working from home, if we're self-quarantining, somebody has got to go and get those consumer staples.
The other is look at those that are more consumer discretionary. If I'm concerned about a layoff or less income, I'm going to cut back on the discretionary items. Think about a Target. I'd look at my portfolio and start segmenting those that are discretionary versus staples, like dry cleaners and hair salons.
For office, I think we're going see a slowdown in leasing and transactions. Companies are pulling back. They're canceling capex or canceling expansion plans. Companies that might have thought about expanding their square footage or doing a move are probably going to pull back. They're going to reassess how work evolves from what it did after 9/11 to what it's doing now in a public health crisis. I've had a number of clients tell me that they've got whole organizations and tenants in their buildings that are telling everybody to work remotely for the next two weeks to see how it works, what they need to do to create new business resumption practices.
Housing would also be on my radar. Right now, everybody thinks that housing is immune. I don't think we're seeing any slowdown in sales, traffic, or new home sale contracts. And my basis for that is I've touched base with a lot of public builders to ask them about their sales traffic reports. All of them reported very strong sales, traffic, and good contract writing. The banks are still doing mortgages. Freddie, Fannie and HUD are still open, accepting stuff. But here's where the complications come on the housing: All that stays great until we hit the wall where companies start laying people off. If you start to see the unemployment rate move from 3.5 percent to 4 and 5, that's that psychological impact that's going to affect folks. That's what may slow down the housing side. But remember, we still started from a shortage of housing inventory. We still started with elevated home prices. And so, this this may bring down some of the affordability issues. It may give time for inventory to come back in the market.
CIRE: What's your advice for all the commercial real estate practitioners out there? Is there a way to help mitigate the damage? I know you had mentioned the taking advantage of some refinancing. You also mentioned the differences in leases.
Conway: This is really why we should exist as professional associations - to give good advice. I would emphasize three things: Number 1 would be communication, Number 2 would be thinking strategically, and Number 3 would be remaining agile.
On communication, I would not sit back and hope my tenants are fine. I would not sit back and hope my portfolio is going to be unscathed. I would not sit back and hope that my lenders are happy and not going to start being inflexible or contracting my operating line of credit. I would communicate now. The banks are being given the most flexibility. They're being communicated to by the regulators saying don't do what you did in 2009. The banks want to hear from you. These are opportunities. They're more inclined to make a credit decision to keep your line of credit, renew it, open it, or give you some flexibility versus three or four months from now when you have a delinquent loan, a loan in the default, and the banks have to take legal action to protect themselves.
I'd communicate like the dickens with your tenants. Today, for example, I went to my dry cleaner, and I asked her how she's doing. She said all her business travelers haven't been in this week. Someone like a dry cleaner may be experiencing distress.
I would communicate with my banker. I would communicate with my tenants. I would just communicate across the spectrum.
Secondly, there's a lot you can do strategically when you're communicating. For example, your bank may be very amenable to expanding your line of credit or giving you one right now for this purpose. The president last night talked about working with SBA [Small Business Administration] to provide some loans for this disruption that the banks may be able to help you facilitate. I would be looking at that for multifamily. If you have student housing in a university, that will be shutting down. I would really be looking at those leases and seeing if you have cancelation clauses. But just sitting back and doing nothing is not a good strategy. Hope is a nice thing to have, but it's not a good business plan. So, I would say communicate, think strategically, and be agile.
CIRE: That's good advice. Turning to the supply chain, it's clearly disrupted at this point - probably the worst it's been that I can remember. What really needs to happen for it to recover? What can commercial real estate do to help ensure that this level of disruption doesn't happen again?
Conway: I've been trying to stay in touch with a lot of the port directors in places that have more direct exposure to Asia and China. Los Angeles and Long Beach are seeing an accumulation of empty containers and a decreasing flow of goods. We have longshoreman workers that are starting to test positive or be quarantined, so that's causing labor disruptions. In California, when they had longshoreman strikes in the past and vessels would sit backed up, they had this big surge and had to unload everything quickly. So, I think the West Coast ports, in particular, are going to be hurt.
Initially, we're going to have the supply chain slow down, and then we're going to have this huge surge when everybody starts to bring things back online. The good news is that we're seeing South Korea and China moving from almost completely idle to 20 percent to almost 50 percent capacity. That's good. We're going to see the flow of goods resume. But if we have hot spots at our ports, can we get those ships unloaded? Can we get those goods moved through the logistics channels into the marketplaces? I think we are probably going to see a disruption at the ports is into the summer. What I hope is that the good Lord is nice to us and we don't have an active hurricane season, because, boy, this is going to be one summer that we don't need an active hurricane season for our ports, particularly in the Gulf and the East Coast.
CIRE: We got a taste of it with tariffs - how interconnected the global economy is. What are your thoughts for how the industry can help kind of future proof itself from any future outbreaks of this or any kind of biological outbreak in general?
Conway: Over the last 18 months, I said the tariffs aren't going to cause a recession. We're going to work through it, and what's going to happen is corporations are going to figure out how to adjust their supply chain. Guess what? That's exactly what happened. We saw industry, business, and manufacturing move to South Korea, to Vietnam, to Mexico. And we saw companies figure out how to adjust the supply chain for the tariff issue. That's what we have to think through here. What are we learning out of a public health crisis? And this isn't only the last one. What are the choke points in our supply chain? I think we're going to have to revisit choke points and risks in the supply chain that emanate from a public health risk.
A worthwhile example to look at is the public health crisis from polio. The real outbreak of the polio epidemic came in 1916 in New York, and it brought to focus both on both sides of the Atlantic how bad this virus was. We had hundreds of thousands of kids being paralyzed each year, and it took us until 1955 to have a vaccine. And it took until 1994 for the World Health Organization to pronounce that the Americas were polio free.
I'm hopeful we're going to see an evolution in our food supply safety where a lot of these viruses emanate from. I'm also hopeful that we're going to see some evolution in the credit facilities and things like President Trump is trying to encourage right now with the Small Business Administration - to give people paid leave, to do some things with Medicaid for those workers that are on an hourly basis. The SBA wants to be able to keep good businesses going in a disruptive period. I'm hopeful those are the two areas we're going to work on. And in that, hopefully this thing goes dormant here when the warm weather comes.
CIRE: I think what we could all use right now is a bit of hope, because it's a bit overwhelming at times. Thank you for joining us, K.C. Fantastic insights, as always. And glad that you were able to share those and a little hope with us as well. It's always a pleasure having you on.
For more information on the pandemic, visit CCIM Institute's Coronavirus (COVID-19) Resources and Guidance page.
Editor's note: This article is an adapted excerpt from a full-length Commercial Investment Real Estate
podcast. Visit www.cirepodcast.com to listen to the full episode or stream wherever you listen to your favorite podcasts.