Waiting to See Which CRE Values Fall Victim COVID-19

Much attention has been paid to the devastating effects of the COVID-19 pandemic on income, unemployment and cash flow for businesses. But new research from Trepp takes an eye opening look at what the shutdown of many businesses may do to the worth of commercial real estate.

In a five-page report, the consulting firm takes a deep dive into how appraisals are calculated. It raises more questions than it answers. But it signals dramatic changes ahead.

“Market value is representative of a transaction where no exceptional factors influence the parties (buyers, sellers, lenders),” Trepp reported. “The concepts of market value as previously defined do not contemplate how short-term occupancy and revenue declines caused by external forces, beyond the control of the owner/property manager, should be treated by the appraiser. Until the pandemic surfaced, many commercial real estate property sectors were pacing above their previous year’s performance metrics. Employment and other market-level indicators such as interest rates and the availability of financing were favorable and readily available across all major metros in the United States.”

The pandemic turned all that upside down, along with just about everything else.

Among the types of properties whose valuations are likely to be most influenced by COVID-19 are lodging, retail and multifamily real estate, according to Trepp’s research.

“Lodging and retail properties have already had to face the immediate reality of lost revenues due to the pandemic,” Trepp reported. “Hotel operators in hard hit areas have seen occupancies plunge from their stabilized 70% range into the high single digits, or in some cases, have been forced to close their doors all together until the crisis subsides.”

In addition, data tracked by Trepp shows the percentage of lodging properties that did not make their April mortgage payment stands at approximately 20%, compared to the previous months where that percentage hovered around 2%. Retail properties financed using the same mechanisms that did not make their April mortgage payment hit 10%, compared to 2% in the previous months.

Conventional multifamily housing is still outperforming its counterparts “as of right now,” Trepp said. Forbearance programs have “provided a lifeline.” But lower rent collections now could translate into lower values in the future.

“Will these forbearance agreements impact the market value from an appraiser’s perspective? If the owner is not able to evict tenants for non-payment of rent, does the appraiser utilize the new lower effective rent calculations based off actual rent collections? Will sales prices be impacted due to the new owner’s potential inability to recoup deferred tenant rental payments?” Trepp asked.

Even more questions came up for operators of those increasingly upscale student housing properties near colleges and universities.

“If campuses remain closed for the upcoming 2020 fall semester, student housing assets are going to suffer loan defaults at an unprecedented level,” Trepp said. “When college students (and their parents) realize how much money can be saved by living at home or someplace cheaper than on/near campus, do those students decide to come back to amenity laden ‘student housing’ complexes?”

More questions abound for the office market, which awaits decisions by companies about whether to send their employees back together or have then continue working remotely.

“From an appraisal perspective this asset class is probably the most stable right now, but that can change rapidly over the coming weeks,” Trepp said.

But some office markets will be harder hit than others. Take Houston, for example. The Covid-19 caused oil glut has delivered a double blow, the report said.

Trepp concluded the report with advice to commercial property owners. “Be proactive,” Trepp said. “Try to adapt to this new normal in ways that would otherwise seem unconventional. Create revenue opportunities by looking at every possible alternative use of your asset. If you end up needing an appraisal, make sure you have your previous years’ financial statements in order, be able to articulate how you plan to make it past this crisis, and know what similarly situated properties are doing to weather the storm.”

Is it even necessary to say, “cut costs?” Maybe not, but Trepp offered some advice about that. “There has never been a more important time than now to prudently and actively manage your property’s expenses,” the report said. “Minimize all controllable expenses and make sure the appraiser knows how you intend to do that.”