While sectors start to reopen with caution, questions remain.
By BB&T and SunTrust, now Truist
As the majority of offices shuttered for the spring to allow employees to work from home and safely socially distance, the commercial real estate market came under intense focus. And while sectors start to reopen with caution, questions remain. We spoke with three experts with SunTrust Bank, which has merged with BB&T to become Truist: Head of National Real Estate Adam Oates, Head of Real Estate Corporate & Investment Banking Kris Dickson, and Head of Truist Community Capital (TCC) Keitt King for their perspectives on where the market is headed next.
Q: What’s different about how the current financial recession is impacting commercial real estate compared to the 2008 recession? Is anything similar?
Oates: One thing I would highlight is the suddenness and severity to this particular downturn. When you look at a sector like hospitality, which has been hit maybe the hardest and fastest, you went from full occupancy to single digits in a matter of weeks. There’s just no blueprint for that.
Dickson: The root cause of this pullback is clearly very different than what we experienced in 2008. Further, the pace and volume of Covid stimulus activity by policymakers have been significant, and we’re not faced with the supply headwinds from new construction stock that we had in 2008. So this recovery should be quicker, though some of that’s obviously predicated upon the timing of a coronavirus vaccine and keeping us from having a resurgence of Covid cases. Similar to the prior downturn, we’ll likely see downward pressure on values and occupancy levels for most CRE property types. Overall, this shouldn’t be to the same order of magnitude as the prior recession, as a result of getting the economy back on track sooner; however, there will be dispersion across asset classes, and it’s not going to be an overnight recovery by any stretch.
King: I come from the affordable housing angle, a very specific subset of CRE. When I think about the last recession, one thing that’s the same is our business is really driven by corporate earnings and associated tax liability. In 2008, as the recession continued, we saw the overall tax liability shrink. While a similar trend is happening now, it’s very hard to project the length of this downturn as a health crisis of this magnitude. And its impact on the economy and overall earnings is such an unknown. You’re seeing the market for tax credits start to pull back because of the belief that taxable income is going to come down over time. We just don’t have a good sense of how much.
Q: Are there existing trends that may have been accelerated because of the pandemic?
Dickson: Some of the trends we’re seeing in retail have been accelerated. Shopping malls in particular were in the process of reimaging their space and planning for the future, and that’s certainly being pulled forward by what we’re going through right now.
Oates: Even as things start to open, it appears there may have been a sea change in how much we buy online and how much we go out. The repercussions of less demand for physical retail space and higher demand for industrial logistics-oriented real estate are substantial. And we see investment dollars flowing in a way that reflects that shift already.
Dickson: For industries that were hardest hit, like hospitality, revenue projections are clearly going to be down for the foreseeable future. But if you look at changes that may have come about due to Covid, like increased adoption of mobile check-ins and more limited housekeeping, those introduce some cost efficiency, which not only counterbalance some of today’s negative impact to revenue, but also could stick around longer.
Q: What potential shifts do you see for professional office space?
Oates: If you look at most of the space we built out over the past 10 or 15 years, most organizations were focused on densification and efficiency. That just turned on its head because the space that was built for 120 people might only work for 80 or 100 if we account for new sensibilities around the amount of social distance we should maintain at work. That would suggest a demand for more space. Having said that, a lot of organizations are looking at the success of working from home, and it seems clear many firms are going to rethink the necessity of being in the office for a lot of our teams.
Dickson: I’m of the opinion the office will have a permanent place in corporate America, even if employees aren’t there every day. We’ve all made remote work a good solution for the short-term, but I think there’s a benefit to culture, camaraderie, communication, innovation, and employee development / career-pathing that comes from being together in person.
King: I go back and forth on that. I see a shift that makes a lot of sense, and surveys have indicated pretty resoundingly that people like the idea of working from home, particularly until such time as we see a vaccine or some sort of cure. But I also realize some people, especially younger employees, need the benefit of face-to-face interaction to help them build up their capabilities, their network, and really help them from a career perspective.
Q: What have some of the immediate impacts been on housing development?
Oates: Multifamily housing, I would say, has experienced an overall better collection rate than we would have anticipated. Having said that, there’s a lot of stimulus in the economy right now that may be artificially holding that number up. The big question is, “What happens when the stimulus money runs out?” Ultimately people still need a place to live, so multifamily traditionally has been the more resilient property type. However, starts are down significantly as all parties take stock of new pricing for capital and goods as well as consumer expectations.
King: The affordable housing sector actually held up really well during the last recession. But, we may see some level of stress in the portfolio this time depending on how long the impacts of the pandemic last. This is because of job losses in the service sector, which employs many affordable housing tenants. That’s one thing I think is a little bit different in our space now. We’re seeing a disproportionate impact on the beneficiaries of the affordable housing we finance. But we’re also seeing efficiencies now — apartments leased without anyone setting foot in the apartment and handling all the paperwork in a contactless way.
Dickson: We also see homebuilders gaining efficiency — they’re selling homes entirely virtually. A couple of our builders in recent months have sold 15% to 20% of their homes that way. Closings are taking place in a contactless and digital fashion now, too, with the benefit of e-notaries. Obviously, that’s more convenient for all parties involved.
Q: Do you anticipate any long-lasting effects on the CRE industry?
King: We don’t know how long some of these trends will last, so it’s hard to say. In the affordable housing space, and in the multifamily space as well, there was definitely a movement toward public transit-oriented development, where you’re trying to build a lot of dense properties near public transportation. That’s the sort of transportation nobody wants to take right now. Now, I don’t know if that will continue to be the new normal. I hope not.
Dickson: The last recession changed our financial situation and what we were able to do, but this one’s changed how we exist. We’re working from home, buying groceries online, seeing our doctors via our iPhones, and socially distancing. I don’t believe how we’re existing presently is our new normal, but I do think our next normal will have some differences that have resulted from this pandemic.
Q: Finally, what can companies do to set themselves up to emerge successful from this crisis?
Oates: Liquidity is going to facilitate the ability to withstand some of the bumpiness as well as take advantage of some of the market disruption. We saw that in 2011 and 2012. Those who came into the last downturn with strong balance sheets and, in particular, liquidity were acquisitive during that time and able to buy properties at a substantial discount.
Dickson: I agree. And I also think it’ll be important for companies to embrace the fact the world is changing. Disruption creates opportunity and the chance to innovate. Not being led to a “this is the way it has always been” assumption is definitely going to be an important trait.