COVID-19 Impact & Road to Recovery - Commercial Real Estate
While we are #allinthistogether, we are not all impacted equally. The same applies to commercial real estate property types and markets throughout the US. In summary, to state the obvious, those property types and markets that accommodate essential service businesses are less impacted than those that are reliant on travel, leisure, entertainment and other non-essential businesses.
It is a bit premature to definitively predict the extent of fallout and impact to any market as Quarter 1 market data shows a far rosier picture than that of what we can expect from Quarters 2, 3, and 4. We can definitively say that the longer we stay in this state of suspended animation and self-imposed economic retraction, as a result of the shelter-in-place directive, the deeper the impact and the longer and more expensive the road to recovery will be.
A few key variables to watch that will likely shape the impact to any specific market are:
1) Density of non-essential businesses;
2) Unemployment (and layoffs vs. furloughs);
3) Cash Reserves;
5) Supply chain disruptions / port activity; and
6) Follow-up legislative action (namely bills that impose expanded or new taxes) in response to anemic tax revenue.
Considering these variables, markets with a high concentration of high-bay distribution space that accommodate e-commerce and omni-channel retailers, won’t suffer as negative an impact as those that consist predominately of regional draw retail, hotel and entertainment, or non-essential business service office.
Since mid-March of this year, more than 3.1 million people have filed for unemployment in California. This eliminates the total number of jobs added since 2010. That’s 10 years of job growth wiped out in a matter of weeks. The unemployment rate jumped from 3.9% to 5.3% from February 2020 to March 2020 (according to the Bureau of Labor Statistics), which is the sharpest increase since the mid 1970’s. With the latest round of layoffs and furloughs we anticipate the unemployment rate to double, if not triple from its March mark.
Through an analysis of about 600,000 businesses, JPMorgan Chase found that the median small business has only 27 days of a cash reserves. This number falls to 16 days on average for restaurants, 19 days for retail, 30 days for healthcare, and 32 days for high-tech manufacturers. Without substantial government intervention, a 30-day closure could bankrupt over 50% of small businesses. This would have lasting implications to vacancy in most California markets.
Non-essential retailers without a strong omni-channel presence, especially e-commerce sales, whose pre-pandemic sales were suffering and with loan maturities approaching, could likely be pushed into bankruptcy. True Religion filed for bankruptcy protection earlier in April, and JC Penney and Neiman Marcus have purportedly been discussing bankruptcy also. These larger department store retailers typically employ 100+ employees at a single location.
While most industrial/warehouse space continue to see strong leasing and sales activity, disruptions in supply chain and port activity have slowed production for manufacturers. From March 2019 to March 2020, the Port of Oakland reported a 10.3% decrease in import volume, 5% decrease in export volume, and 23% decrease in empty container returns. Much of this decline in activity can be attributed to similar market shutdowns in response to COVID-19 in Asian trade countries. Most Bay Area markets maintained less than 6% vacancy even with well over 2 million square feet under construction.
As budgets wane from a rapid reduction in revenue, it is likely most local municipalities, school districts, and State agencies will craft new resolutions and legislation focused on enhancing and creating new tax revenue streams. Depending on the extent of such initiatives, the impact can vary widely. One example, already proposed for the November 2020 ballot, is the California Schools and Local Communities Funding Act of 2020 (click photo for more information), which would effectively remove Prop 13 protections for most commercial and industrial properties, increasing the property tax burden on many California businesses and landlords large and small already trying to recover from substantial lost revenues. (property taxes are commonly passed through to tenants).
Businesses and financial systems cannot function in a world made of uncertainly. In the absence of a clear strategy and time-frame for restoring unrestricted economic activity, businesses will continue to layoff or furlough employees, consumer spending power will wane, businesses will burn through cash reserves, bankruptcies and foreclosures will ensue, and lease defaults will occur followed by evictions once the Moratorium is lifted and courts resume services.
Based on the market variables mentioned above and data we track, we estimate that for each month of economic stagnation, it will take 3 months before variable numbers reverse course and start to rebound in a positive direction. It is important to keep in mind however, that not all businesses or markets are impacted equally, and you should consult with your broker, real estate advisor, or city or regional Economic Development professionals for a more comprehensive overview of the impact to your local market.