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CRE and Surviving The COVID Recession

August 26, 2020

CRE and Surviving The COVID Recession

Taking steps to evaluate the current situation and weather the storm

When it comes to hurricane season, Floridians know the drill: stock up on canned goods and water, fire up the generator for a test run, keep cash on hand, and ensure the storm shutters are in working order. It’s usually the same idea when it comes to weathering a bad economic forecast. For the most part, investors and tenants know the steps to take to somewhat manage an economic downturn. 

But hurricanes, as we all know, can be unpredictable—and the COVID recession is proving to be just as difficult to anticipate. The timing of a vaccine, lingering surges of infections, the prospect of a second wave, and the financial fallout of lockdowns and relief packages have resulted in the great unknown. And that, in turn, is creating uncertainty that surpasses that of the Great Recession.

A “normal” recession vs. a “new-normal” recession

Markets always go through cyclical changes, and these swings are usually separated into four distinct phases, with unique CRE impacts: 

  • Recession: In a typical recession, sellers have accepted the economic situation (at about the four-month mark), and it becomes a buyer’s market. Real estate prices start to come down. A few months later, foreclosures peak and prices bottom out, creating an excellent time to buy. Property values on both residential and commercial properties are severely impacted.
  • Recovery: This phase is marked by two consecutive months of decreasing unemployment numbers, declining rental rates, and a leveling off of vacancies. This phase’s beginning is pretty much rock bottom, still making it an excellent time to buy.
  • Expansion: Low vacancies, higher rents and values, and booming construction switch the market to a seller’s one. Good deals are still out there but require a bit more effort to find.
  • Hyper-Supply: The construction boom from above results in an abundance of properties combined with low rents and high prices—until these factors return to alignment. This is usually not the best time to buy. 

COVID-19, though, is making it difficult to predict any of these “normal” phases. 

The current factors are mixed. Technically speaking, for example, we have seen more than two consecutive months of employment gains. As of this writing, there have been four straight months of decreasing unemployment, from April’s astounding high of 14.7 million to July’s 10.2 million. But the combination of uncertainties, as well as a full recovery that may be dependent upon a vaccine, has made these “definitive” phases not so well-defined. 

Preparing for the long haul

The typical first step in grappling with a recession is determining what phase the economy happens to be in. But with so much uncertainty, that’s no easy task. 

With the onset of the school year and the potential for new outbreaks—as well as additional phases of reopening and closing—there’s a genuine possibility the market will behave more like a ping pong ball, bouncing back and forth between economic stages. 

But there are still ways to analyze the situation and take action:

1. Analysts have speculated about a V-shaped economic recovery (good) or a W-shaped recovery (less than ideal), with the shapes of the letters indicating the course of the economy. But it seems more likely that we’re in for a “K-shaped” recovery, where various sectors rise or fall based on fundamental changes to demand brought on by the pandemic. Thus, evaluate all CRE decisions based on your resources and the unique demand for a potential investment type.

2. Consider property improvements that make sense, if you can afford them. Some actions may not only help maintain the property’s value during a recession but also prepare for new tenant needs in a post-COVID world. Again, evaluate this through the framework of a K-shaped recovery; capital improvements in a smaller office space that make it safer for tenants are likely more valuable than doing anything to a large retail property.

3. Evaluate when and how to keep money on the sidelines, and when you should use it. This piece of advice is tricky, since trying to “time the bottom” of the CRE market is difficult to impossible. This maxim is especially true since specific sectors are trending upward, and we really don’t know what post-election economic sentiment and consumer confidence will look like. Also, record-low interest rates may provide a solid floor for property values. But this level may be broken if the broader economy, including the stock market, drops significantly due to longer-term factors. 

Thus, investors must again use the framework of whether an individual investment makes sense in a post-COVID world. Investing in a high-rise structure in an urban center is likely a bad idea, as social distancing requirements and a trend toward remote work make the viability of these properties questionable. Similarly, regional malls are probably big losers. In contrast, a modern office with a smaller footprint and great amenities may still make sense, and any well-located facility that can be used as an e-commerce distribution center is likely to do very well.

Evaluate each opportunity based on how it may play in the new economy—and deploy your capital wisely.

A final thought on getting through the recession and prospering on the other side of it

Perhaps no other bit of advice matters more than a reminder to be patient if you can afford to do so. The uncertainty of the pandemic demands a mid- to long-term view, along with the ability to adapt. 

Harbor enough liquidity to weather new challenges to investments that you maintain and scrutinize all potential opportunities in light of the pandemic’s significant social and economic changes. The advice that’s vital in any economy applies here, as well: base every decision on a diligent examination of potential ROI.

For assistance in determining how to proceed with an investment or to find the right property for your needs, call Morris Southeast Group at 954.474.1776. You can also reach Ken Morris directly at 954.240.4400 or via email at kenmorris@morrissegroup.com.

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