Recovery from the COVID-driven recession likely won’t be linear, and the commercial real estate sector could be in for some volatility in the coming months.
There’s no doubt many businesses are feeling COVID-related economic struggles because of issues like high unemployment, social distancing rules, the changing workforce, and limited population mobility.
The economy will recover from this, but we don’t know how long it will take or its long-term effect on all sectors. Much of the rebound will depend on the vaccine roll-out and how quickly life returns to normal once the pandemic is over.
Here’s a look at how the recovery could play out and the influence the pandemic may continue to have on the commercial real estate industry.
The alphabet of recovery scenarios
We don’t have a full picture because economic growth will depend on the vaccine roll-out’s speed, the spread of new variants of the virus, and potential government interventions. Recovery could also vary by industry—hard-hit sectors like hospitality businesses are probably in for a longer haul than specific retail companies.
A visualization of the overall economic recovery can take on many different shapes:
The Z-shaped economic recovery is when a temporary boom follows a quick downturn as people are allowed to get back out. After that, there’s a return to “normal” pre-pandemic levels.
A V-shaped recovery occurs when there’s a downturn, followed by a quick return to pre-pandemic levels. It’s like a Z, but the temporary boom isn’t all that temporary.
With a U-shaped recovery, the recession lasts longer than with a V-shape before a gradual upturn occurs. A “swoosh-shaped” recovery is similar, except the economy bottoms out for a bit longer before slowly returning to norms.
Perhaps the most volatile recovery is a W-shaped one, which would see the country start to recover, only to have the bottom fall out again. It would then inch toward pre-pandemic levels long-term.
The worst-case scenario is an L-shaped recovery, where we stay in a lengthy recession with no recovery in sight.
Finally, there’s what we believe may happen, particularly for commercial real estate. In a K-shaped recovery, some sectors recover quickly and enter a boom period, while others struggle for the foreseeable future.
Opinions on where we’re headed vary, although a K-shaped recovery is occurring, to some extent. A V- or U-shaped recovery could also be in our future, but that’s likely dependent on a swift vaccine roll-out for the entire country.
Potential risk factors
Of course, the country’s economic recovery is dependent on many different elements. After all, the virus remains part of our everyday lives for the time being, limiting activities in every sector.
One significant risk factor is virus mutation. With new strains and variants emerging from places like the UK, Brazil, and South Africa, COVID cases could increase substantially before a widespread vaccine roll-out. The existing vaccines might not be as effective against these new variants either, slowing down economic recovery even further. COVID variants becoming a significant issue could drive a W-shaped curve.
Rolling out a vaccine to 330 million people was always a logistical challenge, and that has not changed. It will take some time to get enough individuals vaccinated to defeat the virus, and there could be supply chain problems like we’ve seen in Europe and Canada, too. Delays to the roll-out could slow recovery in the coming months. A lengthy delay could bring about a U-shaped economy, with a worst-case scenario turning it into a W or L.
In addition, there’s uncertainty surrounding how lenders and the government will handle foreclosures and debt service. From a commercial real estate standpoint, there are many empty retail and office buildings and many more tenants who have taken on significant debt to stay in their facilities.
Lenders will want to avoid mass foreclosures, but that might not be possible without government money coming in to support them. And widespread foreclosures and bankruptcies could cause a W-shaped recovery.
What this all might mean for commercial real estate
Much like everywhere else, there’s a lot of uncertainty surrounding commercial real estate. Big banks are currently holding over $2 trillion in commercial real estate loans, and the losses they absorb from those who default could hinder the entire economy.
Office space drives much of the commercial real estate sector, and it is experiencing rising vacancies and falling rents overall. If these results hold, office property values—specifically in specific configurations and areas—could decline significantly, with hotels and various retail buildings falling even further.
There’s hope that a swift vaccine roll-out will convince consumers and businesses to return to their previous habits, like dining out, buying at stores, and working in downtown offices. But there’s no guarantee.
That said, one of the hallmarks of a K-shaped recovery is that certain sectors will thrive—and are thriving. Warehouse space that underlies e-commerce, big-box retail that sells essential goods, and even office space in certain areas (like the suburbs) either may do well or are already seeing great returns. By carefully choosing investments, there are paths to navigate the COVID CRE economy successfully.
Getting the right advice
Since CRE and the economy remain uncertain—and the trend could continue for some time, it remains crucial to evaluate each potential investment and property carefully.
Morris Southeast Group can assist as you assess the best course to take during changing conditions. For investment or commercial property advice, give us a call at 954.474.1776. Ken Morris is also available directly at 954.240.4400 or kenmorris@morrissegroup.com.
