While there is no one oracle at a time like this, we believe gleaning perspectives from a multitude of trusted partners and sources can better prepare us for both potential risks and opportunities. In addition to calling on Cadre's own trusted industry relationships - operating partners, lenders, brokers, consultants, and lawyers - we’ve been gathering information and perspectives from other industry leaders - including Green Street Advisors, McKinsey, Columbia Business School, CBRE, Cushman & Wakefield - to better inform our investment decision making. While discussing internally, we thought the below “notes from the field” might also be helpful for our investors:
Notes from the Field - Key Takeaways
Even real estate is not immune to a downturn triggered by a broad-based cessation in economic activity. The real estate world is awaiting rent collections in the first several weeks of April as a key indicator of the relative strength of tenants, their willingness to pay, and the challenges landlords may face in maintaining cash flows.
The commercial real estate debt market has been a tale of two cities. The public CMBS market has come to a halt, while the private debt market remains open, though volumes are low and lenders are very selective. In reviewing new deals, private lenders, while increasingly protective of their balance sheets, are keeping the dialogue open on existing relationships - so long as the asset isn’t in hospitality or retail. That said, debt brokers have been advising borrowers considering a new loan or refinancing to hold off for now.
Real estate price discovery has been challenging given the economic uncertainty and lack of meaningful transaction volume. In the interim, some market participants are using the public REIT market as a proxy for potential changes in private value. Adjusting for the impact of leverage, the ~35% overall selloff of REITs in the month ended March 16 would imply a ~25% drop in unlevered value as expected net operating incomes and cap rates re-adjust. Until more data addressing underlying sector fundamentals is available, however, it will be difficult to confidently establish valuation.
During periods of economic recession, lease duration is often thought of as a strong indicator of value, as longer leases imply more secure contractual income. This time around, however, the primary factor behind valuation adjustments has been the shutdown in economic activity due to “social distancing” and other containment measures. Asset classes that rely on human density and interaction, namely, hotels, malls, and co-working space, have been hit particularly hard. Similarly, urban downtowns, traditionally seen as premium locations, have been flagged by some as pandemic epicenters that may disproportionately suffer.
Technology is enabling behavioral shifts (e.g. work-from-home, e-conferences, online classes) that may extend post crisis. This moment may prompt us to revisit and more carefully assess what can be done remotely, and what needs to be done onsite. This could result in fundamental demand changes for certain property types, though it remains too early to forecast these more structural shifts.
Relationships matter and proactive communication is crucial. Real estate has always been considered a relationship-driven business and industry veterans, including our own, have emphasized the importance of strong partners during periods of extreme market stress. Proactively engaging tenants, lenders, and partners in constructive dialogue and adopting a problem-solving mindset can generate a win-win outcome for all parties.
Notes from the Field (continued) - by Property Type
Multifamily - While workforce housing has been a popular investment, lower-income families have been heavily impacted by record high job losses. As a result, multifamily assets catering to lower-income families are likely to see outsized rent delays or defaults. This trend will likely be reinforced by emerging tenant-relief laws. The CARES Act passed on March 27 for instance provides a 120-day eviction grace period for tenants in properties with federally backed loans. There are also proposals for more extensive relief, including rent “holidays” or suspensions. The scope and details of these more extensive programs are still unclear but landlords and tenants alike are closely monitoring further developments.
Office - It remains to be seen whether employers emerge from the work-from-home experiment fundamentally rethinking their usage of physical office space. Anecdotally, however, there remains a certain appreciation for the social element of physically working together with colleagues.
Hotels - General consensus is that some hotels may not survive, particularly highly levered ones with CMBS loans, also known in the industry as conduit loans. These loans, which serve as a common financing mechanism for hotels, tend to be more challenging to renegotiate than unsecuritized loans. For hotels that do survive, it may take one to two years to fully recover, if past crises like 9/11 and Zika serve as any indicator.
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