The future of real estate in a post-pandemic America
- May 1, 2020: Vol. 7, Number 5

The future of real estate in a post-pandemic America

by Keith Black

I know that some of the most dangerous words in investing are “it’s different this time.”

I know that the 1979 Business Week cover story on “the death of equities” has been mocked for most of the past 40 years. I know that 2008 was primarily a financial and real estate crisis and that home prices and stock prices made new highs after six years.

But I will say it anyway: What if it’s different this time? What if this is the death of real estate? What if American, and perhaps global, consumers change their ways of thinking to more closely match the Great Depression. Yes, that Great Depression of the 1930s.

Mark this date, March 26, 2020, when the number of unemployed Americans rose by more than 3.2 million in just one week, increasing the unemployment rate from a very low 3.5 percent in February. The previous weekly record was less than 700,000 in October 1982. Worries are that jobless claims can rise by more than 1 million a week until the pandemic passes. In the Great Depression of the 1930s, unemployment reached nearly 25 percent, up from 3.2 percent in 1929. It took from 1930 to 1932 for U.S. GDP to decline by 25 percent. Estimates of second quarter GDP in the United States are as high as a 20 percent to 50 percent decline in economic activity. The stock market decline in March 2020 was the fastest drop since 1931.

Of course, most market participants expect a strong recovery once the virus has passed and both consumers and employees come out of their isolation. This expectation of a strong recovery has a key assumption. Once everyone is healthy again, consumers will continue to have both an ability and a willingness to spend. I don’t think this is true, and the implications for global real estate are dire. Perhaps even more dire than the 46 percent drawdown experienced by U.S. REITs from Feb. 24 to March 23. What if this drawdown in REITs actually underestimates the hurt coming to the commercial real estate sector in the coming months and years?

The National Association of Realtors estimates median vacancy rates in third-quarter 2019 as 5 percent for multifamily, 5 percent for industrial, 9 percent for retail and 10 percent for office. Both vacancy rates and cap rates have steadily trended lower since the 2010 recovery from the global financial crisis. Many might forget that industrial, retail and office vacancies were 15 percent to 20 percent in 2010–2012.

The outlook for multifamily housing closely follows employment and household formation trends. As unemployment rises and incomes are less secure, household sizes remain large or even increase while the formation of new households slows. At the end of one of the strongest economic decades in history, Bankrate notes that 28 percent of American consumers have no savings, and another quarter have less than three months of income in savings. Only 18 percent of Americans can live off of their savings for six months. With a GDP decline of 20 percent to 50 percent in second-quarter 2020 and an unemployment rate likely above 20 percent, many of those currently paying rent or a mortgage will find it challenging to remain current on payments, especially among the 53 percent of U.S. consumers who have less than three months of living expenses in cash. I anticipate a 20 percent rental or mortgage delinquency rate for 2020.

How about the retail and restaurant industry? At year-end 2019, U.S. shopping mall vacancies hit nearly 10 percent, the highest level since Reis started collecting data in 2000. Coresight Research notes 9,300 U.S. store closures in 2019, while some believe that bankruptcies of retail chains can triple in 2020. According to FSR and IBISWorld, 80 percent of restaurants go out of business within five years and 67 percent of the cost of a full-service restaurant goes to wages and food costs, leaving just a slim 6.2 percent margin after occupancy costs. After being closed for less than two weeks, Cheesecake Factory told their mall landlords that they cannot pay rent on April 1. Let’s take an optimistic view that the quarantines and lockdowns start to subside in May 2020, meaning that retail stores and restaurants had nearly three months of near-zero sales. Importantly, those with sales were likely dominated by revenues from delivery, takeout and online sales. In the long run, these types of mobile sales have a much smaller demand for real estate space. My personal estimate is a 30 percent vacancy rate of U.S. retail and restaurant space by year end.

Finally, consider the market for office space. This market is dominated by higher income, white collar workers who are more able to work at home than the retail, restaurant, service or manufacturing workforce. During the current slowdown, record numbers of professors and students, bankers and lawyers, and computer programmers are setting up a home office and learning how to use tools like Zoom, Skype, Teams and Slack. While telecommuting trends have been slowly building for years, the majority of the white collar workforce now has been forced into a work-at-home experiment. Here is where I ask, “what if?” What if the white collar workforce likes working at home? What if white collar employers find that their employees have similar productivity working from home as they previously did while coming into the office? What if the employers of 20 percent of the white collar workforce extend the working at home experiment to the end of the year or even longer? If the work-at-home trend accelerates, this will have a negative demand for office space, especially in the highest cost cities. If white collar employees can work from home indefinitely, they have little reason to continue to live in cities such as New York and San Francisco that have high housing costs, long commutes and high-income tax rates. So, the exodus begins to warmer, hipper climes with lower taxes, such as Austin, Columbus, Nashville and Orlando.

That covers the ability to spend. What about the willingness to spend? What if consumers adopt the mindset of the Great Depression en masse? With constrained incomes, families during the 1930s cut their consumption and reused/recycled/repaired and bartered whatever they could. Rather than the disposable culture of the past 30 years, every item was reused and treasured until it could no longer function. Even when those families reached the prosperity of the post-World War II era, they continued to be known for their frugality, savings and most importantly a reduced willingness to spend money. If another recession is coming, if another pandemic is coming, if government bailouts are fading, if we don’t trust pensions and Social Security to be there for us, let’s save a bit more and spend a bit less.

Spend a bit less at the movie theaters. Spend a bit less at the retail stores. Spend a lot less at restaurants. Let’s not go to the mall anymore, after one-quarter of the stores closed after the Covid-19 pandemic. Let’s work from home. Get closer to our families. Take more walks. Commute less. Learn to cook and frequent grocery stores rather than restaurants. This fits the ESG mindset, which is more common with millennials than boomers. What if working at home means less pollution and the slowing of climate change? What if buying 20 percent less clothing reduces landfill waste? What if I can pay off my student loans faster if I cut my spending in bars and restaurants by 20 percent? The next time a downturn comes, it would be good to have some cash to tide me over.

I hope that I am wrong. But I would be afraid to be a real estate investor if I am right. I hope my tenants pay their rent on April 1. If they don’t, my family and I will be skipping more than a few restaurant meals.

Real estate could be forever changed by this pandemic. A sea change could be upon us. Remember, it is both the ability and willingness to spend that hangs in the balance. Look out below if a depression mindset, soaring unemployment, reduced long-term marginal propensity to consume, or even a millennial mindset of reducing economic activity to save the planet start to take over. It would be almost as though the economy caught the virus long after the hospitals have recovered.


Keith Black is managing director of content strategy at the Chartered Alternative Investment Analyst Association.

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