As COVID-19 continues to ravage the U.S. economy, real estate investors are looking to potential opportunities as businesses continue to reopen. In this search, we can look to the global financial crisis for instructions on where to look for opportunities and what type of opportunities will be available. However, the COVID-19 impacts are different from the global financial crisis and these opportunities will evolve in an unprecedented manner.

Questions hang in the balance. How will the current pandemic differ from the global financial crisis? What impact is COVID-19 having on specific real estate sectors? Which assets will be fertile ground for opportunities in the new normal.

GLOBAL FINANCIAL CRISIS 2.0

To look forward at the current pandemic, we must first look backward for lessons learned from the global financial crisis. The global financial crisis was triggered by a collapse in the financial sector and affected almost all property types, with some exceptions. Driven by excessive speculative debt, the residential loan marketplace shut down, the CMBS markets, a $10 trillion market, went to zero. Banks, typically community-level banks or a handful of speculative lenders, carrying debt it could not sell and defaulting buyers led to failed banks, which led to bank takeovers and afterward led to a flood of special asset properties. At that time, speculative buyers looking for deals had bank special asset directors on speed dial and, depending on the timing of each quarter, could expect offers of properties at discounted values as banks looked to remove nonperforming assets from their books. The impact was uniform and the source of opportunities was mostly centralized.

The pandemic on the other hand is a different animal. The virus presents very specific challenges that are not driven by the financial markets; in fact, the financial marketplace is strong, and certain assets are succeeding more than others. As shown by the parties who received federal program loans, community banks were the main lenders for loans that were given mostly to their current customers. As a result, we are not seeing an onset of distressed asset transactions as we did in the global financial crisis. Rather, given the nature of the pandemic and the availability of financial support through the CARES Act and related stimulus funds, lenders are in a “pause” mindset, as opposed to a panic mode. Moreover, the larger banking institutions were doing very well before the pandemic and have the resources to weather the temporary pain. Furthermore, if you were a trusted party, loan funds are still available.

So, if the financial marketplace is not the source of opportunity like in the global financial crisis, where will the opportunities lie?

COVID-19’s IMPACT ON THE REAL ESTATE MARKETPLACE

The opportunities will be found by briefly analyzing how the pandemic has affected each real estate sector. Although a vaccine is not available and the COVID-19 pandemic is actively impacting the United States as of this writing, we can already determine the material impacts the pandemic is having on certain sectors. As a short but important list: 1) the food and beverage business was negatively affected on a short-term basis but looks to rebound as soon as businesses can be safely reopened; 2) the retail sector will take a financial hit in the short and long term as the old ways for retail shopping will not work in the same way under current guidelines; 3) the office sector will be negatively influenced in the short term and potentially in the long term, depending on how permanently office users decide to shift to a work from home model or modify their premises permanently to adopt to workplace changes; 4) the industrial sector has garnered the benefits of the general public’s shift to online retailing; 5) the hotel sector will be gravely impacted on a short- and long-term basis as travel is close to nonexistent and hotels are not built or sited to comply with current guidelines; and 6) the multifamily sector by our experience has been neutral, depending on the region or resident income level. Within the context of the sectors affected by the pandemic, we can predict where real estate opportunities will be available.

IDENTIFYING OPPORTUNITIES

Considering how the impact of the pandemic differs from the global financial crisis and that retail, hotel and potentially office sectors will be the sectors most damaged by the pandemic, we can quickly identify that the opportunities will be in these sectors and not as special asset opportunities but as distressed assets, short sales, or loan purchases and workouts. A typical deal in these sectors, if income-producing property and not a development opportunity, will be structured as a large, first position CMBS or institutional-level debt instrument with debt service-coverage ratios that must be met to remain in good standing. Assuming a negative short- and long-term outlook, distressed owners will be first looking to salvage equity by negotiating a sale with the lender taking an agreed write-off of debt in order to allow for the “short” sale of the property to the new buyer. In the alternative, the loan will go into default and the lender will be looking to assign its debt, either at a discount or at par, with the buyer’s goal being a future workout with the owner to take over the property or step in as the foreclosing party. Given the longer-term outlook of these markets, lenders will not want to have these assets on their books.

A CLOSER LOOK AT CERTAIN ASSETS

In surveying the current marketplace, early predictions are that hospitality assets in urban centers will be the first to present investment opportunities. Hotels and retail businesses in traditional downtown areas, especially in cities that have been identified as hotspots of the pandemic, will have the greatest challenges. The location of these properties, as well as their reliance on business travelers and hosting special events such as business conferences, will require property owners to consider transferring the asset at a discount. Owners of these types of properties must be proactive and contact their lenders immediately and engage in discussions with brokers before it’s too late. Opportunistic owners will be able to exit their properties without dealing with a distressed situation, and, quite possibly, use any equity they are able to salvage to find similarly situated properties at a discount.

CONCLUSION

For parties that have the means to take advantage of opportunities presented by the pandemic, we expect abundant deal flow. However, in order to take advantage of these opportunities, it will take an investor or a fund that has a tolerance for “hair” on a deal, the capability to source and close deals from unpredictable directions and complete deals in unconventional ways. Similarly, those investors that have patience for certain sectors to rebound in the long term will be rewarded. Not every investor will have the team to understand and complete these opportunities, but the ones that do will thrive.

Louis Archambault is a partner and Luis Flores the managing partner in the Miami office of Saul Ewing Arnstein & Lehr.