Just when we were seeing the light at the end of the tunnel, along came the Delta Variant of the Coronavirus, and “Bamm!”: here we are again with an exponential increase in the infection rates and the filling of hospital beds nationwide. To further complicate matters, there are ample reports of “breakthrough infections” of fully-vaccinated people coming down with Covid. This situation begs the question of “are we headed back to Spring 2020 or is this just another bump in the road on the return to normality?” Is “normality” now a completely abstract concept, or is it a fond memory of where we were two years ago? The best way to analyze the effects of the Delta Variant on the Commercial Real Estate (“CRE”) industry is to look back to where we’ve been and where we presently are in order to manage our expectations for the future.
CRE Lending Becomes Selective
Back when we were beginning to thaw out from Winter 2020, the onset of Spring brought some odd news from China: a new highly infectious flu was rapidly spreading through Wuhan, then the remainder of China, and then Asia in general. First thoughts were that this was just another SARS until it showed up in Washington State, and started spreading throughout the United States. The entire nation quickly shut down, the equities markets tanked, and the flight to US Treasury securities caused a yield level less than 1.00% for the first time. CRE lending came to a halt, particularly the CMBS sector, and acquisitions were either postponed or abandoned.
“There is a feeling that the entire nation is treading water waiting to see what happens. The same holds true for CRE owners…”
The Hospitality Industry
Many existing loans on CRE quickly became financially-challenged with the Hospitality and Retail sectors being hardest hit. For Hospitality, travel came to a full stop, and many properties were mothballed for numerous months until leisure travel started to return in 2021 but with Average Daily Rates still significantly below their peak in 2019. Business travel remains to be next to nonexistent, and per our research on Trepp, many hotels that are heavily-reliant on business travel have Debt Service Coverage Ratios significantly below 1.00X. Owners simply have to feed the debt service until they no longer can while hoping for better days.
Retail & Restaurant Businesses
Retail took it right on the nose as well. Lots of restaurants and mom-and-pop shops closed and vacated, and national chains like Pier One shut down completely, so the retail owners’ cash flows were significantly impacted as well. Can the retail sector afford another slowdown or shutdown? Faced with the challenges of on-line sales, lack of workers, and rising costs, any further disruption without more government financial intervention may cause a collapse.
Office Sector
To date the office sector has felt the effects of the Global Pandemic, but to a lesser extent than in Hospitality and Retail. The unfortunate sleeping giant for office is the “working from home phenomenon.” A generic 10,000 square feet tenant is still paying rent and not stressing the property’s cash flow until the renewal comes up. It is not hard to imagine a conversation with the landlord along the lines of “well, now that we have a significant part of our staff working from home, we need to downsize to about half our current footprint.” The landlord is over a barrel because does he want to lose the income on 5,000 SF or does he want to lose the income on the full 10,000 SF because he says “no,” and the tenant moves out? The office situation definitely falls in the to-be-determined category.
And Unclear Future Ahead for CRE Owners
Returning to the present, as vaccinations became widespread through Spring and Summer 2021, it looked like the U.S. had the Covid situation under control until the Delta Variant appeared. It is my perception that restaurants are still operating at 100%, and shops vary from “unvaccinated people must wear masks” to “masks required.” There is a feeling that the entire nation is treading water waiting to see what happens. The same holds true for CRE owners because what else can they do other than wait just like the rest of us. We’ve all heard the adage that “hope is not a strategy,” but being prepared to navigate through the foggy horizon and being proactive to work with your Lenders on your loan so you will have flexibility is.
