Domestic Affairs, Michael Burger
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Pandemic Proves to be a Watershed Moment for Real Estate

By Michael Burger

As the largest asset class in the American economy, commercial real estate holds a very important position in the success of the market. With COVID-19 upending the status quo as an economic black swan event, it is imperative to assess the impact it will have on various sectors. Commercial real estate specifically occupies a very interesting niche in the grand scheme of things. 

Where the stock and bond markets serve as leading indicators, real estate is a lagging indicator, meaning it takes longer for the space to respond to global macro trends. While the Fed can directly influence the real estate industry through stimulus and interest rate adjustments, the market still has a delayed response to economic downturns and experiences recessions in a very different way. We can expect to see the industry rally back to pre-COVID cap rates, cap rates being one of the real estate industry’s KPI’s and a measure of net operating income as a ratio of the purchase price, and property valuations to ultimately make their way back as well. But what can we expect in terms of transactional volume? Will buyers still be aggressive, and will financing terms be as favorable on the buy-side? Should deals be put on hold and liquidity be a priority? Will lenders follow suit? These are all crucial questions to assess when forecasting the future viability of commercial real estate. As a result, a deep dive into the last recession of this size, which is the great recession of 2007-2009, could be incredibly useful in speculating how real estate can thrive entering a recovery. While the circumstances of this recession are far different from that of the housing market crash, there are some interesting similarities and insights that can be gleaned from a closer look at the overlap between the two crashes. 

At its core, the Great Recession came as a result of banks lending to individuals who could not afford the loans being granted, displaying moral hazard in their debt placement. In an effort to spur growth, these stretched underwriting standards were seen throughout the economy. Banks were significantly overleveraged as a result of their lending practices and held more risk. Once the house of cards came crashing down and the inflated CMBS values were exposed as worthless, the distress rippled through the entire financial system and greater economy. Conversely, COVID-19 was a black swan event that brought a strong, growing economy to a screeching halt. While real estate should struggle, for the time being, the pandemic itself and downturn will not require the significant unwinding of bad loans that were destined to fail. The ‘08 recession demonstrated real estate market failure, whereas 2020 has had little to with the structural integrity of the industry at all. Now, let’s take a deeper look into how the market was fairing before the pandemic. Contrary to the 2008 recession, the commercial real estate industry was in a strong position before the onset of COVID-19. Firm’s balance sheets, capital availability, and liquidity were healthy; companies could manage their debt maturities to longer positions. In fact, one could argue that the industry was even healthier before this current downturn than it was before the ‘08 crisis. Per Deloitte Insights, debt service coverage ratios, a measure of a company’s ability to use its operating income as a means of paying off debt obligations, were much higher in the pre-COVID economy than that of circa 2007, as seen in the figure below:

Image source

Additionally, cap rates were strong across all property types, which is no longer the case by any means. The nature of this recession and its unprecedented effect on consumer behavior has crushed the hospitality industry, and the retail sector is hurting as well. Brick and mortar retail has long been threatened by e-commerce, but now more than ever with social distancing protocols limiting foot traffic and sales volume, the sector looks very vulnerable. This of course can vary from tenant to tenant, with grocery stores, pharmacies, and other brick and mortar tenants deemed more “essential” carrying the weight. In the real estate investment trust sector, Hotels have experienced a dip from 10.4% pre-COVID cap rates to an anemic .1% as of October 23rd, 2020. This sort of decline is extremely unhealthy and endemic to the circumstances of this recession. The economy didn’t change so much as life changed, and the future viability of hotels hinges on a vaccine, like almost every other sector of the economy, but also a considerable increase in confidence among consumers. It’s almost impossible to forecast how comfortable people will feel about travel and hotel visits in a post-COVID world, and even harder to predict what the continued effect of Airbnb and other similar business models will have on the hospitality industry. Additionally, there may be some permanent changes in consumer behavior coming out of the pandemic. Restaurants could face a similar challenge with regard to customers weighing dine-in vs. delivery options. As a result, developers should consider repositioning their portfolios to sectors with a healthier outlook, or maybe even redeveloping their current assets to better fit the changing times. 

Other asset classes like multi-family developments and industrial properties such as logistics centers, warehouses, and data centers have maintained their viability. The strength of industrial properties during the pandemic is directly related to increased e-commerce demand, and conversely the continued downward spiral of retail’s viability in what our new economy will look like. People will always need a roof over their head, and industrial tenants seem to be much more recession-proof than others. Offices, on the other hand, have a much murkier path moving forward. Work from home has brought into question the viability of office spaces, especially for tech companies where the nature of their work allows for the seamless transition from the office to one’s home. Companies like Twitter and Microsoft have made work from home a permanent option, with many other firms allowing for a return to the office no sooner than Q2 of 2021. Conversely, Facebook has secured the lease on a 730,000 square foot office in midtown Manhattan, showing a strong bet on the viability of offices moving forward. The lack of consistency shown between very similar companies shows just how hard it is to predict what the future of offices hold. Will people remain comfortable with the lack of a commute and the convenience of a work-day starting just feet away from their own bed? Or will cabin fever and isolation begin to wear patience thin among the population and catalyze a return to normalcy in the daily work routine? It’s too difficult to say, and it ultimately comes down to the priorities of different companies and the nature of their work. From a developer’s perspective, this sort of uncertainty is risky, as investments and ground-up developments often occur before a tenant can even emerge. 

Thankfully, the worst of the impact on real estate seems to have passed. The real estate investment trust indexes dropped much as 40% in March. On the finance side, the initial shock led to a complete freeze in non-government sponsored enterprise – Fannie Mae and Freddie Mac – lending and margin calls for many of the leveraged lenders. However, unlike 2007-2009, when Fannie Mae and Freddie Mac were deeply involved in the housing crisis, the GSEs have been active and positioned to provide continued liquidity for the housing markets, albeit with more structure. While the Fed’s actions have kept interest rates low to incentivize investment, the lending market will look different moving forward. While some lenders have slowly re-entered the market, most are taking a more “wait-and-see” type of approach. This means that transactional volume may slow down, but good deals are out there for the right asset class and right loan to cost ratio. Now more so than ever developers and investors will have to remain low leveraged not only to realistically receive loans from banks and other capital markets but to maintain their own liquidity. 

Historically in recessions banks can always be bailed out, for they are too big to fail. Tenants were allowed to halt rent payments in the peak of the COVID panic, in many cases seriously depleting cash-flows on properties of all types. If tenants stop paying rent, and the bank is always “insured” in a sense, developers have to maintain liquidity in order to have reserves for ongoing debt service payments. The landlord will always be caught in the middle of the two entities with a higher amount of pressure to perform. It puts real estate players in a very precarious position, but it remains a possibility as retailers go bankrupt and unemployment remains high. 

Like in anything, the smart and well-calculated actors will always have a shot, and in the case of real estate, there are still plenty of viable opportunities for growth coming out of this recession. Some developers will have to explore outside of their comfort zone, others can keep doing business as usual. The industry seems to have experienced some very permanent changes, but this doesn’t necessarily affect the viability of the entire asset class. Ultimately, the vaccine developments in the coming weeks will be very telling in terms of gauging consumer confidence. The virus is at the center of the world’s attention right now, and hopefully if it is dealt with many industries will self correct and regain form as crucial cogs in a once thriving economy. Yet even more pressing given the vague timeline surrounding our collective recovery from COVID-19 is the upcoming presidential election. The two very different platforms of our candidates present many different potential outcomes concerning the commercial real estate sector. As the pandemic and election narratives continue to unfold, the industry will likely look even more different in the coming months that it already does today. □

Work Cited

  1. Image source: ratpack223/iStock; tomertu/iStock;
  2. Berry , Jim. “COVID-19 Implications for Commercial Real Estate.” Deloitte Insights, 2020,
  3. Gujral, Vaibhav, et al. “Commercial Real Estate Must Do More than Merely Adapt to Coronavirus.” McKinsey & Company, McKinsey & Company, 30 June 2020,
  4. Geiger, Daniel. “Facebook Just Reached a Blockbuster Deal to Lease the Massive Farley Building in NYC as a Tech and Engineering Hub. Here’s Why It’s a Huge Win for a Shaken Office Market.” Business Insider, Business Insider, 3 Aug. 2020,
  5. Gujral, Vaibhav, et al. “Commercial Real Estate Must Do More than Merely Adapt to Coronavirus.” McKinsey & Company, McKinsey & Company, 30 June 2020,
  6. Williams, Charlie. “COVID-19 and CRE: 2020 vs. the Great Recession.” Colorado Real Estate Journal, 2 May 2020,

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