COVID-19 Impacts on Real Estate

These are unprecedented times as the impacts of COVID-19 (coronavirus) evolve at a rapid pace. Our Metro DC Avison Young Team has been engaged with you, assessing the impacts of this pandemic on the regional real estate market. We are committed to you and always available to you. We hope you find our latest insights valuable.

Uncertainty is weighing heavily on Metro DC investment sales activity. Buyers, sellers and lenders have delayed, if not rethought or even discontinued, their investment strategies amid this turmoil. For those investors that have chosen to carry on as planned, mandated social distancing and telework present substantial obstacles to appraising and inspecting buildings, negotiating deals, securing loans and otherwise piecing together a successful acquisition, disposition, financing or refinancing.

Sellers are hitting pause on their active and upcoming listings due to the decline in the economy and leasing market. With those corrections, a subsequent asset re-pricing has or will occur ahead. As a reference, in the last downturn, regional pricing declined by 20%. From an offering perspective, in mid-March, nearly 22 million sf of office product was on the market for sale or expected to be coming to the market for sale within months, but that number will dramatically decline in the next few quarters.

Buyers are assessing the magnitude and duration of the disruption to the economy and leasing markets. In recent days, buyers are valuing properties far below pre-crisis levels, often about 10% lower, which will fluctuate further depending on the duration of this pandemic.

Lenders of all sizes are exercising increased caution and selectivity. Large lenders are favoring existing clients and/or high-credit companies. Most life companies price on a relative value basis to corporate bond yields (A to AA). The majority are not quoting right now, but if they were to quote, you would likely see pricing in the 4.5% to 5% range. Smaller lenders fall along two lines: either continuing to be active, albeit focused on existing customers and more conservative deals terms and underwriting; or may be out altogether in the next 60-90 days+ due to risk, liquidity or both.

Opportunistic funds are already being assembled and will become active as commercial properties become distressed. These funds could drive a substantial part of activity in the second half of 2020 and into 2021 as they did coming out of the last downturn.

Tenants across asset classes have started inquiring about rent relief with retail tenants most active in their proactive outreach to landlords and even some landlords reaching out to retailers. Many retailers are requesting three to six months of rent deferral with the deferred rent being amortized over the lease term, which may include an extension. On the office side, some owners are willing to trade a few years of extended lease term for one to three months of rental deferral, or even abatement in the immediate future. In the coming weeks, the biggest change in rent negotiations and concessions could stem from the multifamily sector. The rapid regional spike in unemployment claims caused by increased furloughs and layoffs will challenge some renters to pay their monthly rent ahead. The first significant test will arrive in the next 30 days with May 2020 rent bills due.

Volume is slow and getting slower

Barely a blip on investors’ radar at the start of 2020, the coronavirus influence around volume has become stronger each day of the ongoing pandemic. Deals that were near completion have continued to close with regional office investment sales volume totaling just under $1.1 billion for the first quarter, a weak but not catastrophic figure. For the sake of comparison, the past four quarters averaged close to $1.9 billion, signaling a 42% drop. The decline in volume has been much more dramatic in recent weeks as we reported last week with March sales’ volume declining more than 80% compared to March 2019 volume. As fewer and fewer pre-crisis deals remain outstanding, and as buyers and sellers remain paralyzed by uncertainty, volume will drop quarter-over-quarter and year-over-year. As a reference, in the wake of the 2008 financial crisis, investment volume remained depressed for seven quarters – by 74%, to be exact, in comparison to the preceding seven quarters.

To date, 63% of office trades have occurred in Northern Virginia, and 59% of those occurred along the existing and future Silver Line Metro. That corridor is a high-growth leasing market due to its concentration of transit-oriented development, the growth of the cloud-computing sector and a fast-growing Defense budget, even faster now with the CARES Act fueling growing contractor activity ahead. The average deal size market-wide in the first quarter was $76 million, up from $63 million in 2019, suggesting that neither fear of the pandemic nor issues with debt availability had truly taken hold until the tail end of the quarter.

 

How does Metro Washington, DC fit into the bigger picture?

Although Metro DC’s investment activity is coming to a halt along with the rest of the worlds’, its leasing fundamentals are far more secure in down cycles than most office markets domestically:

The federal government, which occupies more than 48 million sf regionally, is not only the world’s most creditworthy tenant, but is also growing across agencies following the passage of the $2 trillion CARES Act.  

Lobbyists, a major driver of downtown leasing, have also dramatically increased their activity in response to the crisis; lobbying registrations were up more than 60% last week. The increase in activity here will mainly impact institutional investors in the downtown Trophy and Class A segments of the market.

Data centers, a booming sector in the regional economy, are as important – if not more so – than ever, as the global economy teleworks by day and streams entertainment by night, while under social distancing protocols. From the beginning of 2018 through the first quarter of 2020, the Northern Virginia data center market generated more than 500 megawatts of net absorption, accounting for more than 50% of new demand nationally. Leasing demand has generated investment volume with $2 billion of trades last year. Even with the recent correction, land is likely one of the least impacted asset classes ahead. Land deals, where the dirt is ready to develop, appear generally to be happening, as buyers don’t use leverage until they break ground and groundbreaking is generally 12 months+ out.
 
These durable and even counter-cyclical economic drivers make Metro DC a strong candidate for investment when quasi-normalcy or normalcy returns.

For more on the virus’ potential #CRE impacts, read the latest briefings on our
Avison Young Resource Centre