COVID-19 is Changing Commercial Real Estate Valuation. Here’s What You Need to Know.
COVID-19 tossed a giant, never-could-have-been-predicted curveball into the commercial real estate valuation process. Everything was humming along well in the U.S. economy, and 2020 was looking stable for commercial real estate investors. Then…well, we all know what happened. COVID-19 altered every business sector and upended people’s lives almost immediately. Commercial real estate investors and owners questioned whether real estate valuation is possible with so many unknowns and whether they should adjust their investment strategies.
The good news: with the right data and skill level, effective real estate valuation is possible. Even with a volatile economy and several uncertainties, commercial real estate appraisers can still determine which properties are most likely to become profitable opportunities for client portfolios. The process may just look a little different while navigating COVID-19 and its aftermath.
In this article, we break down how real estate valuation has changed due to the COVID-19 pandemic and how to conduct accurate real estate appraisals during these unique and challenging times.
Has COVID-19 Changed Property Values?
Despite the unpredictable climate, commercial real estate owners and investors still need assets appraised. Many property owners and investors question whether commercial property values will match current stock market volatility, and are concerned that commercial properties have either lost value or will bring in less income (due to tenants who are unable to pay rent).
These concerns are understandable. Markets nearly immediately reacted to COVID-19 and REITs dropped, making it difficult for CRE appraisers to estimate the true market value of assets. Additionally, appraisers are cautious in the current climate, as poor appraisals could bring on litigation and have a negative impact on the appraiser’s professional reputation.
While it may seem like commercial real estate is taking a hit, it’s expected that the vast majority of commercial properties will not experience a huge impact from COVID-19. Most CRE experts believe changes are short-term corrections, depending on property type and location. The National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index returns are still expected to rise, although it may take until early 2021 to see real gains. Of course, this is challenging to measure until we see more sales reflecting a decrease in value or an increase in capitalization rates, but there are still plenty of opportunities for entrepreneurs seeking to acquire properties that are expected to thrive.
The Impact of COVID-19 on Commercial Real Estate Valuation
Before COVID-19 hit, commercial real estate was a solid investment and data pointed toward a stable and growing market. Commercial real estate is buoyed by the strong pre-COVID economy, and much of those gains help carry the industry now during the downturn.
COVID-19 is an exceptional factor in real estate valuation, and CRE has tended to recover well following periods of economic downturn. According to a study by Deloitte, COVID-19 had a more immediate negative impact on CRE than previous recession-causing events (which typically saw a 6-month lag between the stock market and a downturn from commercial properties). In the short-term, lending became less available, assets became less liquid, leasing volume decreased, capitalization rates rose, and investment activity went down. However, the CARES act features several benefits to support CRE, helping boost the industry so that losses have not been felt as deeply as they could have.
Many parts of the commercial real estate appraisal process have undoubtedly changed, and CRE lenders must be proactive in how they approach property valuation. CRE valuation is a process that requires skill derived from experience, and the ability to decode historical data-based trends. It’s essential to rely on quality data, and it remains critical to review and consider key data such as demographics, comps, leasing trends, and access to infrastructure. In addition to making data-based decisions, CRE success during COVID-19 and in its aftermath will depend on adaptability and resilience to sudden changes.
The current crisis makes it challenging to appraise properties because appraisers have very little information on which to base their data. There simply isn’t a ‘global pandemic data set,’ to refer to, even when you factor in how H1N1 (the last global pandemic) impacted commercial real estate. The effect on commercial property valuation will depend on many of the same considerations factoring in during pre-COVID times, such as supply & demand, region, income, substitution & comparison, and progression & regression.
How to Make Commercial Real Estate Decisions during COVID-19
Despite broader openings and easing restrictions, risk is still up because COVID-19 is a current problem. We don’t know exactly how or when things will bounce back, but we know that we are facing a ‘new normal’ for some time to come. As society, government and business continue to navigate through it, data will shift and valuations will evolve as CRE appraisers review metrics in near real-time to make decisions.
During COVID-19 and in its aftermath, commercial real estate choices should no longer be broad-based, sweeping decisions. A healthy portfolio will reflect choices made by reviewing and analyzing location data, alongside current data. Assets will operate differently depending on what they are and where they are located. Commercial real estate investors and owners will need to think through the health and safety of their tenants in a new way, and may have to tailor decision-making on a case by case basis. Learning more about COVID-19 could mean changes in building codes, such as the number of people allowed per square foot, the number of elevators required, and which HVAC systems are acceptable. CRE professionals should be prepared to make these changes to ensure profitability.
COVID-19 Impact on CRE Market Sectors
While commercial real estate overall is expected to remain stable during COVID-19 and in its aftermath, sectors will be impacted differently. Some will thrive and exceed even pre-COVID expectations, while others will struggle and might have to get creative to succeed.
Industrial and Logistics
It’s no surprise that COVID-19 massively accelerated the growth of e-commerce. People stayed home and either started buying everything they could online or buying online and picking up in-store (BOPIS). Companies like Instacart and Shipt quickly grew, Amazon reconfigured distribution to serve where the highest need existed, and FedEx and UPS struggled to keep up with demand. Many changes appear here to stay for a while. For example, the increased demand in grocery delivery services makes it clear that easier access to cold storage facilities would be required to accommodate changes in food shopping habits.
Commercial real estate investment in industrial, big-box warehouses and distribution centers is expected to stay stable, as many people still want to avoid large crowds. BOPIS is also expected to continue growing, meaning stores will likely need more storage to accommodate for goods and storage for pick-up orders.
Many retail properties are clearly facing challenges during COVID-19. Most brick-and-mortar stores were already undergoing massive disruption before Coronavirus due to consumers shifting to e-commerce. However, retail properties selling essential goods like food and home appliances, have either remained steady or have increased business.
Many stores that rely on foot traffic for sales were forced to close their doors to visitors, and tenants were unable to pay rent. Government relief helped in some cases, but many commercial property owners had to get creative about offering either concessions or abatement. Owners need to consider what they will do if a tenant goes dark or is anticipated to go dark. This is especially important for commercial property owners with properties close to each other. One property going dark affects others in the area.
Commercial real estate valuation of the office sector is challenging to predict. Work-from-home is proving to be easy with today’s communication technologies, and many workers claim to feel unsafe at the thought of returning to their offices. Office spaces are being reimagined to account for worker safety, including greater distance between workers. Owners are having to reconsider shared spaces like conference rooms and areas for eating and recreation. Many companies are seeing a boost in worker efficiency with work from home, and they are realizing they could save money by not having to accommodate as many in-person office workers. It remains to be seen whether work from home will be temporary, or could shift office culture for good.
Hospitality properties like hotels, restaurants, theaters, etc. have clearly taken a huge hit from a drop in tourism, travel, and the inability for large groups to gather. While facing major problems now, these venues are expected to experience a full recovery within the next 2-3 years, which is good news for long-term investors.
Multifamily properties are proving to remain resilient, even during coronavirus. Despite a skyrocketing unemployment rate, the majority of renters are still making their payments. Additionally, mortgage loans are freezing and potential homeowners do not have easy access to capital. People who may have been considering homeownership are now more comfortable sticking with renting.
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