The Best & Worst-Performing CRE Sectors in the Wake of COVID-19

COVID-19 has had a profound effect on nearly every facet of our lives—the economy, work, social interactions, the list goes on. Throw in the chaos of the general elections and social unrest and here’s what we have today: uncertainty.

Most of us have never experienced anything like COVID-19, both socially and economically. Shutdowns, masks, social distancing, contactless, Zoom are all words we never expected to become part of our everyday vocabulary.

And can you believe the NCAA canceled March Madness? Growing up and into my adult years, I had always considered March Madness as the one sporting event that I could look forward to after the Super Bowl. Not this year.

As a sports fan, the cancellation of March Madness impacted me greatly. It was a sign to me that other dominoes were sure to fall.

After reaching a record high in February, the stock market lost nearly a third of its value in March. From February to April, the U.S. shed 26 million jobs. The unemployment rate surged from a 50-year low (3.5%) in February to levels not seen since the Great Depression in April (14.7%). U.S. GDP fell 31.7% in Q2. For comparison, it had risen 5% in Q1 before the pandemic.

On the real estate front, the impact of COVID-19 on commercial real estate (CRE) was not nearly as devastating as the impact on the broader markets, with some segments predictably suffering more than others.

While some CRE segments fared better than others, certain geographic markets also proved to weather the storm better than others. Based on research by CBRE, one of the country’s leading CRE services firms, here is how each major CRE area is faring in the COVID-19 outbreak.

Impacts on CRE Across Industries

Hotels

To nobody’s surprise, hospitality suffered a massive drop in demand at every price point. It fared the worst of any CRE segment.

In Q2, overall occupancy decreased by 60.1% year-over-year, ADR fell by 37.4% year-over-year, while RevPAR (revenue per available room) fell by an unprecedented 75%. CBRE does not expect RevPAR to recover to pre-COVID-19 levels until 2023.

Industrial

The industrial sector was the direct beneficiary of the shift away from physical retail to e-commerce. Despite the economic downturn, the industrial sector experienced low vacancy rates, record-high asking rents, and positive net absorption in Q2.

The boom in e-commerce led to an increase in the demand for warehouse and distribution space. Along with the boom in e-commerce came a newfound desire by companies to rely less on China in the supply chain and to keep more inventory on hand to guard against supply chain disruptions.

Office

The office sector was another segment instantly negatively impacted by lockdown measures and work-from-home initiatives. Leasing activity in Q2 fell by 44% year-over-year, increasing the national office vacancy rate by 70 basis points to 13%.

Average rents in downtown office markets declined in Q2 and vacancy rose more sharply than in suburban markets, consistent with prior downturns. Non-gateway markets with stronger employment metrics fared better than their gateway market counterparts.

Retail

As with hotels, it was no surprise that retail suffered from the economic impact of COVID-19. In Q2, total retail sales fell 8.1% in Q2, the largest decline since Q2 2009 amid the Great Recession.

Multifamily

Given the magnitude of jobs lost in Q2, the rise in vacancies and drop in rents was relatively minor compared to the drop in other sectors.

Multifamily was buoyed by federal and state stimulus programs, including enhanced unemployment benefits, which helped financially stressed apartment residents make their rent payments.

Net absorption plummeted to the lowest Q2 level in 11 years with vacancy levels inching moderately by 30 basis points compared to Q1, reaching 4.6%. An average month’s rent dropped to $1,720, a 1.4% reduction.

Rent declines and vacancy increases were steeper in urban areas, in states with high unemployment, and in the Class A space. States with lower unemployment in the Class B and C sectors fared the best in the multifamily space.

Demand in the affordable housing space soared as a result of the pandemic, further worsening the affordable housing crisis that had begun following the Great Recession as supply consistently lagged demand, with the gap continually widening.

What Does This Mean?

Some things changed and some things stayed the same. The pandemic has shifted CRE in ways not seen in past crises.

Widespread lockdowns have negatively impacted office, hotel, and retail space disproportionately while benefiting the industrial space compared to prior downturns.

The one sector that is typically the least impacted by widespread financial meltdowns and the one to recover the quickest has been multifamily. This was evident in the Great Recession, as well as this financial crisis.

Having lived through both the Great Recession and this latest COVID-19-induced crisis, what I’ve learned is that not only is multifamily a resilient asset class, but certain parts of the country and certain segments are more resilient than others.

Specifically, Class B and C properties at lower price points have shown less vacancy and rent disruptions compared to Class A properties. And in this cycle, properties located in states with the lowest unemployment rates—with five of the top 10 hailing from the Midwest (Minnesota, Nebraska, North Dakota, Missouri, and Iowa)—were the least impacted by the pandemic.

It appears I’m not alone in this assessment as I see investors from the coasts cashing out of properties with low cap rates and overall returns for the greener pastures of the Midwest.

Has COVID-19 changed your views on commercial investing?

Tell us how in the comments.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.