U.S. commercial real estate prices did not collapse in response to the Covid-19 pandemic the way many investors feared, or hoped. The RCA CPPI All-Property Index stood at a record level in May of this year, fully 118% higher than the lows seen in the aftermath of the Global Financial Crisis (GFC). Consistently over the last year I have been noting that this downturn would not play out like the last and the growth in prices into midyear bears out this notion.
The Covid-19 downturn was a shock to tenant demand as opposed to a collapse in the capital stack. This distinction made it clear to me that the outcomes would be different from the GFC.
Leveraging work by the team at the MIT Center for Real Estate Price Dynamics Platform, in June 2020 I noted that prices would not collapse unless and until current owners were willing to take a loss. I observed this difference even before conditions started to become clearer. As early as March 2020 I noted that unless we ended up with a financial contagion, we could come out of it without major price disruptions as we had with recessions in the past. Public market pricing was telling a different story, however.
The price component of the FTSE Nareit return indices collapsed in 2020 in a knee-jerk reaction as investors feared the worst from the pandemic. The price component of the apartment indices, for instance, fell a cumulative 35% from peak to trough in light of this fear. Growth in asset prices as measured by the RCA CPPI for the apartment sector simply slowed for a time before accelerating again in 2021. Into midyear 2021 however, the price component of the FSTE Nareit index for the apartment sector has rebounded and is now only 2% off of the peak level set before the pandemic hit U.S. shores.
I am not arguing that the public markets were being irrational. (That term “irrational” is a fighting word for many of my colleagues in the economics world.) Rather, I would argue that the public markets were incorporating the wrong information. People were looking only at high-level figures on how prices reacted to the last downturn and reacted quickly without looking into how the fundamentals of commercial property finance were different this time around. Early and aggressive moves by the federal government, various regulators, and the Federal Reserve helped the market avoid the sort of liquidity trap that came about following months of dithering into the GFC.
Does all of this analysis show then that prices are not going to collapse? Is it too early to take a victory lap? There is an argument out there that we simply have not seen the distress at this point. After all, during the GFC it took 18 months from the start of the crisis to see the spike in distressed asset sales that provided a signal on price expectations; in this pandemic era, we are only 14-15 months into the crisis in the U.S.
Nonetheless, shots are going into arms and life is starting to return to normal. The experts over at RealPage are noting a marked uptick in apartment leasing while the team at VTS is observing an improvement in search activity for office leasing. It seems that the public markets are starting to incorporate this sort of positive information on a recovery of the fundamentals, with the price component of all major property sectors recovering in 2021.
Prices will fall again at some point in response to some new economic shock in the future. Maybe a war somewhere in the Pacific, maybe a change to more restrictive monetary policy, maybe a zombie apocalypse … developing scenarios for shocks is a cottage industry. Whatever surprise does come next though, the impact of the Covid-19 upset seems to have played out without the types of extreme downsides seen after the GFC.
To learn more about the data behind this article and what Real Capital Analytics has to offer, visit https://www.rcanalytics.com/.
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