An SOS for commercial real estate

As the length and severity of the coronavirus pandemic continue to wreak havoc on the economy, real estate deals are at best being reworked and at worst falling apart altogether. The data tells a clear story: Transactions are down almost 70% in the second quarter, according to Real Capital Analytics (RCA), a commercial real estate research firm, despite near-record amounts of dry powder waiting to be deployed. Buyers and sellers remain worlds apart as buyers expect to find deep discounts and sellers are reluctant to recognize losses. More than $32 billion of hotel and retail real estate was newly distressed in the first six months of the year, according to RCA, and it’s no surprise. Rent delinquencies have skyrocketed for shuttered stores, and hotel revenues have been stifled as stay-at-home orders have hit business and leisure travel. And the distress could grow much worse; $90 billion more of commercial real estate is seen as “potentially troubled,” meaning it’s in a forbearance plan, suffering rent collection problems or is in early-stage delinquency, according to RCA. But for those investors waiting to put their cash to work, they will most likely be waiting a while longer. Delinquent borrowers aren’t feeling pressure to sell yet as lenders buy time with swift federal banking action providing a backstop and as regulatory relief allows banks to stave off recognizing some short-term loan modifications as troubled. But the resurgence in COVID-19 cases across the country is signaling that the economic recovery will be long and slow. Without continued administrative and legislative support from Washington, the three-month forbearances are not long enough to keep many borrowers solvent.

Traditional forms of liquidity becoming scarce

Adding to the pressure is that banking institutions have been pulling back on the easier lending terms that helped the real estate sector grow so robustly over the past years. Banks significantly tightened the underwriting standards for real estate in the second quarter, making it much more challenging to obtain needed financing, according to Federal Reserve data. These tighter underwriting standards are unlikely to ease as the recovery drags on, and for most borrowers they will only become more difficult to meet.

The takeaway

While investors have capital to spend, buyers and sellers remain at odds over valuations. But as the recovery drags on and without further relief, sellers may be forced to reassess their valuations. For more information on how the coronavirus is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.