Economists' Outlook

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2020 Q1 NAR Commercial Survey Shows Early Impact of Coronavirus

NAR’s latest Commercial Real Estate Trends & Outlook Report (April 2020 report) shows the very early impact of the coronavirus pandemic on commercial real estate. Sales declined by 1% and new leasing volume declined by 2 percent. However, commercial prices rose modestly by 1% on a year-over-year basis. Over the next 12 months, we expect the demand for multifamily properties and industrial properties to increase, while the demand (absorption) for retail and office properties will likely decline. The latest report is based on a survey of commercial members of the National Association of Realtors® about their transactions in the first quarter of 2020.

1% y/y decline in commercial transactions in 2020 Q1

Sales volume fell on average by 1% during 2020 Q1 compared to one year ago, according to NAR commercial members. Respondents reported a mix of gains and losses: 37% reported a y/y sales decline (24% in the prior quarter), 20% reported no change (16% in the prior quarter), and 43% reported higher sales (61% in the prior quarter).

Real Capital Analytics also reported that during January—February 2020, sales transaction volume fell by 35%. RCA tracks transactions of at least $2.5 million (middle to large commercial market), while NAR commercial members’ sales transactions are typically below $2.5 million (median sales of $502,305 in 2020 Q1).

Line graph: Quarterly Sales Volume Year-Over-Year Percent of Change 2012 through 2020 Q1

A lower fraction of respondents reported an annual gain in sales volume in 2020 Q1 compared to the fraction of respondents who reported an annual increase in 2019 Q4. For example, in the apartment class B/C properties, 35% reported higher sales from one year ago compared (44% in the prior quarter). In the office class A market, only 15% of respondents reported an increase in sales volume (22% in the prior quarter). In the retail class A market, only 6% reported an increase (12% in the prior quarter).

Bar chart: Percent of Respondents Who Reported a Year-Over-Year Increase in Dollar Sales Volume 2019 through 2020 Q4

Commercial prices are still holding up, up 1% y/y in 2020 Q1

While dollar sales volume fell, commercial prices rose 1% in markets where commercial members of the National Association of REALTORS®, with 56% of commercial members reporting a y/y sales increase (75% in the prior quarter), 19% reporting no change (9% in the prior quarter), and  25% reporting a decline (16% in the prior quarter).The Green Street Commercial Price Index, which is an indicator for high-quality properties held by REITs, fell by 0.3% in 2020 Q1 compared to the prior quarter, which indicates that commercial prices softened, but have not dropped significantly.

Line graph: Year-Over-Year Change in Commercial Sales Prices 2009 through 2020 Q1

Another indicator that commercial prices are not slumping is that cap rates are still on the downtrend. Cap rates have not Apartment Class A properties had the lowest cap rate, with a median of 5.4% among respondents. Apartment Class B/C cap rates were typically one percentage point higher, at 6.5%. Cap rates for office class B/C, industrial flex, free-standing retail, and senior housing were typically around 7%.

Line graph: Cap Rates in REALTORS® Market and 2.5+ Million Transactions 2010 through 2020 Q1
Cap Rates in 2020 Q1
Apartment: Class A 5.4
Apartment: Class B/C 6.5
Industrial: Warehouse 6.5
Industrial: Flex 7.0
Office: Class A 6.5
Office: Class B/C 7.0
Retail: Strip Center 6.5
Retail: Mall 6.0
Retail: Free standing 7.0
Hotel/Hospitality 6.5
Student housing 6.0
Senior housing 7.0
Source: April 2020 Commercial Real Estate Market Trends and Outlook survey
For $2.5 million or less properties

New lease volume declined 1.5% y/y

The dollar volume of new lease transactions in 2020 Q1 fell on average by 1.5% compared to one year ago, with 32% of NAR commercial members reporting a decline, 27% no change, and 41% reporting an increase.

Bar chart: Year-Over-Year Change In REALTORS® Commercial Leasing Volume 2009 through 2020 Q1

Across all property types, a lower fraction of respondents reported an increase in dollar volume of new leases in 2020 Q1 on a year-over-year basis compared to the fraction of respondents who reported annual gains in 2019 Q4. For example, in the apartment Class A market, only 35% reported an increase in new leasing activity in 2020 Q1 compared to 44% in 2019 Q4. In the office class A market, 21% of respondents reported an increase in leasing activity, down from 39% in the prior quarter. In the retail strip class A market, only 14% reported an increase in new leasing activity on a y/y basis in 2020 Q1 compared to 40% in the prior quarter.

Bar chart: Percent of Respondents Who Reported a Year-Over-Year Increase in Dollar Volume of New Leases 2019 through 2020 Q1

3 to 5% decline in commercial transactions in the next 12 months

On average, respondents expect a decline in the commercial market transactions in the next 12 months:

  • 43% expect a decline in their commercial transactions; on average, respondents expect a 3% decline in sales transactions in the next 12 months.
  • 56% expect prices to decline; on average, respondents expect a 5% price decline in the next 12 months.
  •  46% expect a decline in new lease volume; on average, respondents expect a 4% in the next 12 months.

The phase of the recovery in the next 12 months depends on when the stay in place directives/guidance will be lifted and how much of the social distancing measures will remain to avoid any resurgence in infection rates.  The long-term effect on the commercial market will depend on the severity of the impact on businesses and changes that businesses adopt to become more agile and financially prepared to deal with another health crisis. By property type, the demand for multifamily properties and industrial properties will likely increase in the next 12 months, but there will be a decline in the demand (absorption) for retail and office properties.

Multifamily properties

Demand for multifamily properties, especially class B/C, and rents will likely increase in the next 12 months. The concentration of job loss in these sectors has an impact on the multifamily market because food service workers, housekeeping and personal care workers are more likely to be renters compared to other occupational groups. Only 51% of food service workers are homeowners and only 58% of housekeeping and personal care workers are homeowners, well below the national rate of 64%. The large but temporary loss of jobs will make saving for a down payment for a home purchase more difficult. NAR’s Flash Survey conducted April 5-6 reported that 59% of NAR members reported that buyers are delaying a home purchase for a couple of months. These factors will increase the demand for rentals. Class B/C properties that are more affordable will tend to be in higher demand than Class A due as households work through improving their financial positions.

Industrial properties

Demand for industrial properties and rents will likely increase in the next 12 months. The retail brick-and-mortars were already buffeted by the rise of e-commerce sales prior to the coronavirus outbreak. As of 2019, e-commerce sales accounted for nearly 12% of retail sales from 1% in 2000.  The shift towards online shopping during the coronavirus period may result in a change in buying behavior for consumers that can only favor e-commerce sales. Industrial warehouses that are part of the critical logistics for e-commerce will benefit from this shift. The demand for data centers will tend to increase given the increasing demand for online/virtual transactions and data security.

Retail properties

Demand for retail properties and rents will likely be decreased in the next 12 months with a large potential for the adaptive reuse of vacant malls. Retail nearly came to a complete stop as more than 47,000 retailers across the U.S. temporarily shut their doors or adjusted store hours in an effort to help slow the spread of the coronavirus pandemic. This disruption can potentially lead to a permanent shuttering of these stores which is more severe than the 9,350 big retailers that closed in 2019. Retail operations and foot traffic in retail stores and malls could normalize but there could be a slow progression to the normalization of retail store foot traffic with shoppers staying away from enclosed malls as they remain wary of being infected. However, there is a large potential for repurposing the vacant malls, such as for health care armories or medical care centers.

Office properties

Demand for office space and rents will likely decrease in the next 12 months. The federal government and the Federal Reserve have put in place several measures to contain the economic fallout and keep businesses afloat. These measures will help retain current tenants. However, some businesses may shutter permanently, especially businesses that don’t have the office and business tools in place to avail of the small business loans (Paycheck Protection Program, Economic Injury Disaster loans). Businesses will also likely put on hold new hiring of employees given the uncertainty of a resurgence of the coronavirus pandemic and until after a vaccine is found. Leases will likely become more short-term, and businesses may opt for smaller office spaces because they don’t want to carry that rent burden if another pandemic strikes. Demand for co-working space may fall as freelances decide to just work from home rather than in co-working spaces.

Regarding the economic outlook, NAR’s Chief Economist Lawrence Yun expects that “the second-quarter GDP growth to be the steepest decline in the U.S. history – likely in excess of 15% contraction on an annualized basis. What will be critical is the recovery in the second half of the year. Is it going to be a sharp and quick rebound of a V-shaped or a sluggish recovery of staying low for a period before recovery of a U-shaped? That will depend on the economy’s response to the stimulus measures and the path of virus containment. The best guess is for the second half GDP growth to be insufficient to compensate for the loss in the second quarter. Therefore, we expect GDP to have contracted around 3% to 5% for the year as a whole and net job losses totaling around 3 to 5 million.”

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