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Key Capital Market Trends

With new regulatory trends impacting the capital marketplace, an economy heavily dependent on a vaccine, and strained relationships causing geopolitical tensions, the U.S. still seems to have a way to go until full recovery. Once a vaccine is distributed and herd immunity is created, economists still expect growth to remain somewhat constrained. However, the commercial real estate market is well-equipped to recover in 2021. It is anticipated that the vaccine will allow for economic activity to resume normal levels by mid-2021.

 

Unlike the Global Financial Crisis, companies had generally strong financials at the start of the pandemic, and debt markets remain sufficiently liquid. Fundamentally, the nature of this downturn is different than the last. Cash-flowing properties were forced into default last time as refinancing was impossible. In 2020, lenders were still active, and with the exception of hotels and some retail, refinancing has been possible.

 

There is a separation in fundamentals among property types. For example, industrial real estate, healthcare, data centers, apartments, and self-storage have been positively disrupted. In contrast, offices, hotels, and retail have felt the adverse effects. According to Deloitte, prices are showing early signs of stress across the more negatively impacted property types. Skeptical lenders and equity investors are expected to continue looking favorably on more durable property types.

 

With this as the backdrop, below are the key trends that could significantly impact the market and commercial real estate business in 2021.

 

Distressed Properties

The economic turmoil of COVID-19 has translated through asset sales, with investors planning to scoop up assets on a discount. Although the current pace of distressed asset sales is less than what was seen during the great financial crisis, distressed asset sales are expected to pick up in Q1 and Q2 of 2021. This might help pull down pricing as banks and funds finally throw in the towel on forbearance agreements with borrows and sell the loans. Bridge loans will account for more distress investing, with retail and hotel seeing the largest amount of distressed opportunities.

 

Trouble Still Afoot

With troubled loans rising, banks fear higher delinquencies and are tightening lending standards despite lower demand and as the Federal Reserve encourages lending. In a recent Fed survey, banks lowered credit limits and tightened standards for commercial and industrial loans to large and middle-market firms.

 

Mixed Signals in Asset Pricing

Across property subtypes, there is a divergence on prices based on the unequal impact of the pandemic. Deals priced below $20 million fell 30 percent from a year earlier in 2020, a pace not much different than more mid-sized deals up to $100 million. This smaller component of the market is usually more liquid than the others due to the various participants’ needs and the implications in the fund management world of getting a deal at the wrong price. By contrast, the largest deals are usually the most volatile component of the commercial real estate investment market. These big deals generally see a heavy influence from firms that are part of the fund management world. If these firms buy an asset at the wrong price and cannot hit a targeted IRR, the chances of raising capital for that next fund are greatly diminished.

 

10 Year U.S. Treasury Above Long-Term Trends

The spread between commercial property cap rates and the 10yr UST remains well above long-term trends. Changes in policy expected from the new Biden administration in Washington DC have helped the 10 year treasury inch up in 2021.

 

Construction Loans Gain Popularity

Construction loans in the multifamily space gained popularity during the pandemic and will likely continue to attract lenders. According to Multifamily Housing News, banks have typically capped around 50 percent of the cost during the pandemic, leaving opportunities for other capital providers.

 

Stressed CMBS Market

Commercial mortgage-backed securities were stressed in 2020. With higher investor demand and lower spreads, CMBS should pick up in 2021 as market share increases for assets that are desired by investors.

 

Increase in Reserves

Nobody wants to take a loss on what is expected to be a temporary dislocation to income from the COVID-19 economic disruption. The increase in reserves can be substantial. A reserve that might have been 18 months pre-pandemic could increase to 20 months, 24 months, or even 30 months, depending on the situation.

 

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