The COVID-19 outbreak delivered a severe and rapid shock to the U.S. economy, and the recovery will not be nearly as fast-moving. However, the latest “Real Estate Economic Forecast” points to a U.S. economy that has likely already hit bottom, with growth resuming in the second half of the year that will soften some of the blow. The forecast was discussed on a recent webinar hosted by Anita Kramer, senior vice president with the ULI Center for Capital Markets and Real Estate.

The ULI forecast for 2020 calls for a sharp drop in annual gross domestic product (GDP) growth by –6 percent and unemployment that will more than triple recent levels to reach 11.3 percent by year-end. But the three-year forecast predicts a big bounce to GDP in 2021 and 2022 at 3.9 percent and 3.6 percent, respectively, which would be the highest levels of growth seen since before the 2008–2009 recession.

ULI members can access a recording of this webinar on Knowledge Finder.

It will take longer for employment to recover, with the former tight labor market giving way to unemployment that will remain elevated at 5.9 percent at the end of 2022. The semiannual forecast is based on a survey of 38 economists and analysts at 34 leading real estate organizations that was conducted in early May.

“I think the survey is about right and it is close to PNC’s forecast,” said Stuart Hoffman, senior vice president and senior economic adviser at PNC Financial Services Group. Hoffman was a participant in the survey and also part of the May 19 ULI webinar discussing the results. PNC’s assumption is that April was likely the bottom, with GDP for the second quarter that could reach –35 percent and peak unemployment close to 20 percent. PNC is predicting a U-shaped economic recovery in the second half of the year.

However, the “about right” read on the Institute’s forecast comes with crossed fingers due to uncertainty related to the path of the virus and the time it takes to develop an effective vaccine, Hoffman cautioned. The risk is that the impact on the economy could turn out to be more negative, especially if there are setbacks in the reopening or if there is a second wave of the virus in the fall, he said.

The key to the forecast recovery will be how the United States moves through its recovery, which will likely involve three phases, said fellow panelist Suzanne Mulvee, senior vice president, research and strategy, at GID Real Estate Investments. The first phase is where the country is now, with all 50 states that are in various stages of reopening and easing stay-at-home orders. The second phase will be a “reset” of the economy that includes bringing people back who have been furloughed, as well as accounting for what likely will be a spike in business and sales from pent-up demand.

The third phase will involve a broader recovery, and what that recovery ultimately looks like remains to be seen, said Mulvee. How many businesses will end up closing permanently, and how many of the 32 million people who were furloughed or laid off due to COVID-19 are called back and at what capacity? Even though the shock to the economy has been severe, there are some distinct differences to the current recession that could lessen the blow to commercial real estate.

Impact on Values Could Be Muted 

The economic crisis has taken a toll on commercial real estate sales. Transaction volume is projected to total $275 billion this year, which is less than half the $588 billion recorded in 2019. Volume will climb higher to $400 million next year and to $500 million by 2022.

However, the impact on pricing and cap rates appears relatively benign. The NCREIF Cap Rate is expected to rise by 40 basis points to 5.1 percent in 2020 and 2021 before compressing to 4.9 percent in 2022. Commercial real estate prices as measured by the Real Capital Analytics (RCA) Commercial Property Price Index are projected to fall by 7 percent in 2020, which is mild compared with the steep drop of 20.8 percent the market saw in 2008.

Panelists agreed that the Fed has played an important role in maintaining liquidity and shoring up property prices. “The policy response by the Fed and the government has been unprecedented in both the speed and the magnitude,” said Tim Wang, managing director and head of investment research at Clarion Partners.

“The message has been very clear. The government will do whatever it takes to get us out of the slump.” The stock market is reacting favorably to that, and that also is an important message for commercial real estate, he said.

In the past global financial crisis (GFC), there was a one-two punch from the severe economic crisis and the banking crisis, Wang added. “Hopefully, this time we will avoid a banking crisis. As a result, the decline from a pricing standpoint may not be as severe as what we had in the GFC,” he said. Another positive for commercial real estate values is that interest rates are expected to remain at what is now a more than decade-long run of historically low levels.

Property Sectors Face Varied Challenges 

Thanks in part to a surge in e-commerce, industrial is in the best position to weather the current storm. Industrial is forecast to see little impact, with availability rising 55 basis points to 7.8 percent in 2020 and regaining its pre–COVID-19 level of 7.2 percent by the end of 2020. Industrial will also lead the other property sectors in rent growth over the 2020–2022 period. Although rents are expected to remain flat this year, rent growth of 2.5 percent and 4 percent is expected in 2021 and 2022, respectively.

Apartments will see some slight deterioration in performance, with vacancies rising 100 basis points to 5.1 percent in 2020 and 2021. Although rents will fall by 2 percent this year, rent growth will return next year at 2 percent and rise another 3 percent in 2022. The crisis will likely slow what has been a long run of peak multifamily development over the past six-plus years, which will give some cities a needed breather, Mulvee noted.

Office vacancies will climb higher to peak at 15.1 percent in 2021, while rents are forecast to see a net loss of 3 percent over the next three years. “Office could be the most controversial, because not only are there near-term challenges about how we are going back to the office in terms of sanitation and new practices, but there also are long-term challenges on how this might influence behavioral change or strategic decision-making,” Wang said.

That being said, the role of the office has not changed. People still want a place for collaboration and innovation, and it remains an important place to train new hires and convey corporate culture, he adds.

The COVID-19 crisis and closure of nonessential stores have exacerbated challenges in the retail sector. “Retail has been on a decline, and the crisis accelerates this transformation,” said Wang. However, it is important to differentiate between malls and neighborhood shopping centers since malls have been more negatively affected by the shutdown, as well as by continued social distancing practices, he added.

ULI’s retail forecast, which includes only neighborhood and community centers and not malls, predicts a 3 percent increase in vacancies to 11.6 percent in 2020 and another move higher to 12.3 percent in 2021 before showing signs of improvement to 12.1 percent in 2022. Rents are expected to drop by a combined –10.2 over the next two years before stabilizing in 2022.

Hotels are forecast to suffer the most, with the average occupancy rate plummeting from 66.1 percent in 2019 to 40.1 percent in 2020 and occupancies that will remain below the 20-year average at 54.9 percent in 2021 and 59.9 percent in 2022.

The ULI Forecast also highlights some of the distinct differences that exist in the COVID-19 economic crisis versus the GFC (see below). “This pandemic has been unprecedented in so many ways. The speed is probably the most awe-inspiring,” Mulvee said. “We’re talking about a severe economic downturn that has played out over the course of weeks, while the [global] financial crisis played out over the course of 18 months.”

Hopefully, the reopening will allow the economy to reset to a level that supports a lot of commercial real estate operations, she said. Commercial real estate is also coming into the downturn with lower leverage and better debt-service-coverage ratios, which could minimize distressed sales, Mulvee added.