Coronavirus’ Impacts On Real Estate

Coronavirus affecting real estate

The Coronavirus is clobbering the real estate industry, and it’s going to get worse before it gets better. The effects on real estate will vary by sector and market, and the extent of the impact will depend upon the duration of the economic shutdown. The sectors of real estate that have been hit hardest so far are hotels, restaurants, bars and other entertainment retail (particularly in tourist-driven areas) followed closely by retail and housing (particularly second-home and luxury homes).

Supplies that the builders and developers need are being interrupted more and more as workers stay home, and due to business shutdowns, quarantines and curfews. Huge numbers of layoffs will lead to a further contraction in consumer spending, starting a downward spiral of economic activity. Together, these forces are already pushing the economy into recession. China’s factories and businesses are now restarting, which could be cause for optimism regarding a reasonably rapid return to regular economic activity and reliable real estate markets. That said, China took swift steps that the United States is only slowly and begrudgingly taking now. There are a lot of moving parts, so let’s dig deeper.

Hillyer Riches is an Accountant in Caulfield providing taxation accounting and business advisory services.

The chances are that the world returns to normal. From SARS to Bird Flu to Ebola, it seems there is always some type of health care that we are told will alter the course of our existence. Hopefully, a few years from now, we can put Coronavirus into the category of other “close calls”. But this one feels different. And it is already altering our lifestyle in dramatic ways that prior health scares did not.  Just this week, the NCAA said that it would hold March Madness without crowds, SXWS cancelled its annual event, the Coachella Festival announced that it would be postponed, Google told its 100,000+ employees to work from home, countless other companies encouraged their employees to telecommute. Toilet paper has become an unusually hot commodity. While the real estate industry as a whole appears (at least so far) to not be affected to the same degree as the travel and entertainment industries, what impact can we expect the Coronavirus to have on the real estate industry over the next few months and years? 

The answer, of course, depends on numerous factors, such as how quickly the outbreak spreads, the duration of the outbreak, and the actual impact of the Coronavirus on humans once we can analyse data from the inevitably larger sample size that we are sure to get. Even if the Coronavirus is gone tomorrow, the impact on the real estate industry could be significant.

The market dislocation from the Coronavirus is presenting attractive valuation opportunities in different segments of the Real Estate market. Our order of preference is Office, Industrials and Retail. The office remains the most resilient and vacancies in core markets remain tight. Industrials continue to benefit from modern supply chain logistics and last-mile warehousing. Retail is the most impacted by COVID-19 but now provides excellent value in specific markets, and we continue to believe the reliable operators will come to dominate this segment. The key is to be selective.

The Coronavirus outbreak has now afflicted more than 200,000 people around the world, at time of writing1, and spread to more than 100 countries. Many countries, led by China, have taken extraordinary measures to stem the rapid spread. But with the death toll rising from the rapidly spreading virus, the World Health Organisation has declared this outbreak a pandemic.

The Coronavirus outbreak has now afflicted more than 200,000 people around the world, at time of writing1, and spread to more than 100 countries. Many countries, led by China, have taken extraordinary measures to stem the rapid spread. But with the death toll rising from the rapidly spreading virus, the World Health Organisation has declared this outbreak a pandemic.

The current quarantines, travel restrictions and supply chain disruptions are impacting the global economy and stock markets which have spiralled on recession fears. This is because many believe that unlike China, government response to the virus in countries outside of Asia may be slower with less draconian measures and therefore will be less effective. This implies that their virus containment measures and subsequent recovery paths may be more prolonged than observed in China, which dramatically increases the chance of a recession in the U.S. and Europe.

Governments around the globe have responded swiftly with both monetary and fiscal stimulus measures. We will likely see more policy support in the coming weeks in the form of budgetary easing, which should eventually help stabilise markets and provide a buying opportunity for risk assets. Meanwhile, a multi-asset strategy that allocates across several asset classes can help insulate one from the full impact of the Coronavirus and market sell-offs. Our real estate strategy, for example, is benefitting from a diversified investment portfolio that has a combination of equities, bonds, REITs and infrastructure securities.

While there are unknowns about how the coronavirus pandemic will ultimately impact the real estate industry, a new report suggests it may be slowing the market down.

As COVID-19 has sparked widespread stay-at-home orders and business shutdowns across the country, the volume of newly listed properties in March, according to Realtor.com’s monthly housing trends report, was down 6.4% compared to the year before.

Developments are incredibly fluid, and tremendous uncertainty remains regarding how broadly the virus will spread and what its ultimate impact will be on public health, economic growth and financial and real estate markets.

All eyes are on the financial markets.

Few homes look their best in the dirty greys of late winter, which is, in part, why homebuying season coincides with the arrival of spring. This year, however, the crocuses that can make a house look that much nicer are showing up alongside the less reassuring news of a virus circling the globe.

The spread of COVID-19—more commonly referred to as coronavirus or novel coronavirus—has officially been declared a pandemic by the World Health Organization. It’s already claimed more than 26,000 lives worldwide. Shelter-in-place orders have been issued for cities across the country, and a record 3.3 million Americans filed for unemployment last week.

If you’re already in the market for a house, all the uncertainty might have you worried about the housing market. Will COVID-19 cause housing to collapse, as it did during the financial crisis in 2008?

Historically low inventory and rock-bottom mortgage rates would typically set the stage for a highly competitive homebuying season. While recessions usually have only a minor effect on the housing market, the Coronavirus is making life and markets anything but ordinary.

Zillow conducted a study on housing during previous pandemics and concluded that while home sales dropped dramatically during an outbreak, home prices stayed about the same or suffered a slight decrease. This makes intuitive sense because it’s harder for prices to change when there are few transactions. In short, previous pandemics have simply put the housing market on pause.

Furthermore, the federal government has implemented a moratorium on foreclosures and directed mortgage servicers to offer forbearance or reduced payments on any mortgage backed by Freddie Mac, Fannie Mae, or the Federal Housing Administration (FHA). These are an essential measure that will keep the bottom from falling out of the housing market as the result of a wave of foreclosures, as happened in 2008. Still, it could have the unintended consequence of bankrupting mortgage servicers who would suddenly be on the hook for the missing mortgage payments. It’s hard to know what damage that might bring to the mortgage industry and thus the housing market.

Where the housing market currently stands

The housing market going into the pandemic was, in a word, tight. Consider Seattle, where home prices have risen dramatically as it has become one of the country’s leading tech hubs. And while the nation as a whole is suffering from housing shortages, Seattle’s available homes for sale dropped a dramatic 27.6 per cent year-over-year in January.

The housing market in other cities isn’t much better off: supply is at near-record lows nationwide, and demand is near an all-time high. This combination means home prices are also near all-time highs in most cities as many potential buyers are bidding on a limited supply of homes for sale.

At the end of 2019, the number of houses for sale dropped even lower, particularly on the West Coast. Compared to a year ago, some cities saw double-digit percentage decreases in available homes for sale. However, that is partly a function of there having been a supply spike in the second half of 2019, so the decrease looks starker than it otherwise would.

It’s a commonly searched question since the coronavirus and COVID-19 outbreak: how will Coronavirus affect house prices? The bottom line is it will be negative - prices will go down. People, up until now, have been talking about the property market developing a bit of momentum, with the interest cuts we had last year and the easing in credit conditions. But Coronavirus has changed the story for 2020.

The China property sector has pulled back in the region of -11% year-to-date as at March 11 2020.2 China’s residential property developers reported significant declines in contract sales in January and February but have seen purchases start to recover in March. Investors’ perception is that the worst of the fallout from COVID-19 virus is now past and China appears to be slowly recovering while the rest of the world is currently facing more significant risks around the spread of the virus. China also continues to deploy more significant policy stimulus measures both at the national and the local levels, including targeted property policies: delayed land cost payments, relaxation of pre-sales approval requirements or subsidies for new home purchases. This has helped to slowly tempt buyers back into the market, as Chinese citizens still require a place to live.

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In the first week of March, residential units sold in tier-1/tier-2/lower-tier cities saw -45%/-44%/-29% year-on-year3. Sales are improving as offices reopen. Week-on-week sales are also showing significant improvement. Land sales in the top 100 cities have now recovered to 80% of those as of the same period in 20192. Smaller developers and developers with weak balance sheets are struggling to raise capital in this environment, but our focus remains on the more important, better quality names.

The Real Estate industry in China is likely to see an acceleration of consolidation in 2020 as operating conditions become more difficult for smaller players. While the bulk of our China exposure is through the offshore USD Bond market, we are comfortable that these companies will be able to service their debt and raise fresh rounds of capital should the COVID-19 situation persist for longer than expected. Those developers that are short on near-term cash will likely resort to equity capital raises or asset sales to tide them through this challenging period. However, the risk of default is heightened, making an active security selection approach all the more critical.

On the retail side, China mall operators are reporting increasing foot traffic as stores slowly reopen, but some sites are only seeing 30-50% of the visitor volumes they said a year ago2. Some stores and malls are still operating under reduced opening hours but over the next month or so we expect most operations to return to normal as consumers get back to work after weeks of isolation.

The Impact on Housing and Homebuilding

Homebuilders are feeling not only the demand pullback from home shoppers staying home in droves but also the supply impact of materials that they usually import from China (supplying more than 30% of the contents). In a new survey by NAHB, 81% of respondents said the Coronavirus had had an adverse effect on traffic of prospective home buyers, and it’s probably closer to 100% now with the escalating lockdowns. Another 54% reported issues getting the building materials they need to finish homes. 

Builders are seeing a massive drop in sales now. There is also growing concerned about tighter lending conditions for non-conforming mortgage loans. Buyers who have a debt-to-income ratio higher than 43%-45% or those who are self-employed are now having a lot of difficulties getting mortgages. 

With all of this going on, builders are saying that their land acquisition and development spending will slow in the near term. Even more worrisome is the impact that the stock market crash will have on consumer spending. People who have lost a lot of their “paper” wealth will spend less on discretionary items, and those who are retired, or close to retirement, maybe drastically changing their spending plans. Those who had been planning to buy a home in an active adult community may have to shift their ideas, and that could impact absorption rates at those developments.

Needless to say, there could be a severe impact on nursing homes and assisted-living facilities as well, at least in the near term.

The rental apartment industry is now preparing to deal with tenants who have lost their income and are unable to make the current month’s rent. A large number of tenants will ask for forbearance in April, and even more, will in May. Landlords will seek to emphasise retention, which will mean giving tenants some leniency in the near term. There will be downward pressure on effective rents in the next few months, and property owners will be asking their lenders for forbearance as well.

The long-term outlook for rentals is still bright, however, in light of demographic shifts that are still unfolding. Lease renewal rates were stable before the crisis, and apartment construction was running at more than 500,000 units annually right before the crisis, so it has some ground to give. Class “B” properties will likely fare better than expensive “A” properties or Class “C” developments that may be more susceptible to job losses and lost income among tenants. Some renters will “double-up”, and we may see some “boomerang kids” moving back in with parents in the near term. Underlying positive long-term rental trends will reassert themselves after the crisis passes.

The single-family-built-for-rent business might be a long-term beneficiary as we may see a shift toward larger units that better accommodate working from home (allowing more space for a home office or office nook). Any discussion about the Coronavirus often includes recommendations about social distancing. In its simplest terms, health experts suggest that avoiding crowded areas can be a helpful tool in avoiding the Coronavirus. If the population at large follows this advice, the immediate impact on the retail sector could be significant as people avoid grocery stores, shopping centres, and malls. 

But what will this mean long term? People still need food, clothes, and other essentials. And of course, they want other non-necessities. More and more people are already using Amazon and other online services to do their shopping from home. But there is still a mostly untapped market of people who have never used online shopping. There will be a significant number of these people who try online shopping for the first time as a result of coronavirus fears. This could be a tipping point that forever alters some brick and mortar stores and how they accommodate the online consumer. As at-home and curbside deliveries increase in popularity, retailers will need to consider store sizes, layouts, and pick-up points when they design stores. 

There are also signs that home prices could take a hit from the uncertainty surrounding the pandemic. The median listing price in the U.S. grew by 3.8% year over year in March, to $320,000. However, that was slightly down from the 3.9% year-over-year growth in the median listing price in February. In the week ending March 28, the median listing price had only grown by 2.5% year over year, the slowest pace of growth since 2013 when Realtor.com began tracking that metric.

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With the coronavirus pandemic having such a significant impact on the economy, it may make sense for some consumers to put a pause on home buying or selling plans simply to see how the next couple of months play out. In the interim, first-time homebuyers — in particular — may benefit from using the time to research programs when they’re ready to move forward.

Newly listed properties

The end of March more pronounced the decline in newly listed properties. In the week that ended March 28, the volume of freshly listed properties had decreased by 34% compared to the amount that same week the year before. This was 2020’s most significant drop, according to the digital home listings platform.

The drop, Realtor.com noted, could be an indication that sellers are rethinking their plans to sell or postponing them as the COVID-19 crisis continues to evolve in the spring. Many home sellers consider spring to be an excellent time to sell — not only can the weather be beautiful, but many parents want to be in their new home before the school year starts.

Homebuilder supply lines being disrupted by Coronavirus

The short answer is yes. Nearly a third of home building material inputs come from China, according to the National Association of Home Builders, not to mention more finished products like bathtubs, sinks, appliances, and more. These supply lines have been disrupted.

This could delay home construction at a time when it has finally picked back up. Since the financial crisis, home building has struggled to keep pace with demand because of the cost of construction, lack of available land, and a construction labour shortage.

However, home builder confidence has skyrocketed in recent months, according to the NAHB. This signals that builders are more inclined to start construction on homes. To wit, new home sales—mostly dependent on how many homes are built—have spiked dramatically in recent months, as have construction starts.

But if supply lines are disrupted, it could dampen the pace of home building and contribute to inventory shortages.“Low-interest rates help support demand, and consumer confidence readings in the coming months will be key, but the virus does heighten some of the longer-term challenges on the supply side in terms of housing supply,” says Robert Dietz, an economist with NAHB.

In this environment, buyers who are in very secure jobs are actually in an improved position because the overall market is weaker. Coronavirus will take out a group of buyers – those adopting a wait-and-see approach or who are simply unable to buy due to reduced income. But there’s another group of buyers: those who are in jobs but who face uncertainty about how Coronavirus will affect their pay or whether they will keep their job at all.

Many of these types of buyers will be taken out of the housing market for now.

If you’re a seller, you need to appreciate things are going to be weaker. Those would-be sellers who have flexibility will be able to defer, and that could cushion prices fall.

There will still be people who need to sell for whatever reason. The turnover will decline, but there will always be properties coming into the market. The market has been getting more difficult for the investor. The market in, for example, Sydney is oversupplied at the moment, and there’s already been some downward pressure on rents. Yes, investors can benefit somewhat from the decline in rates, but declining rents offset that benefit.

Then, along comes Coronavirus.

The weakness it is causing in the economy will accentuate the downward pressure on rents in the short term, and that’s something investors need to be aware of.

If prices come down, investors could be in a better position to buy (to create or add to an existing property portfolio), but that weakness in rents is a real factor – it has been for some time and is unlikely to go away any time soon.

A rebound in 2021

2020 will, in many ways, be a hard year for the economy. Talk of a recession is growing, and while the big companies may not lay off a lot of people, a lot of small businesses are facing the prospect of low to no revenue. They may have no choice.

The financial capacity of small and medium-sized business will be harshly affected. If you’re a restaurant and nobody is coming in, you may have no option but to reduce staff or close. The stimulus package is well-targeted, but no stimulus package in the world could stop some of these effects happening.

The RBA has talked about a rebound in the second half of this year. Hopefully, they are right, but I expect at least by 2021. Either way, it’s important to remember the rebound will happen.

People will recover. People will go back to restaurants. People will go to football games. Things will eventually bounce back. Things will go back to normal eventually - but there will be some business casualties along the way.

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