This is the perfect storm for commercial real estate markets in the United States.

As 2020 started, the consensus opinion was that commercial real estate might see a slowdown in growth rates. However, thanks to an economy that was growing slowly but growing and low-interest rates, CRE would still be an attractive investment opportunity.

COVID and Commercial Real Estate Markets

The COVID-19 showed us once again how unreliable even well-informed predictions can be in an uncertain world. Restaurants and shops are empty, and landlords are finding that with the doors closed, tenants cannot pay rents. Most office buildings remain vacant across America. The question is whether occupancy levels will rebound.

With millions of employees working from home, the possibility of office demand dropping as companies opt for remote working for more its workforce, overall demand for office space could decline.

Commercial Real Estate owners and brokers had to feel a shiver run down their spine last week when James Gorman, The CEO of Morgan Stanley (MS), told Bloomberg TV that he expected the financial services giant to come out of the pandemic with “much less real estate.” He pointed to the success that Morgan Stanley has had with remote working this past month. He said that his workforce had proven they could succeed with a much smaller footprint.

The Impact on Credit

Lending markets are tightening up as well. Commercial Mortgage-Backed Securities new issuance will likely drop by half this year.  The reduced rate of issuance could lead to enormous problems for the companies that have more than $60 billion of CMBS debt that needs to be refinanced over the next couple of years.

CMBS default rates were just 2.6% in March, but according to analysts at Moody’s, that does not reflect the damage done across the commercial real estate sector yet. As more tenants find themselves unable to pay rents, that number will move higher. Defaults peaked at 10.27 % of the Great Financial crisis, and some observers and participants in the industry think this time might be worse.

The crisis may pass in a few months, but it will take a lot longer for commercial real estate to recover from the economic shutdown.

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