The market value of real estate requires a willing buyer and a willing seller; both knowledgeable. The economic outlook is a factor in real estate valuation, since the market value of real estate can be thought of as the risk-adjusted, present value of future cash flows. The U.S. economy faces a reduction is GDP potentially rivaling the great depression of 1929, and occurring at unprecedented speed. The great depression was gradually revealed over 12 to 18 months; Covid-19 has put 40 million jobs at risk in three weeks. Layoffs just for hotel and restaurants will likely exceed 18 million. During the great depression, unemployment rose to ~25% and GDP fell by 15%. This is expected to occur in the second quarter. The duration is unknown.

The impact of Covid-19 seems sharper, more intense and vivid (red spheres with yellow spikes that feather. It may last longer lasting than the 1999 Russian bond crisis, the 2001, and the 2008 housing bust. The intensity is higher because of: 1) massive layoffs of 75% of employees in restaurants and hotels, 2) the rapid pace of change and 3) sense of panic. In only three weeks, since March 6, 2020, the scale of economic destruction and chaos is almost unfathomable. During the 2008 housing crisis, the emergency unraveled gradually over six to nine months.

We are experiencing the highest level of uncertainty remembered by anyone alive. Covid-19 occurred here in three weeks; only 10% of the time for the housing crisis. Citizens are listening live to government announcements at the city, county, state and federal level. New York’s governor, Mario Cuomo, predicted that 40 to 80% of people in New York could be infected by Covid-19, for a total of 8 to 16 million people. The number of reported Covid-19 infections in China is 83,000, or 0.0064% of the total Chinese population (83,000 / 1,300,000,000). Why the New York governor is projecting 40 to 80%, when China had well under 1% is unclear. But false information is part of the cause of panic. Panic is causing people to hoard cash in addition to toilet paper. Uncertainty is heightened by an uncoordinated response from government officials. There are no buyers for commercial real estate at pre-Covid-19 prices. Most pending commercial transactions are being cancelled and few new transactions are being initiated.

V-Shape or U-Shape Recovery – Does it Matter?

The nature of the recovery is pivotal to valuation. People pray for a quick V-shaped recovery. However, a U-shaped recovery, with 3 to 6 months at the bottom and then a gradual recovery over six to eighteen months seems more likely. We have been in lock-down for part of a month. The lockdown was expanded until April 30th (on May 29). People are quarantined for at least one more month. What happens then depends on our success of reducing new infections sharply. How many businesses can survive three months with no revenue to perhaps 25% of normal revenue? This is the likely reality for 10 to 20 million businesses. In a V-shaped recovery, within a month, hotels would be at stabilized occupancy and airlines would be back to normal traffic levels. Most businesses that closed during the two or three month shut down reopen. Do you believe airlines and hotels will be at 90% of pre-Covid volume one or two months after the quarantine is lifted?

Commercial Real Estate

Covid-19 has had a massive and immediate impact on commercial real estate. The magnitude of the change is magnified by the current level of uncertainty (written March 27, 2020 and edited March 29). The duration of slowdown for Covid-19 is unknown, as is the rate of recovery. If millions of businesses fail, the ripple effect will impact employees, vendors, landlords and owners. There are 32.5 million businesses in the U.S. Most do not have adequate reserves to operate for three months without revenue. It is now clear many real estate tenants will not have access to their rented premises, or are operating below capacity, and will be struggling to pay their bills.

Following are large industries seriously affected by Covid-19.

Restaurants – 15.6 million employees – 1 million + locations

Restaurants employ 15.6 million at over 1 million locations with annual revenue of $899 billion, before Covid-19. Restaurants providing take out are largely foundering, with revenue of 10 to 20% of before Covid-19. Staff has been slashed at more restaurants by 70 to 75%. It is unclear how long restaurants offering take-out, will remain open with 10 to 20% of prior revenue. Most publicly traded restaurants would not fare well after only two to three months. Most have a reserve account for only one or two months revenue.

Hotels – 8.3 million employees

Hotels are clearly impacted by Covid-19. Many or most hotels have already closed, or are operating with a skeleton staff. Occupancy rates are 5 to 20%. For how long is unknown. Publicly traded, large hotel chains announced layoffs of 80 to 95% of their employees last week. Marginal costs of remaining open are higher than marginal revenues. Many hotel owners will default on their loan payment due April 1. Unless there is a V-shaped recovery, which is not expected, hotel loan defaults will approach 75% after six months. Hotels employ 8.3 million and have revenue of $218 billion. Hotels will be hardest hit. Even if the quarantine were lifted at the end of April, hotels would no likely reach prior stabilized occupancy levels for another six months at a minimum. It depends on how quickly businesses and individuals start traveling. It also depends on whether the level of travel is the same Post-Covid-19.

U.S. Healthcare – 16 million

U.S. healthcare employs 16 million and is facing large layoffs since all activities other than addressing emergencies or Covid-19 have ceased. It seems likely that 25 to 50% of the healthcare workforce is idled, or 4 to 8 million. Unknown damage due to halt in routine activities. Only emergency surgery and Covid-19 and other emergencies are occurring. Many of these employees may be paid.

Business and Professional Services – 19.6 million employees

A relatively low level of disruption is expected, but even 10% is 2 million people

Wholesale and Retail Trade – 19.7 million employees

A relatively low level of disruption is expected, but even 10% is 2 million people

Manufacturing – 15.7 million

A relatively low level of disruption is expected, but even 10% is 1.5 million people

Income Properties

Owners of income properties have been ordered not to evict for two months in many cities and states. How many tenants will elect not to pay for two months? This includes apartments, office, retail, warehouse, gyms, movie theaters, restaurants, etc. One large landlord expects a 50% default rate for April rent, due 5 days from today. The ripple effect from income properties is loan defaults.

Casinos employ 362,000 and generate revenue of $42 billion. Most have been laid off or furloughed.

U.S. airlines employ 452,000 and have revenues of $233 billion. Most have been laid off or furloughed.

Vendors to Restaurants, Hotels, Healthcare, Airlines and Casinos

Vendors will be impacted two ways: 1) bad debts will increase and 2) new orders will slow or be eliminated. One firm is SYSCO; as of this writing, it is valued at $26 billion, has 69,000 employees and annual revenue of $60 billion. SYSCO’s net margin is only 3%; doesn’t allow for much bad debt. Restaurants are listed first in a description of the firm, followed by Healthcare, Senior Living Facilities, Higher Education and Government. The volume of activity has fallen sharply in every category except Senior Housing.

40.6 Million Jobs in Restaurant, Hotel, Casino, Airlines and Healthcare

Healthcare, restaurants, hotels, airlines, Boeing, and casino employ 40.6 million, or 31.0% of the U.S. workforce which totals 131 million. Restaurants and hotels, two horribly devastated sectors total 23.9 million jobs, or 18.2% of the workforce. Business and professional services, wholesale and retail trade and manufacturing total 55 million employees. Some portion will be lost. The great depression was a 15% contraction in GDP and 25% reduction is employment, from 1929 to 1932. This economic cycle will rival the great depression for severity, unless there is a fast V-shaped recovery for revenue for hotels and restaurants. Most of the existing restaurant and hotel businesses will close unless revenues increase rapidly in two or three months. Restaurants and hotels now open are incurring greater marginal costs than the marginal revenue. They are operating at a loss. The limited revenue does not cover even the cost of the skeleton staff, food and utilities. They are losing money after terminating 75% of the staff.

Economic Fabric Stretched or Torn; Does Moral Hazard Matter?

The ripple impact of restaurants, hotels, casinos, movie theatres, gyms and many other types of businesses will affect many businesses. Companies are reviewing plans several times a week; sometimes daily. Options are few and limited for businesses that lose 30% or more of their revenue. Most businesses operate on a margin of 0 to 20% profit. Businesses and individuals who suddenly lose their income stream will need to quickly select who they are paying, unless they have substantial reserves. Most small businesses have reserves for a week to two months. The largest hotel and restaurant chains only have reserves for 1 to 4 months with few exceptions. This does not include lines of credit not on 2019 balance sheet. This analysis is based on comparison of monthly run rate for revenue, liquid assets, liquid liabilities and cash. Most hotels and restaurants have a quick ratio (current assets / current liabilities) of 1.0 to 1.5. The quick ratio for McDonalds is 1.0

No Moral Hazard? – Is Government Encouraging Tenants Not to Pay?

Is the government sending the wrong message with promises of no foreclosures and evictions for two months? Will borrowers with Fannie Mae, FHA, Freddie Mac and other loans decide not to pay for two-months? Orders by city, county and state governments are abrogating private contracts. The U.S government sponsored a 60-day ban on foreclosures and evictions from Fannie Mae, Freddie Mac and FHA? Will home owners interpret this as a signal not to pay their mortgage for 2 months? This plan ignores the issue of moral hazard. It does not clearly lay out what happens after the two months. Do they waive the payments, recast the loan or foreclose? How long will lenders wait before requiring payment?

Wisdom of Paying People Not to Work; Will it Slow the Recovery? Negative Moral Hazard

Unemployment insurance payments will exceed the potential earning at the prior job. If the jobs becomes available, should the offer be accepted? Or is it better to collect more for four months, while possibly not paying rent or mortgages. From late April to late July, many would receive more funds by remaining on unemployment insurance. That is what Chuck Schumer meant by “unemployment benefits on steroids”. This will negatively impact the recovery by delaying a return to employment.

Will Home Owners Interpret this as a Suggestion Not to Pay for Two Months?

Most home loans are Fannie Mae, Freddie Mac and FHA. Will business owners transfer the halt on payments for their residence e to their commercial property or commercial rent? Will the leniency of U.S. lenders encourage business owners to ask for reductions and or payment extension of rent? Today, it is unclear if owners of commercial properties will be receiving checks for rent for April. In addition to layoffs, some business have stopped / delayed paying vendors. Many cities and states have imposed 30 to 60 days prohibition of evictions. It is possible and perhaps likely these will be extended? How many tenants will elect not to pay? Could it be more than 20% of the tenants who do not pay?

Multiple national businesses including Cheesecake Factory and Mattress Firm have announced they are renegotiating April rent. April 1, 2020 is five days from now, and there is uncertainty regarding whether tenants will pay rent, or hoard cash. The March 30th announcement extending the quarantine through April 30 will not encourage tenant to pay April rent.

Benefits and Limitations of $2 Trillion Government Plan

The $2 trillion plan will put hundreds of billions; likely over $1 trillion into the economy in two to four months. Low-wage and moderate income will be protected for four months. The $2 trillion plan will help many small businesses with loans for two months of: salary, interest, rent and utilities. However, the $2 Trillion plan will not stave off insolvency for businesses deprived of revenue for three to six months.

Disaster Awaits Millions of Small Businesses

How many businesses can survive three to six month with 0 to 20% of existing revenue? The answer is most public companies fail after two to six months. Most private companies fail after 1 week to three months.

The $2 trillion bill passed today will not help restaurants, hotels, airlines, movie theatres, gyms and many other types of businesses. Businesses can’t pay rent unless they are operating profitably. The problem is a lack of revenue; providing money to pay employees for two months does not address the underlying problem. There is no purpose in having employees at the location since there is no business activity. Businesses need revenue similar to before Covid-19. Most businesses have a profit margin of 10 to 20% or less. If revenue is reduced more than 20%, most businesses become unprofitable. The program for small business does not have a meaningful impact on businesses with large reductions in revenue. This includes hotels, restaurants, casinos, and healthcare. Healthcare revenues should snap back after the “shelter in place” orders end. However, restaurants, hotels, airlines, and casinos likely face six to eighteen months to regain their prior level of revenue, after the quarantine is lifted.

Tens of millions of businesses are making the decision to layoff or furlough a portion of their employees, or just to close. Other employers have reduced compensation broadly, perhaps 30% across the board. The unemployment report this week (week of March 23, 2020) was 3.3 million, about 5 times the prior record. Exceeding the old record by 400% indicates the severity of disruption to the U.S. economy. Economists had forecast about 1 to 1.5 million; the level of layoffs was twice the highest estimate. Again, hotels and restaurants employee 23.9 million. The 3.3 million announced this week will not be the largest number; total layoffs just from hotels and restaurants are likely to total 18 million, 13.7% of the 131 million U.S. employees.

Is Reopening Hotels and Restaurants Hard?

In a word, yes. Based on 3 months in quarantine and a U-shaped recovery, most restaurants and hotels will fail. The owners in some cases will be personally bankrupted. Many good people will exhaust their personal savings to keep the business alive. Some will exhaust the retirement savings and put mortgages on free and clear homes.
Most existing owners will not have the capital to re-open the business. Many if not most will exhaust their capital trying to save their business. Chain hotels and restaurants are easier to open. But opening most businesses that requires operating capital sufficient to start business and sustain it during the one to two years of startup.
Closing a business like a hotel or restaurant is easy. Any fool can close a business. Talent, intense dedication for several years and capital are required to start a business. Re-opening shuttered hotels and restaurants could easily require two to four years. This is particularly true if the lender forecloses on the real estate.

Covid-19 Impact on Real Estate Values, Sales and Loans


Residential real estate transactions are continuing as normal, as of March 27. Contracts pending will close. It helps the government is available to purchase loans for these transactions. However, this could change after the contracts pending close.

Commercial Loans

Commercial lenders will see loan defaults more similar to the great depression than the 2008 housing crisis. Millions of businesses will fail. They will not be able to pay the landlord rent or the tenant the mortgage payment. Lenders are expected to face some loan payment defaults in April. However, by July the number of defaults will likely have grown due to business failures. With limited exceptions, the U.S. government does not purchase loans for commercial properties. CMBS loans have ceased; banks are hit and miss and life companies appear to be quoting business. Lenders will be wary if they have substantial loan defaults in April to July.

Commercial transactions have slowed or come to a stop due to uncertainty over the future. The buyers and lenders are cancelling the transaction. The current level of uncertainty reduces the number of buyers to close to zero. Few investors would transact the purchase of commercial real estate without a substantial discount. Today, a discount of 25% seems modest and low given the severity of this crisis. It seems likely a buyer could be induced to purchase a property not impacted by Covid-19 at 25 to 50% of the prior value.

Uncertainty impacts the pool of buyers and lenders and the market value. Covid-19 sharply reduces the pool of buyers for commercial real estate given the current uncertainty. Many large owners of real estate are days or months away from defaulting on their loans if revenue falls 20%. The market for commercial real estate today is illiquid with few buyers. It is clear the market value of commercial real estate is lower. The level of discount also depends on the type of property. Hotels and casinos would be deeply discounted. The level of discount for apartments, office, retail and warehouses will be better understood after reviewing data on April and May collections.

By Patrick O’Connor, MAI
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