The coronavirus pandemic is changing how in the future segments such as office space and retail space will be used, which could mess with overall demand.
Because of deal making and new regulation, recessions and financial crises often have a way to change the banking landscape. But they also can have an impact on the way banks lend. For example, in the aftermath of the Great Recession in 2008, banks concentrated much less on residential mortgages, historically their bread and butter due to the wide-ranging issues that arose in the home market. A long period of low interest rates intended to jump-start the economy has made residential mortgage yield much less appealing. Collectively, outstanding volume of residential (single-family) mortgages in the U.S. Banks went from $2.7 trillion in 2006 to $2.5 trillion by the end of 2019, the FDIC reported.
In the same period, the volume of commercial real estate (CRE) loans grew from $886bn to $1.5 trillion. So there are a number of CRE loans that were not even checked during a recession, let alone during a happening like the coronavirus. Typically, a CRE loan is made to a borrower or firm to secure a property for its business. Examples include the purchase of a retailer’s storefront, a company office building, a large hotel building or an apartment building that houses more than four units. While I do think restaurants and hotels will rebound from the coronavirus pandemic, other types of commercial real estate will never be the same as some digital and remote trends accelerated during the coronavirus.
Office space is one sector within CRE that looks like it might be permanently disrupted. Workers who spend the whole day on their computers making phone calls can actually do the same job from the comfort of their home or at a coffee shop (shocking, I know) in an apparently huge shock to the business community. The coronavirus showed essentially that workers are able to work at home and remain productive. This has prompted many companies to start rethinking the amount of physical space they need.
Gerard Cassidy, RBC Capital Market’s equity research managing director is concerned about the need for office space in the major cities of the US because their leases are coming up. Instead of having 200,000 square feet, Cassidy things maybe they just need 150,000 square feet so they would give their employees the chance to operate from home two days a week vs five days a week in the office.
This change is already taking place at tech giants such as Twitter (NYSE: TWTR) and Facebook (NASDAQ: FB), who have said a large portion of their workforce is likely to be remote after the coronavirus. In addition, a recent survey conducted by research firm Gartner found that nearly three-quarters of 317 CFOs and finance leaders surveyed in March are planning to move at least 5 percent of their employees normally working in the office to permanently remote post-coronavirus positions. Another survey conducted by the corporate real estate association CoreNet Global in late April showed that 69 percent of the corporate real estate members of the association expect their company to reduce their office footprint after working remotely during the pandemic. The figure was 51 percent a month earlier. Cassidy sees the office space industry evolving structurally in the next three to five years, something that no one would have foretold before the coronavirus.
This could be a problem for office space loans already in place. If the demand for office space decreases significantly, then the value of the office buildings may also decrease. In this case, borrowers may not want to pay their monthly mortgages because they make the same high monthly payment now but get less equity on the property, a scenario that typically leads to a loss on their investment. If this happens, or the owner of an office building defaults on the loan, a bank’s normal course of action is to come in and foreclose the property, and then sell that building as quickly as possible to recover what remains on the loan. But if the building’s valuation falls enough, the building’s sale may not be enough to make up the difference for what’s left on the loan. A similar conundrum occurred during the Great Recession, when home values fell significantly across the country.
It is not just office space which could be affected. After all, if people are able to work elsewhere, do they have to pay the high rent and home prices in Boston, New York City, Los Angeles, and San Francisco? This could affect the demand for multi-family loans in cities used to buy apartment buildings or complexes with more than four units that could be leased or sold. The volume of multi-family loans at all U.S. banks went from $193 billion in 2006 to $458 billion by the end of 2019, according to the FDIC.
Before the pandemic, many banks were also staying away from loans to retailers, but once the pandemic subsides, this CRE segment could be in even more trouble. According to eMarketer, U.S. retail sales are projected to decline by 10.5 percent in 2020, while e-commerce sales have already jumped by 18 percent this year. Does that look like a trend which is going back to normal? According to Coresight Research, US retailers could close 20,000 to 25,000 stores this year. Over half of those may be in malls. Historic department stores such as Neiman Marcus and J.C. Penney (OTC:JCPN.Q) have huge brand recognition yet filed bankruptcy proceedings.
What will become of the future?
While digital and remote trends have accelerated, right now, I still believe they are on an extreme scenario. People inside their homes will not want to live their entire lives in those four walls. A more likely scenario in the front office sphere is that a smaller and more efficient space is created by the businesses. Cassidy said that he could see many offices losing their cubicles and individual offices and simply becoming open spaces where anyone can plug in. Personally, I think there will be a lot of co-working spaces and sharing space between different companies to save on costs. So, CRE may not fall off a cliff like the residential market did in 2008, but it will probably change.