MBA Commercial Real Estate Finance Forecast
By Jamie Woodwell; Reggie Booker
July 16, 2020
The economic downturn caused by the COVID-19 pandemic is unlike anything the U.S. has previously seen. And so this updating of MBA's commercial real estate finance (CREF) forecast can be viewed as an exercise in hubris, or folly. We generally agree. The key drivers of commercial mortgage activity in coming years - including the course of the virus, our economic and social responses to it, as well as government policies to address it - all remain unknown and well outside the scope of this effort. What we can do is lay out a potential (probable?) course we think may occur, and what that would imply for commercial and multifamily mortgage originations.
The key takeaway is that we expect originations to drop significantly this year before making a sharp, partial rebound next year. Commercial and multifamily mortgage originations may be down 60 percent this year, with total multifamily lending falling by 40 percent.
One of the challenges with this forecast is the different ways the downturn is affecting different property types. Hotel and retail properties have been hard-hit by the virus, with significant declines in the incomes of many properties and to investor interest in that space. But in 2019, these two property types collectively accounted for only 13 percent of total mortgage bankers originations. Industrial (10 percent of 2019 originations), office (19 percent) and multifamily properties (48 percent) also face uncertainties, but to a much lesser degree. Each will be affected differently.
Our forecast is built on the traditional (strong) relationship between property sales activity and mortgage originations, and the relationship between property values (and increases in them) and property sales. Given how quickly the current downturn came on, it is still too early to tell what the impact on property values has been. But recent data from Real Capital Analytics shows a marked fall-off in sales in response to the pandemic - with May sales volumes 80 percent lower than a year earlier, bringing year-to-date sales 21 percent lower than last May's total. This will undoubtedly carry over to demand for mortgages, but the impact will be muted somewhat by refinance activity - especially among multifamily properties taking on government mortgages.
Property values, which drive sales and mortgage volume, will be determined by property cash flows and how investors value them (the capitalization rate). Income at hotel properties stopped on a dime with the onset of the virus and, with many store closures, retail was not far behind. But with states haltingly reopening, those incomes are starting to claw their way back. The impact of this downturn on multifamily and office property incomes remains largely unknown. While some see significant disruptions, there are ample reasons to expect relative stability. The bottom-line is that incomes will decline, but the scale of those declines remains uncertain.
For multifamily properties, much appears to depend on the federal government. Despite major disruptions in the labor markets and the unemployment rate rising above 14 percent, renters have continued to make their payments. This can largely be attributed to the federal stimulus bills, the one-time checks and expanded unemployment insurance. Should such support for displaced workers continue as the economy rebounds, the apartment market should remain relatively balanced. This forecast anticipates continued federal support with a decline in property net operating income (NOI) roughly between that seen in the recession of 2001 and that of the Global Financial Crisis (GFC) - relatively light given the amount of labor market distress.
For office properties, the outcome will hinge on the tug-of-war between how dramatically companies embrace teleworking and shed office space on the one hand, and how companies reconfigure their space (and increase space per worker) to promote social distancing on the other. We anticipate that for most properties in most markets, the latter could largely mute the former, and that the greatest impact will come through shorter-term decision-making that generally maintains the leasing status quo.
Looking across all property types, we expect the aggregate decline in NOI this recession could exceed that of the 2001 recession or GFC, but that impacts will be very different across different property types. The overall decline will also be concentrated in 2020.
The other component of property values is capitalization (cap) rates. Cap rates entered this downturn at record lows, but the spread between cap rates and risk-free yields (in this case the 10-year Treasury yield) was at relatively high levels. We expect cap rate spreads to rise in 2020 compared to 2019. When the decline in the risk-free yield is taken into account, however, we expect only a marginal change in overall cap rates. Property types with greater uncertainty are likely to see cap rate spreads rise more than others.
The result, for property values, would be a rapid but muted decline in 2020 - greater than what was seen in 2001 but not to the degree seen during the Global Financial Crisis - followed by a partial rebound in 2021.
Converting this scenario into commercial and multifamily mortgage originations would imply mortgage bankers lending declines of roughly 60 percent, from $600 billion to $250 billion. In 2021, originations would bounce (partially) back to just less than $400 billion.
Looking at total multifamily lending, which includes lending by small and mid-sized banks and thrifts which are excluded in the mortgage bankers originations in the previous paragraph, lending would decline by roughly 40 percent, from approximately $360 billion to about $210 billion. In 2021, originations would bounce (partially) back to $300 billion.
Given the speed with which the COVID pandemic has hit, and our continually shifting social and economic responses to it, it is hard to know where we are at any given point in time, let alone where we might be headed. Whether hubris or folly, or a little bit of both, we hope you find this helpful.