CO Finance Forum: CBRE’s Spencer Levy on Where We Are and Where We’re Headed

Levy, who is the chairman of Americas research and a senior economic advisor at CBRE, stressed the resiliency and the historical demand of commercial real estate as the beacon for positivity going forward. 

“[CRE] has a very bright future, even in those areas that are getting knocked around right now,” Levy said. “The demand to be in those spaces two years from now will look very similar to what it looked like eight weeks ago. Look at some of the positive changes that we saw come out of the terrible tragedies we’ve seen in the past, not only 9/11 and Hurricane Sandy, but you can go all the way back to 1911 and the Triangle Shirtwaist Factory fire, where 146 people perished because they locked the doors on the building because they wanted to prevent theft. After that, buildings got a lot safer. Buildings have been getting safer and better for over 100 years, so that will continue and demand will continue. This too shall pass.”

Levy spoke with CO co-deputy editor and finance editor Cathy Cunningham for the virtual keynote that took place as part of the finance forum on April 23.

Commercial Observer: We’re in week seven of shelter in place, has your economic outlook changed over the last seven weeks in terms of how our industry will be impacted by the coronavirus? 

Spencer Levy: The short answer is yes it has, and — unfortunately — it’s gotten a little bit more pessimistic certainly in the short term, and the macro outlook has deteriorated both from the standpoint of unemployment and negative GDP in the second quarter. And because commercial real estate lags behind the broader economy, a [CRE] recovery will lag as well. There are some pieces of good news because we track the five major asset classes, and three of the five have outperformed in the short term — office, industrial and multifamily — in terms of rent collections. Unfortunately, retail and hotel have lagged, and because of that, it will delay their ultimate recovery from this crisis. We believe they will ultimately recover. The way we look at it is in a one-two-three approach: a year-one recovery in multifamily and industrial, year two in office and year three in retail and hotels.

Are you expecting a “U”, a “W,” “V” or Nike Swoosh angle of recovery? What’s your opinion at this time? 

Well, we’ve heard every letter in the alphabet to describe it. Notwithstanding the fact that I have great respect for those people who differ from us. We are in the ‘V’ camp, and the reason we are [in that camp] is two-fold. Number one, our prism of [comparables] is much wider than the two comps most people are looking at here in the states, which would be the post-global financial crisis [GFC] and the post 9/11 tech bubble. If you look at those two comps as your time periods, you’re going to reach a conclusion that it’s going to take much longer to recover than if you look at other time periods. The time periods we’re looking at include the SARS period of 2003 in Asia and what’s happening right now with COVID-19 in China. Both of those yielded a much more rapid recovery than 9/11 or the GFC. If you take a look [at both of those] you’ll see that — using office space as a proxy for the other assets types — it took about two years for office rents to go from peak to trough and then about another 4 years to recover; so 6 years peak to peak. Values did recover a little bit quicker — about 4 years. But I will tell you that industrial never went down in value post-9/11. And also, if you take a look at SARS or COVID-19 in China — we can debate how good these comps are or not and there are certainly some good arguments that they aren’t perfect and they aren’t — you can see that China two months ago was completely shut down; today, over 95 percent of shopping centers are open and over 95 percent of Starbucks are open. Almost all industrial capacity is coming back online and foot traffic is higher today than a year ago. I spoke to my colleagues over in Asia [on April 20] and from a [CRE] perspective their tours of buildings for new office space is at 75 percent of peak. So, we can dispute some macroeconomic numbers but that number is real. So that means economic activity is rebounding much faster than many people might believe. 

What have your recent conversations with clients been like at CBRE?

From a capital markets perspective, the markets are open but materiality constrained. It’s constrained on the sales side for two reasons. Number one, institutions are largely out or in ‘pause’ mode. But the bigger reason is price discovery. Nobody knows what the “V” in LTV [loan-to-value] is. Even if cap rates stayed the same, I’ve had many landlords come to me and say, “I don’t know what rent roll I’m buying.” And they won’t know that until we hit bottom. The bad news is that although April rent collections outperformed our expectations in everything but retail, we think that rent collections are going to hit bottom in May or June, which is bad, but there’s actually a silver lining in that once we hit bottom we then have a measure of objectivity for which we can underwrite real estate and move forward and do transactions so it will lead to some measure of price discovery. On the debt and structured finance side we’re also doing deals but it’s clearly constrained. Not only by lender type. While you go down the hierarchy of forgiving lenders, which would start with Fannie Mae and Freddie Mac who have a formal forbearance program, and then work your way down to banks, which have been good because they have FDIC guidance on how they can work with borrowers, then you have insurance companies. I’d say in those three categories we’re seeing reasonable activity. It’s when you get below that, into the conduits and the nonbank financial institutions where the real challenges begin both in terms of new originations — where there’s almost none — but also in terms of workouts for those people who have a troubled asset. We’re optimistic we’re going to see some more bailout activity even at the lowest rungs of the capital stack. The long story short is that the debt capital markets are open but very contained as it relates to which borrowers they are going to choose, using the best borrowers and the best assets, and deals right now in retail and increasingly in office are becoming very very challenging to underwrite. 

Have the majority of deals closed been those that were signed up pre-pandemic? 

A majority of deals were signed up pre-COVID-19. I was on the phone last night with my most senior debt and structured finance professionals on new deals they’re bringing to market, even at some very low LTVs. I heard deals that were being brought at 50 percent LTV, and I heard of one construction deal being brought at a 38 percent LTV — and that was an industrial deal. It’s very tough to get banks to commit to these transactions right now. The reality is that most people at this moment in time, whether it’s a bank or landlord, are almost solely focused on nuts and bolts and asset management issues and many don’t have the bandwidth simply to underwrite or bring it to an investment committee. We’re not as concerned about liquidity. When I say that I mean that we do have a liquidity issue right now because banks aren’t lending as much as they were, but we are confident in the government at this point in bringing added liquidity that will help our industry. 

What do you think it will take for confidence to return to the capital markets? 

To make that determination, this is why I’m on the phone every day with colleagues in Asia and in Europe, because Asia is about six weeks in front of us and Europe is about the same. What is it going to take to re-open the capital markets, who’s bidding, what are they bidding on and what is the nature of those bidders? We’re seeing that right now in China. We’re seeing the bidders being mostly local institutions, and we think that’s how the capital markets begin to open. And it has to be that way because with travel restrictions you can’t do basic due diligence and cant see the asset and it’s hard to [deal with] third parties, but you’re going to start with the domestic individuals, non-institutions, then the domestic institutions, then it will snowball. But I think there’s so much capital on the sidelines right now that’s ready to go. Now, most of the new capital or a lot of capital we’re seeing coming in today are saying, “We want a distressed deal. We want to buy bad loans. Where are the opportunities?” We’re hearing this conversation every day and it really cuts both ways, because the truth of the matter is there are a lot of troubled assets out there and a lot of troubled operating companies. But what we also have is a lot of very accommodating banks out there right now. I’ll give you one example. There was a REIT in Philadelphia — Hersha Hospitality Trust — that had its bank give it covenant relief through May of 2021, so they really don’t have to do anything for a year or more. And you’re seeing more and more of that type of arrangement for some of these companies that are in hotels or maybe retail, where they’re troubled. Also, we’ve worked with some banks that are looking at large loan pools of what might be perceived as distressed loans and they’re not as motivated as you’d think to sell them because the TALF program the Fed has instituted has been reasonably effective in the short term of keeping liquidity in the system and liquidity in the banks. So, distress isn’t there, but what will give confidence in the system is price discovery. Once we see that rent collections have bottomed and started to pick up again, I think the market can confidently underwrite moving forward. 

Is it too early for distress in the market today? When will we see a wave of distressed opportunities in the debt markets? 

I say this as a market participant, and the answer is hopefully never. But, there will be some, depending upon how much relief is given at the different types of lending institutions. Right now, I think the area where you will see the least opportunities certainly in the short term is from banks and the insurance companies. But unless we see federal bailout dollars come in soon in the non-bank financial institution space — the mortgage REITs and non-bank and CMBS lenders — that’s where you’re going to see the trouble. Once again, I think a lot of people are looking at the federal government for some type of bailout relief. In the absence of bailout relief, you’ll start to see it there and in the next couple months but with bailout relief it could be longer than that. 

No two crises are the same, but how does this crisis differ in terms of the response from lenders and servicers and industry participants and how they’re dealing with borrowers today?

There’s one really big change this time from all prior crises I’ve seen. In prior crises, landlords, tenants and their lenders almost immediately took an adversarial stance toward one another. While there’s been some of that this time, there’s been very little of it this time on a relative basis, where I have seen [them] work together more constructive than any time in the past in large part because — and I say this big picture — there are no villains here and no one made a mistake in terms of their assets or lending posture. In the 9/11 tech bubble, the tech companies were the villains and in the [GFC], Wall Street was the villain. There’s no villain here.

With the timeline of one-, two-, three-year marks, do you believe this timeline will be much different for the New York area? 

Let me put it this way: the New York area — and I’m a New York guy, even though I don’t live there at the moment; I grew up there — is the most resilient place on the planet. They have the best infrastructure on the plant; they have the best human capital; they have the best cash capital on the planet. This stuff is irreplaceable. A lot of people are saying, “Well, it’s because it’s so dense and because public transportation packs people in.” New York is not going to recover as quickly this time as it did in prior crises; ok, that’s a rational argument to make. But that’s the same argument made after the horrific tragedy of 9/11. It was that people were afraid to go back into New York and D.C. What happened? Two things. First, in the short term, there were fewer people going in and there was a brief period of time in New York where the lower floors in office buildings were renting for higher rents than higher floors because of that fear and security issue. But then security improved and people regained confidence and came back into the city. And then other industries discovered that New York is a really great place to do business, particularly in the tech space and in the Midtown South region. All these things happened but during that post-9/11 period, people were making the same arguments, which is why I don’t believe it today. One other comp I think is relative to this discussion is Hurricane Sandy in 2012 in New York. [It] caused tremendous damage in lower Manhattan, causing billions of dollars of damage to critical infrastructure. What happened? Because of the change in building standards both locally and through FEMA, much of this infrastructure was moved upstairs so that the buildings were safer. So if you combine the security change that happened post-9/11 and the safety change that happened post-Sandy, you’re going to see the same thing now from a wellness standpoint. In the longer term, you’re going to see more structural changes to buildings, not dissimilar to what you saw post-Sandy, including having upgraded HVAC systems to keep the air cleaner in your building. 

What does NYC’s reopening look like to you? 

I think it’s going to be similar to what we’ve seen in other markets around the world. It’s going to be a staged, stepped reopening, and the market I would point to from a retail perspective is Austria. Austria reopened it’s small shop space this week and it’s opening its large shop space next week and its restaurants in three weeks. And then those markets that have reopened their office buildings have other things they’re thinking about, like temperature checks and forms of social distancing with respect to how many people are allowed to be in an elevator and how many people can go into certain parts of the building. They won’t all happen here, because it may sound easy but that’s a HIPAA issue. So there’s a healthcare issue there that landlords are going to have to overcome and then you have to overcome the fact of who’s going to administer the tests and what do you do with a person who has a temperature that’s above normal? It’s complicated but what we’re suggesting to our clients is take a look at the comps overseas on how they’re doing it and come up with a well thought out plan you think can work for your building while you’re waiting for whatever state- or federally-mandated changes that are going to be put into place. Landlords that are proactive and are thoughtful and methodical will be better off when the doors open. 

This interview previously appeared on a CO virtual conference and has been shortened and condensed for print and online publication.