EY Real Estate Markets Update
Economic and real estate overview
June 2020 Disclaimer
• EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client- serving member firm of Ernst & Young Global Limited operating in the U.S. • This presentation is © 2019 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. • Views expressed in this presentation are those of the speakers and do not necessarily represent the views of Ernst & Young LLP. • This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and circumstances. • These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice.
Page 1 EY Real Estate Markets Update Economic and real estate overview
Mike Straneva Partner US National Director of Transaction Real Estate Ernst & Young LLP
Page 2 EY Real Estate Markets Update Where are we in the cycle? Real estate recession
Self-storage Multi family Office Single family Senior housing Community centers Manufactured home High-productivity malls Industrial Neighborhood centers Student housing Power centers Lodging Data centers M-RevPAF Growth Slowing M-RevPAF Growth Negative (Expansion) (Oversupply/ Low-productivity malls Cell towers Material rent growth Obsolescence) Rising/stable occupancy Rents falling New construction Occupancy falling
M-RevPAF Growth M-RevPAF Growth Flat Accelerating (Bottoming) (Recovery) Rents and occupancy stabilizing Low/modest rent growth Little to no new construction Rising occupancy Little new construction
Page 3 EY Real Estate Markets Update Today’s economy: the glass is broken
• REITs have suffered significant price declines in most sectors • Interest rates are at historic lows but floors and increased underwriting makes lending difficult. • Inflation could be a long term problem but today’s issues relate to deflation. • The bid ask spread between buyers and sellers has chilled the market for all but a few select property types like industrial and data centers. • Wave of distressed buyers looking for asset purchases are on the sidelines while distressed debt, mezzanine and rescue capital are the flavor of the day. • Unemployment is at historic highs supressing consumer demand. • Government CARES Act and treasury intervention in the market place is unprecedented. • Business is waiting to see the results of the reopening while the results of the stimulus packages are set to burn off. • On top of all this, it’s an election year.
Page 4 EY Real Estate Markets Update Economy is witnessing the highest unemployment rate since 1982
May ’20 14% Unemployment rate 13.3%
12%
10%
8%
6%
4%
2%
0%
► Surprisingly, May saw 2.5 million jobs ADDED, bringing the unemployment rate down from 14.7% in April to 13.3% in May.
Source: US Bureau of Labor Statistics
Page 5 EY Real Estate Markets Update This is the unequitable effect of the Coronavirus
US Unemployment rate (%) by race US Unemployment rate (%) by education level 20 21
18 19 17 16 15 14 13 12 11 10 9 8 7
6 5
4 3 1 2 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 May-20 May-20 Total No HS HS No College Some College College + Total White Black Asian Latino or Assoc. Deg
Source: US Bureau of Labor Statistics
Page 6 EY Real Estate Markets Update What will increased government borrowing do to future US yields?
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0% Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Mar-19 Mar-20 Sep-12 Nov-12 Sep-13 Nov-13 Sep-14 Nov-14 Sep-15 Nov-15 Sep-16 Nov-16 Sep-17 Nov-17 Sep-18 Nov-18 Sep-19 Nov-19 May-12 May-13 May-14 May-15 May-16 May-17 May-18 May-19 May-20 10 Yr 5 Yr 2 Yr
• Stimulus packages, including the CARES Act, total $2.3 trillion, with more in the works. • The Fed’s initiatives include rate cuts, lending programs and credit facilities and have the potential to inject a total of $6 trillion into the financial system Source: US Treasury, Forebes, CNBC
Page 7 EY Real Estate Markets Update The dollar has slightly appreciated although the Fed Fund rate is near zero
US dollar index vs Fed Funds Rate 106 3.0% US Dollar Index Fed Funds Rate 104 2.5% 102 100 2.0% 98 1.5% 96 94 1.0% 92 0.5% 90 88 0.0% 1-Jul-19 1-Jul-18 1-Jul-17 1-Oct-19 1-Oct-18 1-Oct-17 1-Feb-20 1-Apr-20 1-Feb-19 1-Apr-19 1-Feb-18 1-Apr-18 1-Feb-17 1-Apr-17 1-Jan-20 1-Jan-19 1-Jan-18 1-Jan-17 1-Jun-20 1-Jun-19 1-Sep-19 1-Dec-19 1-Jun-18 1-Sep-18 1-Dec-18 1-Jun-17 1-Sep-17 1-Dec-17 1-Dec-16 1-Mar-20 1-Mar-19 1-Mar-18 1-Mar-17 1-Nov-19 1-Nov-18 1-Nov-17 1-Nov-16 1-Aug-19 1-Aug-18 1-Aug-17 1-May-20 1-May-19 1-May-18 1-May-17 Pros: Cons: • A strong dollar makes foreign goods more affordable for • American exports are more expensive abroad. consumers. • There is less domestic demand for US-produced goods because • For large multinationals, a strong dollar means greater ability to of cheaper buy foreign goods. foreign companies. • Reduced demand for American-made products will place • A strong dollar cools inflation and economic growth, which may downward pressure on US employment. be overheating. • A stronger dollar signals that investors believe economic growth Source: The Wall Street Journal, US Federal Reserve will accelerate in the longer term. Page 8 EY Real Estate Markets Update Oil prices, employment and rig count plunge before oil recovers to $35 per barrel WTI spot price ($ per barrel) Texas employment vs. rig count $120 1000 6%
$100 900 4% 800 2% $80 700 600 0% $60 500 -2% 400 $40 -4% 300 -6% $20 200 100 -8% $- 0 -10%
$(20) Jul-15 Oct-16 Apr-19 Feb-20 Apr-14 Feb-15 Jan-18 Sep-19 Jan-13 Sep-14 Dec-15 Jun-18 Jun-13 Mar-17 Nov-18 Nov-13 Aug-17 May-16
$(40)
Texas rig count (L) Texas non-farm employment YOY % Ch (R) Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 Apr-19 Oct-19 Apr-20 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20
Source: Bureau of Labor Statistics, Baker Hughes
Page 9 EY Real Estate Markets Update No world economy has been spared
GDP Growth Forecast 2019 vs. 2020
China 0.4% 6.1% India -3.1% 5.6% Indonesia -2.3% 5.0% Russia -6.3% 1.0% Emerging Brazil -4.8% 0.8% Mexico -5.2% 0.4% United States -7.0% 2.2% South Korea -1.0% 1.9% Australia -5.9% 1.8% Canada -10.7% 1.4% France -9.4% 1.3% 1.2% Developed United Kingdom -8.3% Japan -6.5% 0.8% Germany -6.1% 0.6% Italy -8.7% 0.1%
2019 2020
Source: Oxford Economics
Page 10 EY Real Estate Markets Update Real estate funds are sitting on a record amount of dry powder
Top RE PE Fund Managers by fundraising 2014-2019 Rank Manager Headquarters Capital raised ($m) 1 Blackstone New York $ 64,931 2 Brookfield Asset Management Toronto $ 29,014 3 Starwood Capital Group Miami Beach $ 16,861 4 GLP Singapore $ 16,435 5 Lone Star Funds Dallas $ 16,200 6 AEW Boston $ 12,227 7 The Carlyle Group Washington DC $ 10,860 8 Rockpoint Group Boston $ 10,741 9 BentallGreenOak New York $ 9,713 10 Angelo Gordon New York $ 9,449 Total $196,431
Source: Preqin, PERE
Page 11 EY Real Estate Markets Update Frothy market multiples look to increased earnings
Broad market indices performance Shiller PE ratio 220 50 45 200 40 180 35 30 160 25 17.7 140 20 15 120 10
100 5 0 80 Oct-18 Jan-00 Jan-07 Jan-14 Jan-21 Jan-28 Jan-35 Jan-42 Jan-49 Jan-56 Jan-63 Jan-70 Jan-77 Jan-84 Jan-91 Jan-98 Jan-05 Jan-12 May-19 4-Jul-16 4-Jul-17 4-Jul-18 4-Jul-19 1/1/1872 1/1/1879 1/1/1886 1/1/1893 4-Oct-16 4-Oct-17 4-Oct-18 4-Oct-19 4-Apr-16 4-Apr-17 4-Apr-18 4-Apr-19 4-Apr-20 4-Jan-16 4-Jan-17 4-Jan-18 4-Jan-19 4-Jan-20
DJI NASDAQ S&P 500 PE Ratio Long term average
Source: Factiva Source: ThomsonOne
Page 12 EY Real Estate Markets Update Bank regulators are accommodating lenders that make concessions to borrowers: what happens in the fall when the easy covenant waivers could end?
The OCC and FDIC issued separate but overlapping bulletins recommending that banks make allowances to borrowers affected by COVID 19. Both regulators announced that banks would not be penalized by examiners for taking steps to mitigate financial losses in the coming months.
► The OCC told banks that allowing loan payment flexibility for struggling customers had the potential to “ease cash flow pressures on affected borrowers, improve their capacity to service debt, and facilitate the bank’s ability to collect on its loans.”
► The FDIC echoed the OCC’s advice but put additional emphasis on the importance of flexibility for small businesses: "these types of prudent arrangements for borrowers who operate small businesses can contribute to the well-being of local communities.“
Source: American Banker
Page 13 EY Real Estate Markets Update Impairment
Page 14 EY Real Estate Markets Update Selecting market assumptions during disruption
• How do we determine market assumptions in a disrupted environment?
• How do we approach fair valuation during a period of depressed transaction volume? Some believe the values are decreasing, but what can be proven?
• When will transaction evidence reflect value impacts?
• How do you adjust cap and discount rates with little transactional evidence?
• For sensitivity and scenario calculations, can we simply broaden our assumption ranges?
• The Appraisal Institute, Valuation Impacts of COVID-19:
• “… the appraisal report should address the uncertainty in the market caused by the COVID-19 crisis not as a limiting condition, extraordinary assumption, or disclaimer, but rather as part of the discussion of market conditions. While the crisis is still unfolding, it might also be a good idea to highlight key points in the letter of transmittal relating to COVID-19 as a significant factor.”
Page 15 EY Real Estate Markets Update Estimating cap and discount rates absent transaction data
A majority of respondents agreed that it is too early tell how market cap and discount rate assumptions will be affected in the long term. However, we can look to textbook buildup formulas and valuation rules of thumb while we wait for transaction data to materialize. • Cap rate • Overall: band-of-investment method (next slide) • Terminal: overall + 50–100 bps spread
• Discount rate • Risk-free rate + risk premium • Direct cap rate (overall rate) + long-term growth rate
• Common themes • Credit loss, rent abatement and rent escalations add to the risk profile of the cash flows and increase discount rates. • While mortgage rates are still arguably flat since Q1 2020, the equity returns requirements have likely increased, thus lifting cap rates.
Page 16 EY Real Estate Markets Update The band-of-investment method to calculate overall rate
Mortgage/equity assumptions Scenario 1 Scenario 2 Band of investment, per The Appraisal of Real Loan-to-value ratio 75.00% 70.00% Estate, 14th Edition: Interest rate 4.00% 4.00% • “A technique in which the capitalization rates attributable to components of a Amortization (years) 20 20 capital investment (debt and equity) are Mortgage constant 7.36% 7.36% weighted and combined to derive a weighted-average rate attributable to the Equity ratio 25.00% 30.00% total investment.” Equity dividend rate 10.00% 12.00% • Ro = M × RM + E × RE Weighted average of mortgage and equity requirements (scenario 1)
Key assumptions Mortgage requirement 75.00% x 7.36% = 5.52% • Loan to value – what is your lender’s max? Equity requirement 25.00% x 10.00% = 2.50% • Mortgage constant – debt service/loan Indicated cap rate (rounded) 8.00% amount (equals rate if interest-only) Weighted average of mortgage and equity requirements (scenario 2) • Equity dividend rate – look to preferred Mortgage requirement 70.00% x 7.36% = 5.15% fund returns Equity requirement 30.00% x 12.00% = 3.60%
Indicated cap rate (rounded) 8.75%
Page 17 EY Real Estate Markets Update Valuation process in a time of uncertainty
Valuation Current state Duration Recovery Exit strategy 1approach 2 3 4 5
► Use single set of cash ► Reviewing knowledge ► Considering what the ► Model recovery and ► How long do you flows or scenario about the individual duration of the impact stabilization of key intend to hold this analysis? property risks will be (long-term or assumptions on both asset? shorter- term cash the income and ► Stratify the portfolio ► Leases: tenant ► Held for sale asset for risk based on bankruptcy, collection flows) expense side (keep in criteria: do we need to mind, expenses may property type and loss, rent abatements ► Frequently thought of update? exposure (hotel and or modifications, near- as a period of months have temporarily decreased) ► What is the hold retail focus)? term renewal unless there are period we should be probability, an indications of long- ► Consider occupancy, ► Portfolio sampling: using for our apply findings opportunity to blend term impact rental rates, discounted cash flows? and extend leases reimbursements, globally or proceed ► Possibility of slow to operating expenses ► What does the with detail review ► Transactions: sales or no change initially, terminal cap rate looks based on results? new leasing activities followed by multiple ► Consider when like? Any long-term falling through (lease- quarters of increases assumptions will come ► Determine the best changes? up delays) back to normal and set of facts and data ► A look back to 2008 why ► Is a discount rate available? (A well- ► Rates: cap and and 2009: potentially adjustment rounded team effort discount rank metrics, three quarters for necessary? is key (e.g., asset monitoring the market impact to settle in management, M&A, ► Benchmarking against accounting, advisors, competitors appraisers, brokers).)
Page 18 EY Real Estate Markets Update CMBS late payments up for lodging, retail and mixed use
CMBS update Monthly % of CMBS loans in grace period or < 30 ► The 10-year spreads on AAA-rated days late payment tranches of commercial mortgage- backed securities (CMBS) jumped nearly 400% in March from an average of approximately 80 bps to a high of 330 bps as uncertainty around the COVID-19 pandemic spread, essentially halting all new conduit lending.
► The Federal Reserve has since proposed purchasing up to $100 billion of AAA- rated asset-backed securities to inject liquidity into the market. This announcement pushed spreads back down into the low 200s as conduit shops cautiously ramp up new issuances.
► April CMBS remittance data per Trepp reveals late payment and nonpayment Source: Trepp of hotel loans increased tenfold, and retail loan nonpayment increased nearly fivefold.
Page 19 EY Real Estate Markets Update People are rethinking the value of real estate
Green Street Advisors Commercial Property Price Index vs. Premium/Discount to NAV Jan 07—May 20 150 40%
140 30%
130 20% 120 10% 110 0% 100 -10% 90 -20% 80 -30% 70 GSA CPPI (L) -40% 60
50 GSA Premium/Discount to NAV (R) -50%
40 -60% Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Oct-12 Oct-13 Oct-14 Oct-15 Oct-16 Oct-17 Oct-18 Oct-19 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 Apr-19 Apr-20 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20
Green Street Advisors Commercial Property Price Index is indexed to 100 in August 2007.
Page 20 EY Real Estate Markets Update But there are stark contrasts in REIT share values across property types
Premium/discount to NAV by property type 60%
40%
20%
0%
-20%
-40%
-60%
-80%
Apartment Industrial Mall Office Health Care
Source: Green Street Advisors
Page 21 EY Real Estate Markets Update RE under-performing broad markets
Performance: real estate vs. broader markets
50% annual % change: 31 Dec 2011 - 10 June 2020
40%
30%
20%
10% 12.19%
0% -0.37% -4.31% -10% -11.05%
-20%
S&P 500 Dow Jones FTSE/NAREIT All REIT NASDAQ
Source: NAREIT
Page 22 EY Real Estate Markets Update Survey results
Page 23 EY Real Estate Markets Update Survey results
Q What type of tenant relief are you considering?
Rent deferral 35%
Free rent 8%
Reduced payments 13%
Application of security deposit 9%
Application of unused tenant improvements 5%
Other 3%
Not offering rent relief 2%
Not applicable 15%
I do not know 10%
• The majority of respondents are offering rent relief in the form of rent deferral with reduced payments and application of security deposit following.
Page 24 EY Real Estate Markets Update Survey results
Q How do you think property values will be impacted as a result of COVID-19?
Lodging, tourism and Developments in Retail gaming progress Office
Significant increase 1% 2% 3% 3% Increase 1% 1% 1% 2% No change 7% 6% 30% 30% Decrease 18% 27% 30% 42% Significant decrease 72% 63% 37% 23% 0% 20% 40% 60% 80% 100% 0% 50% 100% 0% 50% 100% 0% 50% 100%
Apartments and student Single family housing residential Industrial Health care
Significant increase 4% 5% 10% 17% Increase 2% 7% 18% 13% No change 48% 50% 55% 41% Decrease 32% 26% 8% 24% Significant decrease 14% 13% 8% 5% 0% 20% 40% 60% 80% 100% 0% 50% 100% 0% 50% 100% 0% 50% 100%
Page 25 EY Real Estate Markets Update Survey results
How have you planned or how do you plan to adjust your financial forecasting in light of the economic uncertainty Q surrounding COVID-19?
Topline revenue disruption 61% Increase vacancy & collection loss 49% Delay lease-up 38%
Reduce expenses 35% Increase discount rates 26% Increase hold period 25%
Increase terminal cap rates 22% I do not know 18% Increase expenses 8%
No changes 6% Other 2%
• Sixty-one percent of respondents anticipate topline revenue disruption due to uncertainty surrounding COVID-19.
Page 26 EY Real Estate Markets Update Survey results: terminal cap rates
How much do you plan to change your terminal capitalization rate assumption(s) between December 31, 2019 and Q June 30, 2020?
Lodging, tourism and Retail Apartment gaming Office
No change 6% 13% 12% 13% Increase < 50 bps 13% 15% 16% 15% Increase 50—100 bps 22% 44% 15% 32% 11% 29% 15% 32% Increase > 100 bps 9% 2% 2% 2% Plan to decrease rates 0% 0% 0% 0% Too early to tell 50% 56% 60% 56% 0% 50% 100% 0% 50% 100% 0% 50% 100% 0% 50% 100% Single family Student housing residential Industrial Health care
No change 5% 17% 6% 7% Increase < 50 bps 30% 17% 13% 13% Increase 50—100 bps 15% 50% 0% 17% 19% 35% 20% 40% Increase > 100 bps 5% 0% 3% 7% Plan to decrease rates 0% 0% 0% 0% Too early to tell 45% 67% 58% 53% 0% 50% 100% 0% 50% 100% 0% 50% 100% 0% 50% 100% Most survey respondents agreed it was still too early to tell whether exit prices have been affected by the COVID-19 pandemic. Hard-hit property types include lodging, retail, student housing and health care.
Page 27 EY Real Estate Markets Update Survey results: discount rates
How much do you plan to change your discount rate assumption(s) between December 31, 2019 and June 30, Q 2020?
Lodging, tourism and Retail Apartment gaming Office
No change 8% 13% 11% 12% Increase < 50 bps 11% 21% 21% 19% Increase 50—100 bps 25% 47% 17% 40% 8% 32% 12% 33% Increase > 100 bps 11% 2% 3% 2% Plan to decrease rates 2% 0% 2% 0% Too early to tell 43% 47% 54% 55%
0% 50% 100% 0% 50% 100% 0% 50% 100% 0% 50% 100% Single family Student housing residential Industrial Health care
No change 17% 24% 11% 21% Increase < 50 bps 22% 0% 20% 16% Increase 50—100 bps 9% 35% 18% 24% 20% 43% 21% 42% Increase > 100 bps 4% 6% 3% 5% Plan to decrease rates 0% 6% 0% 0% Too early to tell 48% 47% 46% 37% 0% 50% 100% 0% 50% 100% 0% 50% 100% 0% 50% 100% Again, while many agreed it was still too early to tell, more respondents plan to increase their discount rates in response to the COVID-19 pandemic than their terminal capitalization rates. Very few respondents expect an increase over 100 bps.
Page 28 EY Real Estate Markets Update Survey results
If you believe property values have been or will be negatively impacted by COVID-19, how long do you anticipate it Q will take for values to recover (i.e., when will cash flow projections stabilize)? 1 to 2 quarters
1 year
No negative I do not know impact
3+ years
1 to 2 years
175 respondents
The majority of respondents feel property values will be negatively impacted within the next one to two years.
Page 29 EY Real Estate Markets Update Impairment
Q Where do you expect to capture the majority of impairment or value declines as a result of COVID-19? 186 respondents If you plan to record impairment, what is the approximate amount as a percentage of total carrying value?
31-Dec-20 I do not know 52% 2021
< 10% 25% No valuation impacts anticipated 10%—30% 19%
30%—50% 2% 30-Jun-20 50%—75% 1%
I do not know > 75% 1% 31-Mar-20
Most respondents expect to capture the majority of their impairment or value declines in the remainder of 2020.
Page 30 EY Real Estate Markets Update Survey results
Do you have any properties/projects under development? If so, what adjustments do you anticipate making to Q your projections?
No adjustment 15%
Extending lease-up timeline 12%
Extending development timeline 26%
Revising construction budget 6%
Adjusting discount rates 2%
Not applicable 27%
I do not know 13%
Many respondents anticipate extending the development timeline on properties already in development.
Page 31 EY Real Estate Markets Update Survey results
Q Has COVID-19 impacted your company’s acquisition or disposition strategy?
46%
39%
15% 13% 13% 11% 8% 6% 4%
Acquisitions Dispositions Asset liquidations Short-term delays in Short-term delays in Optimistic No change Too early to tell I do not know indefinitely paused indefinitely paused acquisitions dispositions acquisitions
• Forty-six percent of respondents say their dispositions are indefinitely paused, with 39% indicating short-term delays in acquisitions.
Page 32 EY Real Estate Markets Update Property level trends
Page 33 EY Real Estate Markets Update Hospitality
Reopening
► Focusing on new cleaning standards, social interactions and workplace protocols to meet the new health and safety challenges and expectations presented by the COVID- 19 crisis
► Developing operating models for low occupancies
► Understanding customer preferences/expectations (e.g., daily cleaning, social distancing impact on gyms and restaurants)
Takeaways for valuation
► Scenarios analyses: Variables include opening date(s), range of potential occupancies and average daily rates, and impact upon other revenue components (e.g., food and beverage, banquet, parking). Weighting scenarios should be considered to determine overall value.
► Cap rates and discount rates are expected to increase, and it is expected that cap rates and discount rates will have a wider range than in the past given uncertainty of future performance.
► Timeline for recovery is heavily dependent upon market and segment/chain scale.
Page 34 EY Real Estate Markets Update Disruption is accelerating
Lidl to open 150 stores Entrance Asos the US Ocado Amazon Dollar Shave Club Same Day delivery Amazon Amazon The Honest Co. Trunk delivery First online sale Alibaba Prime Prime Day Dash Button Singles Day Brick & Mortar book store AliPay Zalando Bonobos P&G e-store
1995 1997 1999 2000 2003 2005 2007 2009 2011 2013 2015 2017 2019 2020
Blockbuster Pets.com Tower Sears JC Penney Crazy Eddie FAO Schwarz Great Mills Records Nine West Tuesday Morning Schlecker Bottom Dollar Foods Boo.com Mattress Firm Pier 1 Imports Comet JJB Deb Shop David’s Bridal Neman Marcus Franks Nursery A&P Pay N Save Circuit City Sports Brookstone Dean & Deluca Fresh & Easy KB Toys Rockport J. Crew Radioshack Mammouth Claires Macintosh Retail Group Payless Toys R Us Stern’s Levitz Virgin Hancock Fabrics Diesel WebVan Friedman’s megastores Sports Authority Gymboree Sunflower Market HMV BHS Charming Charlie Charlotte Russe
David Morgan Walden Books Exit/bankruptcy Source: Press clippings
Page 35 EY Real Estate Markets Update Retail
► National Council of Real Estate Investment Fiduciaries (NCREIF) property index for retail declined by 2.06% in Q1 and -1.91% in the last 12 months — only index other than hotels to show a decline in the first quarter.
► March consumer spending decreased 7.5%.
► Retail sales fell 8.7% in March; impact is different by property type.
► Clothing stores sales dropped 50.5%.
► Furniture dropped 26.8%.
► Food and beverage experienced record sales increase of 25.6%.
Takeaways
► Note the following adjustments to cash flow projections:
► Modify rent growth assumptions to low or negative rates
► Revise tenant renewal probabilities that may be at risk
► Consider collectibility of rent deferrals
► Re-evaluate speculative leasing assumptions
► Challenge operating expense projections and operations costs
► Consider risk of tenant bankruptcies, defaults and renewals within the discount rate
► Expect higher return requirements for new development/redevelopment projects
Page 36 EY Real Estate Markets Update Office
A new reality Forecast net office leasing declines for ► Long-term effects could decrease the demand for office space, but it won’t go away major US markets for first quarter 2020 entirely or immediately; investment emphasis may shift to remote technology Office Lease Declines ► Office space will continue to evolve to meet workforce preferences, including a possible reduction of space as remote working becomes the new normal for some Office Market Square Feet office users. San Francisco -1,477,843 ► Office providers that focused on improving the work experience through amenities Manhattan -915,760 may experience less of a downside. Boston -382,892 In the news Los Angeles -350908 ► Leasing activity slows down for traditional office space due to “wait and see” Houston -238,851 approach. Landlords looking to figure out “win-win” deals with tenants by offering rent deferral options and transferring those payments to the end of the current Washington, D.C -200,427 lease term. Landlords are also applying security deposits to the current month’s Dallas-Fort Worth -71,832 payment and renegotiating extensions and rent breaks. Chicago 230,041 ► Typically, the payment of rent is not excused due to a force majeure event, so even if a “pandemic” is the definition of a force majeure clause, tenants are Denver 251,597 typically still required to pay rent. Atlanta 926,842 Coworking spaces US -3,199,574 Source: Cushman & Wakefield ► Lack of new members and an increase in cancellations are putting a major strain on the cash flows that already operate at a fairly low margin; questions regarding refunds to members and landlord concessions abound.
► Providers focused on technology/ecommerce sector may be less impacted.
Page 37 EY Real Estate Markets Update Apartments
Major short- and long- term challenges on the horizon
► In hard-hit metros like NYC, up to 40% of tenants may miss April rent payments. We can expect similar results in emerging COVID-19 “hot spots” in May and June until federal stimulus and unemployment disbursements begin to materialize.
► Projects under lease-up are most susceptible to lengthened stabilization periods given difficulty in renter mobility
Takeaways
► The CARES Act established a 120-day moratorium on evictions and late fees for any properties receiving federal funds. Many local municipalities have taken similar measures to protect tenants. However, the commercial mortgage industry did not receive specific relief funds as part of the CARES Act, resulting in a disconnect between cash flows in and cash flows out. We expect commercial mortgage relief to be explicitly addressed in future bills.
► Move-ins and move-outs are largely in a holding pattern. Spring and summer lease expirations may continue on a month-to-month basis and “sight-unseen” leasing activity is likely to rise as a result of enabling technology.
► Major long-term lifestyle changes are likely. Remote working could become the new normal for many employees, leading to “reverse urbanization” where tenants move to the suburbs for more space and lower rents. Modern multifamily developments with micro-units and an emphasis on common areas now seem less appealing.
Page 38 EY Real Estate Markets Update Industrial
►Supply chains are under extreme pressure, including the enabling real estate:
► Industrial real estate fundamentals have been exceptionally strong over the past few years with the rise of e-commerce. This trend should continue throughout the COVID-19 crisis as logistics demand is higher than ever with local and national stay-at-home guidelines.
► Supply chain changes may affect warehousing as re-shoring becomes more prevalent.
► Health and safety challenges are the big unknown; will warehouse workers get sick resulting in a domino effect on industrial tenants’ ability to pay rents?
► The Defense Production Act (DPA) invoked by President Trump on March 18th requires businesses to prioritize contracts necessary for safety or defense. This could mean expansions in manufacturing capacity and/or distribution needs. Real estate owners should get in touch with affected industry tenants to offer additional space where available.
► Medical supply companies (surgical masks, ventilators, hospital beds, etc.)
► Wholesalers, grocers and restaurateurs requiring additional dry and cold storage
► Surplus of gasoline may require storage space
► Manufacturing production delays today may seek increased production once the threat of virus is passed.
Page 39 EY Real Estate Markets Update Data centers
Shelter from the storm
► Substantial increase in videoconferencing, gaming and cloud services data traffic
► Only segment of the 16 National Association of Real Estate Investment Trusts (NAREIT) industry segments with positive performance in Q1 2020
► Limited impact to construction in US (for now), but customer installs may be complicated by supply chain/equipment delays
► Investment-grade tenant base (e.g., public cloud providers), which reduces rental revenue risk
Takeaways
► Favorable long-term outlook supported by likely COVID-19-related shifts (work from home, videoconferencing) and secular demand drivers (e.g., Internet of Things, autonomous vehicles, public cloud)
► Cap rates anticipated to remain stable
► Potential long-term impact to new construction and customer installs due to supply chain disruption, workforce constraints
► Shift to public cloud to accelerate as cash-strapped enterprise customers seek cost- saving strategies coming out of crisis
► Expanding pricing power from public cloud providers, which may limit rent growth
Page 40 EY Real Estate Markets Update Rent relief
• NAREIT survey, representing 70 REITs, $508 billion in equity market capitalization and 56% of the FTSE NAREIT All Equity REITs total equity market capitalization
Equity market cap weighted share typical rent received in April Property sector April rent received May rent received Industrial 98.6% 95.7% Manufactured 97.1% NA homes Apartments 94.3% 94.7% Office 93.3% 92.1% Health care 87.4% 89.9% Freestanding retail 71.4% 70.1% Shopping centers 45.6% 47.7%
Source: NAREIT survey of members, public disclosures and FTSE NAREIT All Equity REITs index equity market capitalization as of April, 30, 2020 via FactSet
Page 41 EY Real Estate Markets Update What’s next?
Page 42 EY Real Estate Markets Update The road ahead — The great reopening
• America awaits the results of the great reopening • Will tenants fulfil their contractual obligations • Has government stimulus averted a significant economic crisis or just delayed it? • What will be the effects of COVID on the various real estate sectors – short-term and long- term? • When will consumers and occcupiers make their next move to their new real estate strategy? • How are financial institutions going to deal with covenant violations and impending defaults?
Page 43 EY Real Estate Markets Update Questions
Page 44 EY Real Estate Markets Update thank you
Page 45 EY Real Estate Markets Update EY | Assurance | Tax | Transactions | Advisory
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