It’s clear that COVID-19 has significantly affected most facets of our economy, including commercial real estate. So how do we specifically measure the impacts of the pandemic on the commercial real estate market? Are the values for all property types declining? Do investors consider certain property types safer than others? Or maybe the bigger question is this: Has the pandemic changed how commercial real estate is valued?
Methods to valuing commercial property
Let’s take a look at two methods we use to value commercial property —the income and sales comparison approach—and how they are being disrupted by COVID. We use the income approach to value most commercial properties, which is based on converting anticipated benefits to value. When those anticipated benefits change, the value of the property also changes. But since the current real estate market is so volatile, it is difficult to look at anticipated benefits with the income approach. Instead, it’s critical to focus on future market conditions.
We also use the sales comparison approach, depending on current and reliable data for valuation. But fewer property transfers have made sales data trends more difficult to estimate. We are now seeing that comparable listings are requiring extended marketing and exposure timelines, as much as a period of one year or longer. So, for example, if the market value of an asset has historically been based on a marketing period of six months, it’s reasonable to assume that a discount in value is warranted if the expected marketing period is now two years (based on specialists’ opinions of that particular property type and area).
Clues to value
Because the availability of reliable data continues to lag behind the real-time market, it’s not always easy to use traditional data approaches to provide answers to forecast questions. So, for people looking to sell, lease, buy, refinance, build, or appeal property taxes, we might infer that the following items indicate a negative impact on property value:
- Higher vacancies (when compared to the market’s typical vacancy rates) have led to a lease-up discount in valuation.
- Increased rent defaults result in collection loss, even though the building’s vacancy rate is unaffected.
- Smaller, independent businesses fall out of favor with investors who look toward safer investments with credit-worthy tenants.
Differences between sectors
The biggest changes to property values have affected the retail, hospitality, and office sectors of the market. The office sector is especially impacted as changes to near-term tenant renewals, speculative leasing, and increasing rent concessions force owners to adjust potential gross revenue projections. The traditional brick and mortar retail centers have experienced a dramatic decrease in pedestrian traffic which is in turn hurting retail sale. Reduced retail sales leads to potential store closures leading to increased vacancy and reduced market values. The hospitality sector is projected to have the worst year on record for hotel occupancy due to lack of business travelers as well as an overall decrease in entertainment related travel. This can be seen in the year over year decrease in important key performance metrics like occupancy, revenue per available room (RevPAR), and average daily rate (ADR).
Conversely, the industrial sector has greatly benefited from recent e-commerce trends and the exponential growth of e-commerce as a result of the health crisis. Multi-family real estate has not experienced a dramatic decrease in value since it tends to be one the most resilient during an economic downturn.
As you can see, there is not a one-size-fits all valuation adjustment for the different property sectors within commercial real estate.
The COVID-19 pandemic has created challenges and uncertainty in the real estate markets. This uncertainty has affected the volume of sales and lease transactions, so forecasting where the marketplace goes next becomes anyone’s guess. But whatever the future holds, we hope you’ll consider contacting the experts at MarksNelson to help your business find a solution.