Key Takeaways:

  • State ordered lockdowns challenge disrupted property cash flows and challenged ability to service debt. Lockdowns from late-March to May drove commercial property debt delinquency rates to more than double, from 3% to 7%, driven primarily by hotel / lodging and retail.
  • The economic disruption from pandemic containment efforts has jostled valuations across many property types, which still are below where they were at the start of the year, which in turn contributed to delays and cancellations of commercial property transactions.
  • States consider additional lockdowns amid elevated levels of infections. The impact of the second round of lockdowns would likely look different from the first:
    • Delinquency rates would increase, albeit at more moderate pace, and remain high
    • Valuations could remain subdued, with exception of property types that have proven to be unaffected or benefit
    • Transaction activity would remain low, despite more distressed sales due to challenged business plans and ability to refinance

Here we go, again?

The current broad market environment is bewildering. This is even more true for long-lived assets like commercial property. It seems as though different parts of the market are showing different signals. The US stock market has almost fully recovered its pandemic-related losses, unemployment remains in the double digits but seems to be falling as quickly as it rose, the yield on US Treasuries are at near all time lows, and the federal government is debating additional stimulus while many states consider Lockdown 2.0 amid rising infections.

During the first month of summer, with businesses re-opening across many states and the broad economy still clearly intact (even if a bit bruised), the sentiment was one of optimism. However, much of that optimism is beginning to fade and uncertainty increases, again. Many of us are left wondering, is this the end of the beginning or beginning of the end?

Unfortunately, at this point in time, any answer to that question is speculative. However, while we cannot determine where we are in relationship to a world post-health crisis, we are able to start to see how the first round of close-open-repeat orders affected commercial property markets using commercial mortgage-backed securities (CMBS) and real estate investment trust (REIT) data.


Chronological recap

  • January – February: The first case of COVID-19 in the US was on January 20th in Washington state. It wasn’t until 59 days later, on March 19th, when California was the first state to issue some form of a stay-at-home order – restricting the state’s economy and consumer behaviors.
  • March – April: Following the Golden State’s example, over the next 19 days, 44 states and the District of Columbia issued similar orders in an effort to contain the virus. Six states never issued stay-at-home orders (Arkansas, Iowa, Nebraska, North Dakota, South Dakota, Wyoming), but only represented approximately 3% of the total population.
  • May – June: For most Americans, the state lockdowns lasted approximately 39 days, after which most states began phased re-openings of their economies starting in late-April through late-June. National new cases reversed course, beginning to rise in mid-June. By the end of June, the national daily rate of new cases exceeded that at the start of the month.
  • July: California was again the first to issue restrictive measures in early July. As daily new cases continued to rise through July, many states reconsidered following California again with additional lockdown measures.

Sources: National Academy for State Health Policy, Washington Post, New York Times, Census

Stress seen in CMBS

As stay-at-home orders were issued and businesses closed their doors, rent collections declined, and many owners of the properties were not able to make timely payments on their mortgage loans. As a result delinquencies across lender portfolios increased following the lockdowns. Prior to the lockdowns, approximately 1% of all loans were delinquent (30 or more days late) by count and 3% by unpaid loan balance. However, as a result of the pandemic and the state actions to mitigate the health crisis, delinquencies jumped. In May, 4% of all loans were delinquent, representing 7% of unpaid aggregate balance. Also of note, during this time, the percentage of loan payments that fell in the grace period (payments not received or late but by less than 30 days), also jumped from 1-2% (by count) pre-lockdown to 6% in April.


As no surprise, most of the delinquencies were driven by hotel / lodging and retail. From March through May, the delinquency rate of loans backed by hotel / lodging properties jumped nearly 8-fold, from 2% to 17%; over the same period delinquency across retail loans doubled, from 5% to 10%. While there was a slight increase in delinquencies across multifamily and office, these were much more modest and paled in comparison to the harder hit property types.



Investors discount valuations

For lenders and debt investors, these delinquencies may turn into realized losses, however for owners and equity investors they represent the decline in properties ability to generate cash flow. As a result, one would expect to see a decline in property valuations as delinquencies increase; which is exactly what is happening.

Looking at the public equity markets, publicly traded REITs trail the broad market by roughly 10% year-to-date, with large differences between property types. Notable leading property types include those which benefit from ecommerce and don’t require consumers to be onsite – specifically Data Centers, Infrastructure, and Industrial. Whereas the year-to-date laggards are those which require onsite consumption, such as Lodging/Resorts and Retail. Even with lower capital costs and strong collections (so far), the market is not sparing many REITs which are trading at double-digit discounts from pre-pandemic valuations.

Persistent delays and cancellations

In addition to the operational hurdles and administrative delays caused by the pandemic lockdowns, the uncertainty around valuations has contributed to many transactions being delayed or cancelled. During the lockdowns, commercial property activity in the private markets all but disappeared. According to a SIOR survey, only 26% of in-progress transactions remained on-schedule in through and 31% in May. In April, 49% of all in-progress transactions were either on hold (31%) or cancelled (17%). In May, there was minor improvement, as 46% of all in-progress transactions were either on hold (28%) or cancelled (18%). Business re-openings across the country in June brought a new wave of optimism, and helped push the portion of delayed and cancelled deals down to 41% (25% on hold, 16% cancelled), but this remained the same in July (23% on hold, 18% cancelled) as the health crisis resurfaced.

Reading the market signals

While most property operating performance data are private, we are able to get a view of property operating performance by leveraging the new Reonomy CMBS data. The Reonomy CMBS data sample used for the observations in this report includes over 43,177 loans backed by commercial properties (hotel / lodging, office, industrial, multifamily, retail) and with an unpaid principal balance greater than $0 as of January 2020.

Putting it all together; sizing up a second shutdown

How might a second lockdown play out for commercial property? First, it is unclear if other states will follow California’s example and start to lockdown again; however, if they were to follow California, the impact to commercial property might not look the same as the first.

On the debt and loan side, overall delinquencies would likely rise driven largely by hotel / lodging, retail, and less so by office and then multifamily. But this rise in the delinquency rate would not happen as quickly as it did from March to May and not by the same factor (i.e., 8x for hotel / lodging and 2x for retail). This is because many of the properties that were cuspy going into the first lockdown became delinquent, and those that remained current have likely figured out how to survive in the lockdown environment or at least weather periodic lockdowns. However, delinquency rates might remain elevated for a longer period of time until there is a clear path to a more permanent re-opening, as pre-pandemic property business plans might no-longer make sense in a pandemic world with recurring lockdowns. If the unemployment and bankruptcy rate remain elevated, one could also expect to see modest steady increases in delinquencies across  both office and multifamily loans – which were not hit as hard in the first lockdown. Finally, one may expect to see a higher level of loans in grace period, as the added stressor of lockdowns will challenge many property cash flows.

On the equity side, the prospect of an economy not running at full capacity will continue to dampen expectations of future cash flow generation across nearly all property types, save the niche sub-types (e.g., data centers, infrastructure, etc.). On top of that, the prospect of additional lockdowns will be particularly painful for hotel / lodging and retail valuations. However, many of these discounted prices may be overly harsh if there is a scalable cure or therapy within the coming 12 months and consumer behavior has not fundamentally changed from pre-pandemic.

So long as valuations are in flux, transactions will likely remain subdued. Assuming transactions take at least 90 days to complete (e.g., sourcing, due diligence, negotiating, contracting, financing, and closing), then many of the cancellations seen in April and May were started before the pandemic hit, so one would expect to see the percentage of cancelled transactions decline going forward. Even if fewer transactions are cancelled going forward, the overall volume of transactions may continue to decline, given tighter underwriting standards from lenders due to more conservative views of business plans (i.e., debt service coverage ratios) and property valuations (i.e., loan-to-value). Despite the cost of credit being low, access to credit is tight, which is a particular problem for hotel / lodging. One in six (17%) of hotel / lodging and one in seven (14%) of retail properties have loans maturing before the end of 2021, using the CMBS data as a proxy. Unable to refinance, many of these properties may be forced to sell. Industrial also has a high proportion of loans looking to refinance soon (18%), but this property type faces fewer valuation challenges which would interfere with refinancing. Forced sales across hotel / lodging and retail would increase overall distressed transaction volumes (single properties and some large portfolios), but likely not enough to off-set the transaction volume decline from non-distressed transactions.