Entering 2020, we assumed that the U.S. Presidential election, accompanied by a potential change in control of Congress, would be a likely turning point for a real estate cycle that was already quite long in the tooth. That was before COVID-19 and the fiscal, monetary, and lockdown responses to it.
Instead, the results of an election during a period of bitter divisiveness are far less important to the near-term real estate outlook than the extraordinary environment in which it took place:
- Interest rates are likely to remain low for the foreseeable future, due to a combination of accommodative monetary policy and a global economy that will be constrained by COVID-19. The spread between real estate yields and risk-free rates was wider than historic norms in early 2020, and since then, the 10-year Treasury has been stuck well below 1%. So far, that has cushioned, from a valuations perspective, a recession-induced drop in property rents and occupancies.
- The Fed’s stated willingness to intervene in credit markets has prevented, at least so far, major disruptions in lending markets across all asset classes, including real estate. As a result, real estate debt remains more readily available, at lower rates, than during any prior downturn.
- There is a solid consensus that stimulus is needed, despite a bitter partisan debate about the magnitude and composition required to support an economy struggling to cope with a pandemic. Federal deficits will be a constraint on future presidents and Congresses, not today’s. The unemployment assistance and small- and medium-sized business loans provided by the CARES Act and Fed actions propped up tenant demand for real estate in a period of unprecedented weakness. Whether the next round of stimulus comes sooner or later, that stimulus will eventually backstop tenant demand.
That is not to say we are operating in anything like a normal period. With employment and economic output far below pre-COVID-19 levels, cashflows are difficult to underwrite. While the environment remains favorable for both stabilized-asset lending and borrowing, there is less debt available for assets without stabilized cashflows. The divergent paths of different property types are wider than they have ever been, and we expect liquidity likely to remain plentiful for some and nearly non-existent for others, even within the same cities. In addition, the nascent post-COVID-19 recovery may yet be derailed due to its extraordinary uneven “K-shaped” pattern that has reinforced inequality trends already in place prior to 2020.
Pre-Election Base Case
With those caveats aside, we can briefly summarize our pre-election base case, which is largely still intact. We assumed the economic recovery that began in the summer would remain intact, but that this would be a “long-haul” expectation where real estate demand gradually turned more positive rather than a rapid re-acceleration. We assumed additional fiscal stimulus would be passed sometime between the election and January. Property incomes would lag behind this recovery, particularly in the office and retail sectors, with some further value declines almost certainly ahead of us. Yet in an environment of low interest rate expectations, we expected that once investors had visibility into when cashflows would stabilize, cap rates eventually would decline below pre-COVID-19 troughs. That “eventually” may already be here for many logistics properties, and soon to arrive for some other property types.
U.S. Election Results
Now that we know the results of the November 3 election, we are contemplating some incremental changes to this outlook. With a Joe Biden victory and Republicans likely to retain control of the Senate, expectations of another CARES Act-scale stimulus package are now seemingly off the table. The “lower for longer” interest rate environment may become “low for even longer” if Congress stands in the way of the Democrats’ bolder fiscal stimulus goals, supporting real estate valuations. We expect a compromise package that provides support to both unemployed workers, albeit less than they received under the CARES Act, and needed assistance to small- and medium-sized businesses that comprise the bulk of the tenant base for commercial property.
However, state and local governments remain in dire fiscal straits, and if this package does not include assistance to plug their budget holes, they will make job and service cutbacks far exceeding the 2009-2012 period. At the same time, state and local governments will look to raise revenues anywhere they can find them, including commercial property taxes.
Even with the election behind us, we still lack visibility into when most property incomes will bottom out. The news this week of a potentially effective vaccine may mark an important inflection point, but it is premature to make any assumptions. Regardless, our funds are well-positioned for a wide range of economic and real estate scenarios. In the near-term at least, our incremental investments will be in sectors supported by long-term structural and demographic drivers. We will continue to communicate with you openly and frequently during this extraordinary period.