While summer fairs and carnivals are mostly on hold, 2020 has taken us on a wild ride as the Covid-19 pandemic whipsawed the global economy in the first half of the year. The U.S. economy crashed downward in March as shelter in place rules drove unemployment to record levels, surpassing peak levels of the 2008 Great Financial Crisis (GFC) in just one month. U.S. unemployment reached 14.7% in April, well above the 10.9% peak of the GFC. Including part-time workers who wish to work full-time (the U-6 rate), unemployment reached a staggering 22.8% in April. Real GDP fell by the second quarter of the year, the worst decline on record.
Politicians scrambled to put a social net under the economy, again quickly breaching levels of the GFC. The Fed balance sheet swelled by $3 trillion from March to May, more than double the amount during the GFC. Interest rates first spiked as lenders underwrote unforeseen risk, then crashed globally as countries began to backstop their economies. U.S. ten-year treasury yields have remained under 1% since early March, the lowest rates on record.
But the U.S. economy has tools in place now that it did not have in the past. First, an e-commerce distribution network was already growing and was able to continue some level of retail service despite shelter in place rules. Consumers, however, changed their purchasing patterns, dramatically switching from restaurant purchases to groceries1, dropping clothing and department stores, and increasing purchases at hardware, building supply and garden stores. Overall, retail sales at general apparel, furniture, and other retail stores (GAFO) fell by 29% from February to April, while electronic shopping rose by 19%2.
Second, technology allowed many office workers to continue working from home rather than in the office. Even schools scrambled and finished the year with at least some level of education online. While only 24% of university presidents intend to have students fully return to campus in the fall3, office building owners are prioritizing the implementation of new healthy building initiatives to welcome tenants back to the office. Fortunately, a multitude of technology firms have developed systems that can significantly improve the health and wellness of workplaces – beginning with pre-entry wellness checks, touchless entry, social distancing sensors, low-touch and voice-enabled kitchens, autonomous cleaning and improved air filtering, among other systems. Additionally, new cybersecurity, at-home network security, on-the-go human resources and remote collaboration tools are improving remote-work productivity4.
Just as quickly as the economy careened downwards in March, we saw a steep, but partial, recovery in May and June. The unemployment rate fell to 11.1% in June as 7.5 million jobs returned. Biggest employment improvements occurred in many of the hardest hit industries in the March to April downturn, including vehicle sales, apparel, furniture, and sporting goods retailing, dentists, and hospitality. Transportation and oil remain the hardest hit industries. Retail sales followed a similar trend as total retail and food service sales increased by 27% from April to June.
Unlike previous recessions, the housing market has stayed relatively stable thus far. In fact, residential investment growth in the first half of the year, declining by only 1.8% in Q2 as compared to a 23% decline in consumption of services and a 9.4% decline in exports5. While single family sales volumes declined in March to May, housing values continued to rise, mortgage rates declined, and delinquency rates remained low. New single-family home sales returned to the January level by June6.
The U.S. economy has tools in place now that it did not have in the past. Just as quickly as the economy careened downwards in March, we saw a steep, but partial, recovery in May and June.
In the multifamily market, occupancy rates remained high at 92% for Class A7 and 94% for Class B. Class A occupancy declined by 50 pbs in 2020 Q2, a function of two factors. First, new construction increased total stock by 2.5% in the first half of the year as nearly 200,000 new units were delivered, a peak rate for the market. Second, net absorption, while positive, was only 42% of the pace of the past three years. Comparatively, occupancy held stable in the Class B sector in the second quarter, declining by only 10 pbs. Class A effective rents decreased by 0.8% in the second quarter, underperforming Class B which increased by 1.9%. The mortgage market also remains healthy as 98.1% of apartment loans were current as of June 20th8.
Going forward, the market will continue to face risks. Demand is likely to hold up better in the Class A sector as unemployment rates are highly correlated to educational attainment. In June, the unemployment rate was 16.6% for those without a high school degree, falling to 6.9% for those with a college education9. Thus, tenants of the lower-cost, Class B and C properties may have a harder time paying rent going forward, particularly with uncertainty regarding federal policies to continue extended unemployment benefits. However, the Class A sector will continue to face risk of excessive new supply at least through the end of the year. While the construction pipeline is likely to slow dramatically until the economy improves, another 100,000 units are expected to be completed by year-end. Construction jobs continued to rise for both residential and nonresidential sectors through June. Markets in which multifamily inventory is expected to increase by 7% or more include Miami, Nashville, Boston, Charleston, Orlando, and Charlotte10.
Similar to the single-family market, sales of multifamily properties dropped dramatically through May, although pricing remained steady. Apartment sales volume declined by 81% from the previous year in May. However, apartment sales volume of $3.1 billion was the highest of all property types, equivalent to nearly 32% of all property sales. Cap rates fell by 10 pbs year-to-date11 in the first half of the year, driving property prices up by 7.1% yoy in June, but down slightly by 0.3% from April to June12. REIT prices increased by 5.4% in the second quarter but remain 28% below the October 2019 peak. Dividend yields at 4.0% in June declined by 21 pbs over the quarter but are well above the 2.8% level of October13.
The path forward is not yet clear. While we hope to continue to ride the roller coaster up, several factors point to a slower recovery. First, the Covid pandemic is not yet over. Recovery risk is further amplified by federal policy uncertainty and the ability of the pharmaceutical industry to create a vaccine and/or cure. Transportation, nursing home and oil jobs are still in decline. High unemployment rates will continue to put downward pressure on consumption of both goods and services which will create contagion in other lagging industries such as government and education (loss of tax revenues), and technology sectors (for those dependent to some extent on advertising revenues). In the meantime, low interest rates are likely here to stay for a while which should support real estate pricing if demand holds up. Eventually, the unprecedented support provided to the economy by the Federal Government will need to be resolved.
1 In February 2020, restaurant sales ($54.1 mil) were nearly equal to grocery sales ($54.8 mil). Restaurant sales fell to $27.8 mil in April 2020 while grocery sales increased to $63.2 mil.
2 U.S. Census Bureau, Estimated Monthly Sales for Retail and Food Services, by Kind of Business
3 https://collegecrisis.shinyapps.io/dashboard/ as of 7/24/20
4 CB-Insights, “Reopening: The Tech-Enabled Office in a Post-Covid World,” 2020.
5 Bureau of Economic Analysis
6 U.S. Census Bureau and U.S. Department of Housing and Urban Development, New One Family Houses Sold: United States [HSN1F], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed. org/series/HSN1F, July 30, 20203 https://collegecrisis.shinyapps.io/dashboard/ as of 7/24/20
7 Class A defined as properties with a 4 to 5 star CoStar rating. Class B defined as properties with 25+ units and a 1 to 3 star CoStar rating. Source: CoStar.
8 Mortgage Bankers Association
9 U.S. Bureau of Labor Statistics
10 CoStar U.S. Multi-Family National Report
12 Unless noted, pricing and sales data provided by Real Capital Analytics. Pricing data based on the RCA CPPI index.
13 Source: NAREIT
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