CRE Midyear Industry Outlook

BRG – JPMC – CRE Midyear Industry Outlook – Transcript

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Host:

Hello and welcome to today's program: Commercial Real Estate Midyear Industry Outlook. And now I will hand it over to JPMorgan Chase's Head of Community Development Banking, Alice Carr. You may begin.

Alice:

Hello, welcome everyone. And thank you for joining us today for a discussion about commercial real estate and to discuss the challenges and opportunities facing the industry. I have the pleasure of moderating the discussion today with our two distinguished guests, Al Brooks and Victor Calanog. And I'll start by giving you a brief introduction to those two.

Al is, has been with the firm JPMorgan Chase for over 20 years, and he has been the head of the Commercial Real Estate group since 2015. He's a member of the Commercial Banking Executive Committee and the JPMorgan Chase Real Estate Council. We also have Victor Calanog, PhD. He's the Head of Commercial Real Estate Economics at Moody's Analytics. Dr. Calanog leads the economic and research team, who's responsible for the creation of econom-- econometric models, the data flow and collection process, trend aggregation, and forecasting through report generation. I have the pleasure of moderating this short 30 minute discussion. So I'll get right into asking some questions. I'll start with you Al. So Al, obviously you have decades of experience in commercial real estate, and you've seen economic downturns and economic booms. Can you please give us a state of the state as you see it right now?

Al:

Sure. First, I gotta tell you, I thought I'd seen a lot of extremes in the past; there's nothing like what we've had this time. I mean, it is even more extreme than the Great Depression. As an example, we've had a greater decrease in GDP than ever, we've had a greater increase in unemployment ever. And yet, I think the government and the whole, the whole country has done a pretty good job. The government's come in and, and really come through with strong programs, they really moved with purpose and vigor to support businesses and also to and support workers. And I think that's, that's really helped so far.

So, despite these record numbers - and I'll leave the discussion on that to Victor, he's the expert - but if you look across the various asset classes in, in CRE, some of them are holding up remarkably well and others are certainly impacted. The ones that are impacted frankly were already being impacted. And so this is exasperated the situation in my view by putting those assets that were already under strain, under extreme strain.

So first of all, let's start, start with a good, and we'll go to the ugly later. On the affordable side, your area, which will [chuckles], obviously I'll leave that to you to discuss later, but affordable is holding up surprisingly well. But is it really surprising? I mean really, at the end of the day, the most important, one of the most important needs for a human being is a roof/shelter. And our affordable portfolio and affordable housing provides that for those that need it most. So not surprising, that's holding up pretty darn well.

That's also true of just multifamily lending. We are the largest multifamily lender in the country. And that particular area of our, of our portfolio is doing extremely well. Some of the markets, even with all the strain on them, are still 95% paying and 95% occupied; everything is working pretty well. The worst case markets that we've got are sitting at 10 to 12% vacancy. And that again is a pretty darn good number. And every other asset class would be delighted to only be 10 to 12% vacant.

We move down to the next kind of good news story would be industrial. Obviously with a sea change in retail, the huge amount of space needed by players like Amazon and Walmart that have become giants in the industry of e-commerce. We have tremendous numbers of, of new buildings being built. And frankly, we cannot practically get them built fast enough. That direction, that particular trend that-- it was already going on before this all started has, has continued. And there's really no, no sign of it abating.

The, the one that's sort of in the middle as far as an asset class would be Office. So far, at least in our own portfolio, it's performing extremely well. The one that's kind of the question mark for all of us is, I think we're all learning how to work from home pretty well. I'm not sure we're going to need to have everybody go back all the time in the future. So this notion that we only get combustion when we're all working next to each other and we only come up with great ideas when we're all working next to each other. I think there's some of that that's true, but I think that people are going to rethink how much of that they need. And if in major metropolitan markets, people can avoid a commute, we're actually seeing from our own firm at least tremendous productivity by having people not sitting in their cars or sitting on the train commuting, and actually putting in those additional hours to serve their customers. So so far, that's, that's, that's certainly a question mark in our mind. Fortunately, most of the buildings are leased on a long-term basis. So I think we're going to have some time to figure it out.

The next one that truly is pretty darn negative is retail. And it really depends on which area of retail you're talking about. If you're talking about B and C grade malls, that was plenty negative before this happened. And I don't think anybody would attribute COVID to the problem there. We're just over-retailed in our country. We have way more space for retail than any other country per capita. But if you kind of break through the last downturn, we had very few problems in what your typical neighborhood shopping center, which was supermarket, drug-anchored, the number of side shops spaces, people through the last downturn, continued to buy pizza, continued to buy all of the, you know, the fast foods, those sorts of things. This time around many of those, let's talk about the barber shop, the nail salon, they were forced to close by Fiat, so they didn't have any choice. And this has been a tough period for them.

Now, fortunately, we've had programs like PPP that hopefully will ameliorate some of those problems. But ultimately, it's a question mark on how many of those people in the small business sector will make it through to the other side of this. So lots of concern there. My view is: we gotta do everything we can. That's just my own personal to, to save those businesses. They really are the fabric of the communities that we all choose to live in. Everybody has their favorite restaurant, everybody has their favorite places to go get their coffee. To the extent we can save those businesses, I think we staved the fabric of our own community.

And then finally probably the one that's been hit the worst, and oftentimes is 100% vacant, is the hospitality in their area. Now we at J.P. Morgan don't focus on that particular sector, but most of the other institutions do. And that particular sector is incredulous. For all the obvious reasons, people are not getting on airplanes, they're not traveling. We do have some of our customers that own these buildings, and they're currently running them with a cashflow projection of zero. So very, very difficult market for that particular class. So I'm going to stop there and I know Victor can really fill us on a lot of the economic stuff.

Alice:

Yeah. You know, Victor let's hand it over to you and you can talk about asset classes being impacted and maybe what you anticipate for the next six months.

Victor:

Thanks Alice and Allen, thanks again to the JPMorgan Chase team for having me. Our, our view of the economy and where it's headed, it hasn't changed much over the last four to six weeks. Which is neither good news or bad news, really because we're still expecting 2020 to be pretty severe. I know Al mentioned this, that it was kind of severe. Let me just give you the numbers. In terms of contraction, something in the order of 6.5 - 6.8% down for U.S. GDP and for perspective, that's about 1.5 to 2 times as bad as '08 and '09. Except it doesn't happen over 18 months; it's happening in fast forward, over this calendar year, mostly concentrated right now in the second quarter.

Any green shoots Victor? As we reopen the economy, economic activity is returning. So you will more positive indicators when it comes to things like jobs, construction, and manufacturing indices and the like. Again, starting from a pretty deep hole that we dug ourselves into in May. As long as reinfection rates don't prompt another wide-scale closure effort, we are tiptoeing back to some semblance of growth. I remain skeptical that it's going to be a V-shaped recovery, but we will see.

Now, what does that mean for commercial real estate? Every asset class is being impacted by this, really overused word at this point, but still appropriate: unprecedented situation. But in relative terms as Al mentioned, some are being hit harder than others. The obvious immediate victims are hotel and retail, which really most anticipated given shorter term leases, the shutdown and travel, and the problems that had been ailing brick and mortar even before COVID-19 hit. And what I wanted to just mention is it's very much reflected in the most transparent and most frequently updated slice of the commercial real estate debt markets. CMBS, where depending on how you measure it, anywhere from 70 to 90% of the distress are in loan supported by, surprise, hotel and retail properties. It is nowhere near over. One indicative forward-looking measure that we track would be which CMBS loans have servicer comments mentioning COVID-19. And a week and a half ago, that balance was in the mid 40 billion.

Now, right now, not all of those loans are delinquent or have been moved to special servicing. But anytime you see COVID-19 in a servicer comment, that's probably a flag that you should follow. Again, as Al mentioned, what we're seeing is that the properties that are holding steady for now are multifamily some segments of industrial and many segments of the office sector. For the office sector, you've got a lot of buildings, which are not physically occupied. Folks are returning though, but with long-term leases, you still have 10 large tenants paying rent. In multifamily, we aren't seeing much movement in terms of occupancies, still in the 4.7 - 4.8% range. An open question is whether a lot of renters are receiving some form of support, support via PPP and other programs.

So over the next six months, we need to verify whether fundamentals still hold steady or tank. In San Francisco, for example, it looks like there's some growing evidence of apartment leases being broken. But that segment of the rental housing market, that still looks pretty solid. LIHTC and affordable housing with vacant still at vacancy still from our point of view, at 2.4%. That's around half of market rate. So I'll stop there for now and I'll turn it back to you, Alice.

Alice:

Yeah, no, thank you, that's great. I think I'd like to talk a little bit about the lending environment and commercial real estate. And even before we started the webinar, we had a question come in from one of the participants asking about JPMorgan Chase continuing to lend on commercial real estate and where that would be, what product types, and what lending terms are and how they've changed. Al, you want to take that one?

Al:

Yeah, sure. Happy to take that. Yeah, the markets have moved significantly and we can't ignore that. So that's certainly going to be a part of the underwriting is that we're just in a much more, much tougher market to project and say, "Hey, you know, when you're making long-term decisions on these mortgages, it's super important that you have a sense of what can this property take? What sort of stress can it take?" So clearly we're, we're, we're more conservative than we were a year ago.

That said, all markets in all asset classes were moving forward. The only thing I would say probably only for our top, top, top tier customers on an existing deal would probably be something in the retail sector. Certainly not going to be aggressive and that util we see bottom. But on our normal, our biggest businesses, which would be multifamily lending, and then on the affordable side of multi, clearly we're wide open, very interested in doing business. But with a caveat that we've got to acknowledge we're in a much tougher market. So, we certainly don't want to put somebody in a product that doesn't make sense for them. But, clearly we're, we're back there.

We're also, I would also say, a business that we do in our real estate banking businesses do a significant amount of build to suits. And we've been doing quite a few of those. We've created a very quick, easy process for customers. So that's an area where we've done quite a bit of business over the course of the last couple of years. And we plan to continue to do that big way.

Alice:

Okay. And I know, I know being part of your team, Al, that the team is really anxious to continue to lend and to engage with clients. On lending terms in particular, have you seen a lot of, of movement?

Al:

Yeah, I would say we're, we're much more concerned about making sure we don't put somebody in a, in a coverage ratio that could be broken easily. But I would also say this: look, interest rates are at record lows, so this is a fantastic time to take a look at your portfolio and see if there's opportunities to improve cashflow. And we're very into doing that for our customers. So if there's an opportunity to take your entire portfolio and roll it into a much, much better interest rate, that's in everybody's best interest. And where we're wide open to do those sorts of opportunities.

Alice:

That's great. And speaking of opportunities, Victor, what do you think will be the-- where would the most opportunity be post-COVID-19?

Victor:

Thanks, Alice. Since this COVID situation is not a mass extinction event, fingers crossed. We aren't predicting a level decline in the number of households in the U.S. Although recessions do tend to slow household formation. So the multifamily market, therefore, is really likely to hold steady and/or depending on how you cut the geography even benefit from stronger fundamentals over the long run.

For example, a lot of folks are wondering if there's going to be some kind of deurbanization. The jury is still out on that, but if there is, and the mix of renters versus owners do not change, then cities might lose some occupancy. But nearby suburbs might actually offset that as households now try to shell out to rent larger space for cheaper rent levels. With a shift of greater interaction and commerce conducted online - I know Al touched on this - our estimates actually show up a 500 basis point increase in the proportion of e-commerce relative to total retail sales only the months of April and May. That's about the 10 year trend from 2011 to 2019 compressed into two months. But specific slices of the industrial property market will also benefit.

Now, this won't be abandoning manufacturing facilities in Cleveland and Detroit, no. But the battlefield between big players like Blackstone and Prologis, it's not for warehouse and distribution facilities that are supporting the growth of e-commerce. I don't know about you guys, but the consumption of streaming services and the number of streaming service providers increased significantly in my household. And I'm really not sure we're going back to levels pre-COVID-19 even if we reopened. So industrial properties like data centers will also likely do well in the post-COVID-19 future. Back to you, Alice.

Alice:

Yeah, thank you. That's great. Before we even headed into this, this pandemic, we had an affordable housing crisis throughout the country. And we know that the need for affordable housing is only exacerbated by an economic downturn. Al, what do you think that key industry players can do to have a positive impact and create more affordable housing?

Al:

Well, I'm going, I'm going to start on this and I'll let you finish because you're the expert. But I would say this: I don't know if there's a more important crisis in our country we really think through what drives most people's budget. If you look at most, most Americans budget, it is-- either the biggest payment they make is a mortgage or it's rent. And if you're an individual on the lower, lower side of our income, it creates a greater and greater percentage of what you, what you spend.

There's an absolutely huge need for affordable housing, that's getting greater and greater and greater every year. It's it, you can see it on the streets, we, we haven't had this amount of homelessness in my lifetime. We've also have, like I started to see such a strain on people's budgets. So you know, some of the things I think we're doing through the LIHCT efforts are, are very good. But we are going to have to be creative. It's one of the things, all the way to our chairman, we're trying to think of ways that we can break the back on the actual cost of what does it take to build units. And I know this is your specialization, so I've just talked in generalities. I'd really appreciate if you could give me your thoughts, Alice.

Alice:

Yeah, no, I, I think that there is no, there is no easy answer. We've seen a lot of policy discussion throughout the country for additional resources to build housing across the spectrum. Low, low income housing tax credits are very important and we've seen additional support for those. But I do think, just echoing on what you said, that it is important for banks and institutions to start to think of other ways where they can come up with long-term patient capital or other sources that can help fuel additional affordable housing. And that's one of the things that's obviously near and dear to my heart. So thank you.

Al:

A comment on that. I think the crisis is, is obviously growing. And one of the parts that I think that sometimes people forget is: this isn't just extreme low income; it is actually moving all the way into what normally people would consider middle class incomes in most of the major metropolitan markets we serve. So, this is a crisis that is just continually expanding into greater and greater numbers of Americans. And we are going to need to think this thing through; it's not going to get fixed just in the normal methods we've had in the past.

One thing I think we really need to move the dime off of is, as a country, we've sort of been anti-renter. It's almost this nimbyism and many of the communities we serve where, yeah, I understand there's a problem with affordable housing, but I sure don't want it built in my town. So, you know, I do think we're going to have to kind of flip the script on that as, as a country, as a people, to be more of a team on this, because frankly, it's just getting worse. And, you know, from my perspective, it's starting to really now creep into people frankly that have middle income wages. If you look at teachers, policemen, firemen, they're having a very difficult time living in New York, San Francisco, Los Angeles, Seattle, Chicago, all the major metros now.

So this is a problem that's starting to tear at the very fabric of the country. So I would encourage everybody that's listening today to give this some thought. I mean, we really do need, I think to be creative about, do we have public land we could use for housing? Do we have-- can we change some of the zoning regulations with regard to creating tons of parking? If the property is close, is there a way we can have that be dedicated to a higher density of housing? And I do think we need to be more of a team-oriented about where we put them. You know, so just, I don't mean to sound like I'm on a soapbox, but I am a little bit. This is an area, particularly after working with Alice for a while I've become much more passionate about

Alice:

Yeah, no, those are excellent points. I appreciate you making them. Victor, let's move on to, to a broader scale discussion. How might the global scale economy impact our local commercial real estate industry?

Victor:

Thanks, Alice. That's a great question. I do think that the biggest risk right now, given global trends, is the continued uncertainty surrounding the COVID-19 situation. You've got countries like Brazil and Mexico vying for the top spot in terms of new infections. Don't worry, the U.S. is still up there too. So this uncertainty about reopening another possible route of shutdown, some of which have been implemented, for example in Beijing and Germany, will likely keep things like trade and economic interactions somewhat depressed over the rest of 2020. That's why our economic forecasts are so severe.

Over the long run, we're looking at possibly some form of new normal where businesses reevaluate their supply chains. A lot of countries are making noise right now about moving their facilities outside of China with some competing incentives given by countries like Japan to lure businesses over. But moving manufacturing plants take time. And if Apple moves a large number of its facilities from China to another Asian country, it's not like they'll now change logistics and shipped through the Suez Canal instead of the Pacific.

So onshoring, bringing back manufacturing jobs to the U.S., it's also possible, but might also be a pipe dream. And even then, we'll have a double edge of the fact that property types like industrial. Will there be a renaissance for manufacturing plants at the cost of maybe less demand for warehouse and distribution in places like the Inland Empire if, and this is a big if, trade slows down because we're now producing goods domestically again? So in the short run, slow and uncertain growth; in the long run, very much speculative still. Back to you, Alice.

Alice:

Great. Thank you. I'm just going to throw it out to the audience that we are accepting questions. So if you have questions, you can go ahead and send them in and we will address them as they come in. I in the meantime, it doesn't look like we've got anything yet. Al you touched a bit on retail trends. Can we go a little bit deeper into that and maybe talk, you talked a little bit about malls. What about the definition of industrial and, and how has that changed over time?

Al:

That's a great question because Alice, they're very, very interconnected. Some real estate writers have gone so far as to say that industrial is the new retail. I'm not sure I'd go that far; I do think that people are still gonna want to go to a physical store for certain types of goods, particularly high end fashion sort of thing. I don't think that's all going to be done through e-commerce. What I would tell you is Staples, I think people are really getting used to, "Hey, I don't really need to go and shop for things. I know exactly what I want; they can come in." And I think that we're going to see more of that activity than less. And I, I agree with what, Victor said earlier which is that was already a trend that was occurring; it just got accelerated. But I just don't think we're going to go backwards on that one particularly.

One thing that I think is something to consider: industrial has moved from being extremely trade-oriented, which it still is, but it is also now about servicing customers in local markets. So it's surprising to me how much is being built based on where population centers are serve those centers. So it isn't just, gosh, we really need to have a huge number of industrial buildings in the Inland Empire and then to service the New York market, as … kind of the whole idea of where do we have the industrial links or, you know, those ships coming in from the Pacific, those coming in from the Atlantic, it's also, where do we have the population density? So we're seeing places in Pennsylvania that have become King of Prussia, that have become huge industrial areas. And they're really there to service the huge population density on the Eastern coast.

So there are trends that I think are going to be here to stay. So I don't see people being okay with losing all the convenience of e-commerce; I think that's going to continue. I also think one thing that hits me - and I I'd like to ask you this question cause I know you live in a really nice community here in Los Angeles - part of why people buy where they buy is they like the cute coffee shop, they like the cute cafe. I don't think that's going to change; I think that's human and that's what connects you to the place you live. I'd throw that out to either you or Victor right. So the place for retail forever in my view.

Alice:

Yeah, no, I agree with that. And I think as people were sheltering in place, they were really dying to get out to their local coffee shop and to take their walk down to the village stores. And that is, that is something we're seeing people now do with masks on. And-- people are anxious to get back to that, to that kind of social retail environment. Along those same lines, we, we-- I'd like to talk about returning to the office. And we pulled some of our listeners about how they were planning to reopen their offices. And it's very interesting that we had pretty good response rate and about 25% did not know, did not have a date set. But about half of them felt like in the next month they would have employees returning to the office. Do you want to talk a little bit about, about what you see there?

Al:

Yeah, I'd be happy to. We have a plan at JPMC. Obviously there's a lot of different aspects. And I'd also like Victor to respond to this as well given that he talks to many, many players in the market. But in the case of just JPMC and our customers that have talked to us, even in markets like New York, where one of the biggest and toughest problems to overcome is it's hard if you employees are using rapid transit, whether it be trains in from Long Island, or Connecticut, or subways in the city, all of those modes of transportation are pretty dense, you've got people really close and it's a bit frightening for your employee.

So one of the things that we're trying to do, for instance there in the, in New York, is to try to be super considerate of this. But we're not going to bring back-- other parts of the country, we're going to bring back more, you know, we're gonna, we're gonna eventually get up to 50% of our staff at the office building pretty quickly. In places like New York, we're gonna ease into it much slower. And the first wave of people will only be about 10%. And it's really because of this. So we're trying to be as deliberate as possible. We're also trying to err towards safety.

And frankly, we found that our people are super productive at home. So there's not even a business imperative to move them quickly. We-- safety's first, but even from a business perspective, we've got plenty of time to do this right. And I don't think me and talking to other of my friends at the other major institutions taking a pretty similar approach, Alice. And Victor, I I'd be really curious cause obviously you have a ton of customers as well. I'm curious as to what they're saying,

Victor:

It's similar Al, I would say, at least for the companies that are larger and lean towards the more enlightened, right? If it looks like you're productive anyway working out of the office, then why rock the boat at this point given all the uncertainties that are out there? I think the general principle remains: can we offer choice to our employees, some of who might not have an ideal working environment at home? And therefore they can make the calculated risk of whether or not they're okay with rapid transit to work in the office, but we're not going to push it and say, "Okay, guys, you need to go to the office today." So it's really more about, really to your point, safety, human concern, and really giving our employees a choice about where it's best for them to make sure that the job gets done. I think that's the general principle I've heard from many of our clients. Back to you guys.

Alice:

Yeah, and I think we've all been surprised at how productive we've been the last few months working from home. I for one really miss being in the office and seeing my team and my coworkers. But it has been remarkably a productive time. And, and there have been benefits that I think we will take into return to office environments. So with that we are out of time. I did want to-- and with just a final question, it's a, it's a one word answer question, which probably doesn't do it justice, but I'll start with Victor. In one word, do you think today's impacted economic environment is worse, similar, or better than the 2008 financial crisis?

Victor:

It will be worse. I think it's worse. But the recovery path will probably be different too. That's not one word at all. Sorry.

Alice:

I know. I know. And Al you can have a few words.

Al:

Better. And the reason, I can't help it either, is I think we're going to come back stronger than people think. It's not going to be a toothache that one was.

Alice:

Yeah, yeah. That is a very good point. Well, thank you both for joining us and thank you for all of you out there listening to this webinar, and we really appreciate your interest this morning. Thank you.

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