Six months later, COVID is continuing to cause significant declines in many industries and property types.
by Kent A. Hileman, MAI, ASA, CMI, Partner at Property Valuation Services
Six months ago, I wrote an article on the effects COVID-19 would have on commercial real estate values, notably as shown through the income approach. In that article, I specifically referenced my opinion that it would have an adverse effect on certain industries within commercial real estate, such as hotels, health care, retail and office. Below is a quote from that article.
“It is clear values are going to fall in commercial real estate – generally speaking, as explained here. But the question nobody knows the answer to is how bad will this be and how long will it last? Will it be as bad as the stock market which plummeted about 30% in less than a month? The answer is, nobody knows. It all depends on many factors. Some of those factors include how long it takes the US to bend the curve where COVID-19 becomes under control. Which then affects when America can get back to work, into the retail centers, into office buildings, surgical suites, and when we all start traveling again, Lastly, after we curtail the pandemic and get back to work, what measures are we still going to have to take? Will we still be required to social distance for a while? And if COVID-19 gets under control as we expect it to within the next few months, will it come back in the fall and be a recurring issue for some period to come? Many experts expect it to, but then expect us to be much better prepared with testing and medications.
The point is there is still so much that is unknown. All these unknown factors will affect Rental Rates, Vacancies, Collection Loss, Risk, Cap Rates and, as a result, Value. An investor will not be able to ignore the risk in these uncertain times. But how much and how long it will affect values are yet to be determined.”
Do we now know the full effect on commercial real estate values? The answer is, kind of, the picture becomes a little clearer every day. It also varies dramatically within cities, regions, and property types. For example, though not commercial, residential single home values have risen in most areas as residents flee the large metropolitan areas for suburban areas, with the ability to work remotely. Industrial properties have also fared well during COVID and seem unaffected in their growth trajectory. But certain property types I mentioned in my previous article have taken a large hit.
As companies continue to work remotely and learn that they can do so without the need for the expense of office buildings, the office industry is taking a vacancy and rent hit. Many office buildings are sitting near-empty and the long-term viability of these offices is uncertain. It is anticipated that many companies will shift to a more remote model for some functions requiring less physical office space. This impact varies greatly by geographic location. Areas like New York City are getting hit hard, whereas suburban Kansas City is experiencing a decline, but not as drastic as NYC. Large metropolitan areas are taking a larger percentage drop than suburban areas, generally speaking.
Nursing homes, where COVID-19 has had a significant impact and where a large number of US deaths have originated due to age, have also been some of the hardest hit. It also varies by region as certain regions have been hit harder than others. But vacancies have risen significantly in nursing homes shrinking the already narrow profit margins and thus declining their property value.
The restaurant and hotel industries have been two of the hardest hit by the pandemic. Occupancy rates for hotels dropped as low as 10-20% in March, and although they have steadily worked their way back up, they still sit (on average) around 50%. Hotels cannot make a profit at these levels. Restaurants in certain cities, like NYC, still sit relatively empty. They were recently allowed to open back up with minimum occupancy, but the governor is already calling for possible closures again due to increased COVID outbreaks. Meanwhile, I have personally been in restaurants in suburban Kansas City that were at capacity in the last month.
If you refer to my original article for the explanation of the income approach and how reduced occupancies / higher vacancies, additional rent loss, and greater risk and uncertainty affect value, they are all negative, as you can imagine. Depending on the property type and geographic area, commercial valuation drops have been anywhere from a few percentage points to 20-30%.
COVID has caused significant declines in many industries and property types. Be sure your local Assessor takes this into account in their most recent valuations (or upcoming valuations), no matter where you are located. Depending upon your property type and your geographic area, the drop could be significant, and the local property tax Assessor / Appraiser may not be taking the full COVID effect into account.
About Kent Hileman, MAI, ASA, CMI
Kent Hileman is an owner of PVS and has been with the company since 2000. He has been involved in the appraisal or value analysis of over 400 hospitals plus thousands of medical office buildings, psychiatric and rehab hospitals, surgery centers, and more. He has also appraised or analyzed other complex commercial property types such as hotels, motels, golf courses, industrial, warehouse, office, funeral homes, car washes, office buildings, and more. He holds the highest designations as it relates to appraisal/valuation, MAI from the Appraisal Institute, ASA in real property from the American Society of Appraisers, ASA in appraisal review and management from the American Society of Appraisers, and CMI from the Institute for Professionals in Taxation. He is licensed in a multitude of states for both appraisal and property tax consulting. Kent has experience presenting / testifying at various levels of appeal throughout the Country, from informal to State to assisting at the Court level. He was a member of the 2011 IPT Symposium Committee and presented during the hotel / healthcare breakout session on various topics and issues surrounding the valuation of these complex properties as it relates to property tax.