Real Estate Principals Series: Still a Lot of Economic Pain, Glimmers of Hope

September 29, 2020

By Nevil Thakkar

EisnerAmper hosted the Real Estate Principals Series, a quarterly event featuring industry leaders discussing the economic impact of COVID-19 on California’s economy and commercial real estate markets, and the investment strategies real estate owners are using to navigate the cycle.

The speakers included moderator Bruce Carlson, Managing Director at Kennedy Wilson Brokerage; Jeff Bellisario, Executive Director at the Bay Area Council; and Jim Costello, Senior Vice President at Real Capital Analytics.

Key Bay Area Economic Indicators

  • California’s unemployment rate is approximately 13.3% as of July 2020. While down from a peak of 16.4%, it remains the sixth highest in the nation.
  • As of early September 2020, California accounted for 28% of weekly U.S. unemployment insurance claims, even though only 12% of the total labor force lives in California.
  • The region added approximately 100,000 jobs in June, but employment growth slowed to just 60,000 job additions in July. The Bay Area is still down more than 400,000 jobs from its peak.
  • All sectors have been impacted with job loss across the Bay Area, with leisure and hospitality making up approximately 30% of the job loss.
  • Consumer spending in California is down 12.2%; in the U.S. it is down 7.3%. There’s been a 20%-plus downturn in consumer spending in San Francisco as of the end of August 2020.
  • Due to people moving or working remotely, spending in San Francisco on general merchandise is down 26.9%, at restaurants and hotels is down 52%, and on entertainment and recreation is down 71.6%.
  • Transit usage in the region is down 85%.
  • San Francisco experienced a 45% decrease in real estate sales transactions in the first half of 2020, mainly due to the price expectation gap between buyers and sellers.

Taxes Can Fill the Budgetary Gap

There are a few counties that are considering modifying their existing appraisal standards in an attempt to increase property tax revenues. This will hopefully make up for some of the tax shortfall due to the pandemic.

Conversion of Commercial Property into Residential

Increased vacancy rates, along with the prolonged work-from-home model adopted by many businesses, have increased the stress level of commercial property owners. However, converting existing commercial property into residential is costly. Unless there is a tremendous dip in the value of commercial property combined with an increase in demand of residential space, owners might not make the switch.

Demographic Changes

There is a small but visible population migration from the city to the nearby suburbs. For example, Sacramento County has seen an increase in residential buyers and tenants coming from San Francisco and the Bay Area. However, this shift could be temporary brought about by cost savings from remote employment. Suburbs that can recreate an urban atmosphere will be attractive if there is a big shift to a remote work model, even after the pandemic subsides.

Banks in No Hurry to Record Losses

With reduced property transactions, there are not enough indicators of price discovery for properties. Hotel and restaurant properties have already experienced a fall in property rates. Banks are involved in the loan restructure to stay current with the economic environment of the borrower and the market. The fire sale of distressed real estate assets, as experienced in the previous recession, has not come to fruition. As such, there is no real pressure on banks to record losses.

What Shape Will the Recovery Take?

The work-from-home setup supports office-based jobs like those in the IT and finance. However, businesses like entertainment, hotel/restaurants, travel and leisure are still in a lockdown mode. Such businesses will take time to bounce back and perform to pre-COVID-19 capacity. Though there are some encouraging signs, such as financial markets and unemployment percentages bouncing back from their April lows, that does not necessarily mean the economy is in a V-shaped recovery. While the introduction (and adoption) of an effective vaccine can be a game-changer, the economic recovery remains a slow process.

About Nevil Thakkar

Nevil Thakkar has combined accounting and auditing experience which includes services to fund of funds, private equity funds and real estate funds.