The COVID-19 pandemic has sparked a major government intervention to stabilize the financial markets. The scale of the federal stimulus through the Coronavirus Aid, Relief, and Economic Security (CARES) Act, to the tune of $2T, is unprecedented and will likely be followed by another (bigger) stimulus package which is in the works. Federal Reserve (Fed) Chairman Jerome Powell has repeatedly stated, “There’s a lot more we can do to support the economy, and we’re committed to doing everything we can as long as we need to.” This strong message from the government has provided a significant boost to market sentiments.
The real estate market has been hit hard as businesses have been shut down with no visibility into the duration of the lockdown. The stimulus has helped certain subsets of the commercial real estate sector avoid a complete collapse while other subsets face a challenging future unless addressed by the next stimulus package. For instance, as businesses remain shut, we have seen unemployment soar to record levels, which in turn, should have led to significant defaults in home rental/mortgage payments. However, with the Fed’s intervention through direct payments to individuals and loans to small businesses to support payroll, recent data suggests the impact on the multifamily and housing sector has been largely mitigated. The market is supported by the large liquidity injection from the Fed and will require continued support until the market stabilizes, not when the shutdown ends, but rather when economic activity resumes and the effects of the downturn have subsided.
On the securities side, the Fed began to purchase private AAA-rated Commercial Mortgage-Backed Securities (CMBS) debt issued before the coronavirus shock. However, there are no plans to purchase new privately issued CMBS debt. This means that the big banks, which typically offer such private CMBS debt, can be expected to greatly contract their issuance and/or cut back on the leverage ratios, fearing that there will be no buyers. Thus, the real estate sector faces the prospect of a slowdown in the private CMBS market which is worth $500 billion, with large amounts of that debt going delinquent as businesses shut down across the economy.
Commercial real estate debt as a whole amounts to a massive $3.6T. Much of this debt is tied up in even more illiquid and opaque loans than the CMBS, which are publicly traded. With no Fed support, we have seen the markets come to a near standstill and become significantly expensive for borrowers. Currently, the Fed continues to buy only Residential Mortgage-Backed Securities (RMBS) from Fannie Mae and Freddie Mac, or RMBS guaranteed by Ginnie Mae. No purchases of privately issued RMBS, totaling over $1.7T (Source: SIFMA – Fixed Income Outstanding), seem to be forthcoming from the Fed even as it has announced its decision to purchase corporate junk bonds. We expect lenders with significant liquidity to come out stronger from the downturn, and we are already witnessing significant spread widening. The ferocity of the downturn in the real estate sector will become clear once attempts are made to resume business as usual after the lockdown and once the Fed eases off the stimulus.
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