Commercial real estate deals are collapsing amid the coronavirus outbreak and market players are fewer and further between, with the worst yet to be seen.
A new report by Real Capital Analytics says signs of the COVID-19 crisis are starting to appear in the U.S. market for commercial property assets.
“Price discovery in the market for commercial real estate assets can be a long process,” wrote Jim Costello, senior vice president at Real Capital Analytics and the author of the report. “There are a number of steps that buyers and potential sellers will go through before adjusting their expectations in the light of an economic shock. Deals that fail to close and a reduction in market players are leading indicators for changes in market pricing.”
The purchase of an iconic Manhattan office tower is one standout example of a cancelled mega-deal amid the pandemic. Last month, SL Green Realty Corp. had plans to sell the former New York Daily News headquarters, which had been featured in the 1979 Superman movie, for $815 million. New York property investor Jacob Cherit was meant to purchase the building but his primary lender, Deutsche Bank AG, withdrew from the transaction due to market instability.
On a smaller scale, a million-dollar multifamily deal in Florida fell through just a month before closing. Commercial broker Jaime Sturgis represented the seller of an eight-unit apartment building who canceled the sale after the buyer requested “unreasonable concessions” tied to the economic fallout from the virus. Sturgis told The Real Deal: “The buyer was asking for security deposits from all the tenants to make sure they would continue to pay their rent. He was also asking for other carte blanche contingencies that were out of line. The deal was supposed to close in 30 to 40 days.”
Between 2016 and 2019, the report says only 0.4% of deals in contract that failed to complete in a single month, but in March, this figure climbed to 1.3%. While 1.3% isn’t huge, Costello said in the report that it’s not just about a rise in the number of deals falling out of contract, but also about the decline in the number of closed deals.
“The writing on the wall signals changes in price expectations,” he said. “A rising number of busted deals shows that participants saw the growing economic calamity and realized that the assumptions they had in place for transactions no longer worked.”
The pool of buyers thinning out is another sign that the commercial real estate market is starting to crack. Over the past three years, the report says there were over 2,100 unique buyers of commercial properties every month in the US. In March this year, there were just 790.
“With fewer participants to look at a deal when it is brought to market, a seller is less likely to achieve the pricing they were hoping for in a transaction, as bidding simply will not be as competitive,” Costello wrote. He is expecting a decline in deal activity for both March and Q1, but he says there will likely be no big move in prices for at least another quarter.
“Buyers and potential sellers are moving apart on price expectations, but unless and until owners are forced to sell because of financing challenges or other outside events, prices will not budge,” the report stated. “Deal volume will continue to retreat in the coming months until participants adjust their price expectations.”