In the wake of the COVID-19 situation, governments worldwide are making reforms and changes to their monetary policies to best balance the economy. Over the past few weeks, the US Federal Reserve has enacted several changes to the supervisory and regulatory practices to better support the US financial markets.
Understanding what these measures are and how they might impact the US commercial real estate markets is essential to making informed and guided investment decisions. The Fed’s most recent actions are in favor of liquidity and tenant demand within the commercial real estate sector.
Read on to know about COVID-19 impact on US commercial real estate markets and the four types of significant Federal Reserves Actions taken in response to the global pandemic.
A brief note on COVID-19 impact on the US commercial real estate
The country’s economic shutdown has impacted various industries, and the commercial real estate sector is not one to escape. The commercial real estate sector is one of the worst-hit industries and has left multiple stakeholders in a state of panic, confusion, and uncertainty.
One of the most evident impacts of the economic shutdown is the surge in forbearance requests and an elevation in the mortgage defaults risk caused by the shutting down of retail stores, restaurants, hotels, medical offices, and other types of establishments in general.
Additionally, many of the Multifamily renters are now unemployed. Despite the curb on tenant evictions from the property for missing rent payments on time, there is a huge risk of potential delinquencies. It has led to a rise in the projected potential losses by many real estate investors, and the capitalization rates are expected to rise by at least 50 to 100 points.
How would this impact property values? That’s a question that cannot be answered with certainty as of now.
However, the US Federal Reserve has already introduced liquidity facilities, eased the monetary policies, and loosened the regulatory compliance and guidance for different financial institutions.
The goal is to combat business closures, potential liquidity crunch, and rise in mortgage defaults. While one can argue that the federal reserve’s unprecedented market intervention was unseen, we believe that it is necessary for the time of crises such as COVID-19.
However, how successful the Fed would be in implementing these and managing the capital surge that has occurred is something that only time can answer with certainty.
Four types of significant Federal Reserve Actions taken in response to the global pandemic
#1 – Easing down the general monetary conditions
The goal of easing down the general monetary conditions is to expand the banking system reserves and make way for lower credit costs. To accomplish it, a variety of short term credit instruments are being priced off the rate for federal funds.
Furthermore, the Reserve requirements were eliminated to boost the money multiplier, therefore not requiring the financial institutions to maintain a specific amount of reserves against deposits. It will allow the banking systems to lend without having a maximum lending ability curtailments.
The lower short term policy interest rates have been introduced to provide for lower-cost mortgages. This will boost the discounted value of monthly net rental flows, which is an action that was much needed in a dire economic crisis.
The Fed has introduced the quantitative easing program (QE Program) through which the economic slowdown caused in the wake of the COVID-19 situation can be fought effectively. In this, the commercial mortgage-backed securities are allowed to purchase securities in the open market without having any limits. It will enable agency lending and will support the flow of credit to commercial real estate multifamily markets.
#2 – Expanding Fed and Bank lending directly
To expand the Fed and Bank lending directly, the Federal Reserve has encouraged all the financial institutions it regulates to undertake the following actions:
- To fully utilize the discounting window without any stigma.
- To participate directly in the federal Reserve Treasury Department economic injury disaster long program.
- To offer small-term loans to and consumers and small and medium scale businesses in the wake of COVID-19 situation.
- To make use of the Federal daylight credit.
#3 – Providing liquidity to the financial markets
The Federal Reserve acted rather quickly to the stresses caused by the COVID-19 situation and prevented the financial markets from freezing. Of the many actions the Fed took to enable a continuous flow of cash in various sectors of the economy, here are the most noteworthy ones: The Paycheck Protection Program Liquidity Facility (PPPLF), The Main Street Lending Program (MSLP), and The Primary Market Corporate Credit Facility (PMCCF). The PPPLF program was initiated to preserve the tenant’s ability to pay rent by conducting their businesses smoothly.
Since commercial real estate is impacted mostly by the rental income, this initiative was much needed. The PPPLF allows lenders to make Paycheck Protection Program loans to businesses under high stress due to the pandemic.
Further on, such lenders can sell these PPP loans to the Fed and issue loans to small businesses. To sum it up, these PPP loans will act as a bridge until the restrictions are lifted, and businesses start operating again. They will preserve rent flow to the commercial real estate investors and mortgage payments to the commercial real estate lenders.
The Main Street Lending Program (MSLP) is for small and medium-sized businesses. This loan program can be tapped by investment companies, real estate investment trusts, and other entities that fulfill the qualifying conditions.
In the interim, if the commercial net rent flows degrade to an extent where the real estate investment trust or an investment agency is unable to fulfill its obligations, then these companies can tap into the MSLP for getting a four-year term loan. These loans will not carry the burden of prepayment penalties.
Furthermore, the Primary Market Corporate Credit Facility (PMCCF), extends liquidity options to the corporate bond market, specially designed for corporates with longer maturity. This program allows firms that have access to capital markets to borrow longer-term bonds without fearing that the longer bonds will freeze in the market.
#4 – Easing down the regulatory requirements for lending institutions
The Fed has eased down various regulatory requirements in the wake of the COVID-19 outbreak. One of the most notable ones is easing down the liquidity and capital requirements for lending institutions, which paves the way for more robust lending to small and medium-sized businesses and households.
Furthermore, the Fed has loosened the deadlines for financial reporting requirements, allowing lenders lots of flexibility to conduct their business.
The Fed’s response to the COVID-19 outbreak has both direct and indirect implications on the commercial real estate industry sector. By ruling out policies that support the households, tenants, and the lenders, the real estate market economy is somewhat balanced. The unprecedented economic and financial support should reasonably help the commercial real estate sector handle the COVID-19 crises.
While most investors aren’t taking an active interest in their real estate investments and are “waiting for the storm to pass.” The Fed’s support and extension have an immense contribution to the commercial real estate investment trusts (REITs) and other real estate investment and lending agencies in general.
Further on, the exact impact and implications of the COVID-19 on the commercial real estate sector is still unknown. Tenants might continue to seek forbearance, which will lead to a decline in property values, which can, in turn, lead to an impending downfall in the real estate sector.
The easing down on the monetary policies might further spur down and lead to higher inflation rates once the economies start to recover. This resulting inflation might lead to higher interest rates, making it even harder for beginner commercial real estate investors to enter the markets.
Until the situation settles down and the economy gets stable again, the Fed’s goal is to maintain the liquidity and provide support for businesses to function without disrupting the markets.
The result of these efforts can be known only when the storm calms down. Until then, investors must cooperate with the Fed’s policies and try to fight the pandemic without panic or confusion. If not anything, investors must make efforts to understand the reasons for different easing down policies and do their part in preventing a greater downturn.
Making the best use of the situation that’s a win-win to the lenders, small and medium-sized businesses, and the rent-paying tenants are the ultimate goal of the Fed. These implications may be different in different parts of the country, and different types of portfolios – thus, consulting a real estate advisor is recommended if you want to understand the implications in depth.