NCREIF Property Index (NPI) Declines in 2Q as Structural Changes Accelerate

Investment returns were negative for all commercial property types except industrial assets in the second quarter of 2020, and transactions tumbled to the lowest level since the Great Financial Crisis (GFC), according to the National Council of Real Estate Investment Fiduciaries (NCREIF). The NCREIF Property Index (NPI) reported a 2Q total negative return of 0.99 percent, which includes a -2 percent appreciation return net of Capex, offset by a plus 1.01 percent income return. On a leveraged basis, the decline was -2.76 percent.

“Valuations in the current environment are heavily focused on cash flow stability,” said Ken Riggs, Vice Chair of RERC, a SitusAMC Company, who participated in a NCREIF webinar August 11 discussing the NPI results and the impact of COVID-19 on valuations. “It’s about your confidence level in forecasting revenues,” Riggs explained. “Across property types, the mantra has shifted somewhat from ‘location, location, location’ to ‘tenant, tenant, tenant.’ We have a true tale of two cities as far as what property is attractive. We’ve seen deals fall apart because an office building had a tenant in the airline industry, and properties selling at a premium because Amazon is the occupier.”

The shock of COVID-19 is igniting and accelerating structural changes to segments of the economy, with significant implications for commercial real estate, Riggs said. For example, pandemic lockdowns appear to be the nail in the coffin for ailing B- and C-quality regional malls, and now Amazon is reportedly eyeing some of them for potential space for fulfillment centers.  Amazon wants to get closer to the customer and do that with speed and efficiency.

“Many of the malls built in the 1980s are in strategically good locations,” Riggs explained. “You have to look at the land value. There’s not much to repurposing those buildings if you strip out the shelving -- it’s essentially open warehouse space.” Simon Property Group and Amazon have been in talks about converting some department store anchors into Amazon distribution hubs, The Wall Street Journal reported on August 9.

In addition, some retail sub-sectors have continued to prosper despite COVID-19, including grocery-anchored community centers and power centers. “Power center returns were the biggest surprise,” Riggs said. “But if you drive around a Costco, you’ll see lines of people waiting to get in. Stores such as Petco and Pet Smart are going gangbusters with the recent spike in pet adoptions, and home improvement centers are busier than ever.” Home Depot’s sales rose 23 percent in its second fiscal quarter, as many Americans invested money normally earmarked for travel, entertainment and restaurants into home improvement projects.

Rents for office properties in central business districts declined more than their suburban peers in the second quarter. “A lot of adjustments are going to occur long-term, and to me those are more structural changes,” Riggs noted. “How many employees will want to ride on mass transportation? How many people will continue to work from home after the pandemic, and what impact will that have? Generally, it’s the B and C properties that will bear the brunt of the shift. There’s always demand for Class A office space.” 

Meanwhile, rents at suburban multifamily properties fared better than downtown dwellings in Q2. “Even before the pandemic, we started to see pressure on rents for downtown high-rise apartments due to supply additions in some major markets,” Riggs pointed out. “Now we are seeing a flight out of high-rises and into garden apartments, which are typically in suburban markets.”

NCREIF reported far more write-downs than write-ups in Q2. “The big question is how much damage has been done to the economy, and whether that will create an elongated process for write-downs,” Riggs said. In the 1990s, write-downs stretched out over a five-year period, while in the GFC, they lasted about 18 months.

“We could experience a period of continued revenue deterioration because of the fundamentals, and potentially a lag in appraisals reflecting value declines, and in some cases, there could be significant declines on the horizon for some challenged assets,” Riggs said. “On the other hand, we have better data, more consistent cash flow methodology than in the 1990s, and assets are valued quarterly. The industry has matured quite a bit. I do think valuers are in a better position to help investors and owners work through this cycle with a greater degree of confidence of how to measure value in this new environment with new realities.”