"Usually, we say location, location, location," Conway said. "Now, I believe it's equal parts location, employment, and capital. Understanding the why and where of businesses, as well as their capital needs, will help CRE professionals more accurately determine NOI, value, and demand for commercial real estate."
When the Bureau of Labor Statistics (BLS) publishes its monthly jobs numbers, the world takes notice. Markets move and politicians tweet. But for commercial real estate professionals, K.C. Conway, chief economist for CCIM Institute, thinks there are more insightful indicators that, taken together, would provide a better understanding of what's ahead for the CRE industry. First, he suggests focusing on two forward-looking employment reports that precede the monthly BLS jobs report: ADP's National Employment Report and Challenger, Gray & Christmas's monthly job cuts report. ADP foretells what is happening with private employers, whereas the Challenger, Gray & Christmas numbers provide insight as to where the size of the workforce of private employers is headed ― and the subsequent demand for CRE space. "CRE rents and occupancy rates rise and fall on what happens with employment," notes Conway.
But those aren't the only places industry professionals should be looking for information on what promises to be a turbulent 2021. Conway suggests following transportation metrics such as airline passenger counts from the Transportation Security Administration and rail traffic from the American Association of Railroads. As goes the business traveler and intermodal rail traffic, so goes the travel and leisure industry and supply chain, an area that impacts consumers, retailers, manufacturers, and logistics infrastructure alike.
After employment and transportation, Conway advises to then take the pulse of CRE capital activity. TREPP offers data on the volume of loans being transferred to special servicers and delinquency by property type, which are good proxies for the ripple effect of COVID-19 on the health of CRE debt. For bank debt, Conway looks at FDIC reports on bank failures. Additionally, Conway suggests CRE professionals monitor the Texas ratio, which is the percentage of a bank's capital tied up in bad loans. A healthy bank would have a ratio of less than 5%. The double whammy of COVID and a destructive season of natural disasters have left some banks with Texas ratios reaching 30%.
"As much as Trepp CMBS delinquencies are a good proxy for what's coming at you in CMBS, the Texas ratio is a good proxy for what to expect in terms of problems in the banks," Conway says. "And that ratio is telling us that there's substantial erosion occurring."
Finally, Conway is encouraging CRE investors and participants to know the fiscal conditions of their state and local governments. The 2017 Tax Act brought into focus the impact of state and local taxes on business and workforce migration patterns. Pre-COVID-19, the trend was moving away from high tax states. This general movement accelerated during the pandemic as workforce migrated away from higher density (and higher tax) areas. Expect this trend to continue as companies discover they can "ditch a lot of the office" and attain skilled workforce in affordable secondary cities.
This challenging environment has Conway recommending that CRE professionals become "capital advisers" in 2021, with a keen focus on the why, where, and financing elements of CRE decisions.
"Usually, we say location, location, location," Conway said. "Now, I believe it's equal parts location, employment, and capital. Understanding the why and where of businesses, as well as their capital needs, will help CRE professionals more accurately determine NOI, value, and demand for commercial real estate."
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Leslie Shaver
Les Shaver has been covering commercial and residential real estate for almost 20 years. His work has appeared in Multifamily Executive, Builder, units, Arlington Magazine in addition to GlobeSt.com and Real Estate Forum.
