Determining how to react to the coronavirus in policy terms has been held back by the uncertainty about its effect on public health. The speed and depth of the market reaction in recent days has changed that calculus: Policymakers are likely to be forced to act even though it remains unclear exactly how bad the health implications will be.
Fears that the coronavirus will spread globally and that it would slow economic activity led equity indexes to drop roughly 7.5 percent on Monday and oil prices to sink more than 30 percent—the worst one-day drop since 1991. The Dow Jones closed Monday at 23,851, down 7.8 percent in one day and down roughly 20 percent below its peak in early February. The yield on the 10-year Treasury sank to a historical low 0.33 percent on Monday, and closed at 0.57 percent, down about 100 basis points over the last month.
Faced with this type of panic, the question about the coronavirus is less about how much the virus will spread and more about how to stem the economic impact. Similarly, the impact on the commercial real estate market no longer seems remote or limited to a handful of segments, such as hotels or industrial parks that rely on shipments from Asia. As the impact spreads into the economy and the financial markets, commercial real estate will inevitably feel the pain in greater measure.
Maybe not to the same degree that the housing and subprime loan crisis bled into the market in 2008, but nonetheless in the same manner. Commercial real estate’s success over the past decade was led by the robust capital markets forces, so anything that changes the equation will create uncertainty and likely short-circuit a great deal of activity.
Impact on CRE Demand
As interest rates have dropped, it has created a wave of mortgage refinance activities, and boosted the premium of commercial property relative to the risk-free rate. However, if the result of the virus is depressed economic activity and shrinking GDP growth, the benefits of cheap debt may be outweighed by the potential loss of demand for commercial space and lower rents.
The total number of cases reported globally is over 110,000 and growing, and entire cities in some countries such as China and Italy have been placed under quarantine. The federal government in the U.S. has been criticized for being unprepared and there have been reports of a shortage in tests for the coronavirus. Already there is a large drop in leisure and business travel, as many companies have stopped all non-urgent business travel and many conferences have been cancelled. Some schools in the U.S. are cancelling classes. All those are indications of declining economic activity that seems likely to lead to reduced GDP and reduced employment.
Speaking at a webinar on Monday sponsored by the National Association for Business Economics, RSM U.S. Chief Economist Joe Brusuelas identified several types of economic shocks that could be caused by the coronavirus. One is a supply shock caused by the loss of output from the Asian economies, and the loss of income dependent on goods from Asian supply chains. Another is a demand shock created by the loss of Asia’s demand for foreign goods, goods produced in Asia, and the loss of domestic demand for goods due to uncertainty. He also noted the shock to financial markets caused by lack of confidence, increased uncertainty and the loss of goods purchased due to the wealth effect.
The Federal Reserve cut the policy rates by 50 basis points last week to 1.0 to 1.25 percent and could return to zero rates if the markets continue to slide. The Fed could also commit to a quantitative easing strategy to buy financial assets to maintain pricing stability.
A more effective response—which Brusuelas recommended—involves fiscal policy. Steps he recommended include direct payments to plug holes in private balance sheets, an increase in social safety-net spending and job creation via infrastructure spending. He emphasized that effective policy would put dollars in the hands of working-class households and not large corporations. “We can’t have another form of crony capitalism,” he said.