WILMINGTON — Research conducted by the real estate editorial branch of The Motley Fool, an investment advice company in Virginia, ranked Wilmington the fifth-most exposed U.S. city to the risks of a downturn in its commercial real estate market due to the Covid-19 pandemic.
The analysis examined data from the Bureau of Economic Analysis (BEA) and retail information from Moody’s Analytics to determine cities’ shares of workers in the commercial real estate market, focusing on retail, accommodation, and food services employment (classified as ‘nonfarm employment’).
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As the pandemic has forced nationwide closures of non-essential businesses, the research suggests that commercial real estate (CRE) investments in the retail property sector “face the greatest risk of downside exposure,” particularly declining cash flows and potential loan defaults.
The real estate editorial company, named Millionacres, ranked the top five metropolitan areas where “CRE will be hit the hardest,” with Wilmington ranked number five on the list, preceded by Fort Walton Beach in Florida, Las Vegas, Myrtle Beach, and at number one, Atlantic City. The determination was made based on industry share of nonfarm employment, which it identified as service sector employment.
“In many markets with a high concentration of retail employment we see two core risks,” Millionacres editor Deidre Woollard said of the research. “The first is that closed stores will not be able to afford leases without any income coming in. The second is that employees themselves will be unable to pay rent or mortgages.”
“Even before the pandemic hit, the CRE retail sector was showing worrisome signs of a secular slowdown,” according to the report.
Mainly because of “the rising dominance of e-commerce,” it showed that the industry’s rebound after the late-2000s recession had slowed rent growth, net absorption (the net change in physically occupied space measured by square feet), and the number of retail real estate completions, measured in millions of square feet.
Nearly 80 miles south of Wilmington, Myrtle Beach — with a 31% share of service sector employment — had the second-highest retail sector vacancy rate in 2019, approaching 21%. Wilmington, on the other hand, had a healthier rate of 13.9% in 2019, which was still 3.7% higher than the national average.
Before the recession that started around 2008, vacancy rates hit a low of 6.4%, according to the analysis, but nine years after reaching a high of 11% in 2010, last year’s number had only dipped to 10.2% nationally.
“Prior to the pandemic, many market projections encouraged cautious optimism for the retail sector in 2020 and beyond. However, in light of the game-changer that is COVID-19, Moody’s is now forecasting a 2020 vacancy rate of 13.5% attended by a 3.7% decline in asking rents, both of which make the events of 2008 look tame by comparison,” according to the report.
It also showed national rent growth rebounding slightly from 2011 to 2015, plateauing, then slowing to 1.2% growth in 2019. (Wilmington’s rent growth jumped from .2% in 2018 to 2% the following year.) Moody’s ‘Protracted Slump Scenario’ forecasts a 3.7% decline in 2020 due to the pandemic, before making its way back to 1.3% by 2024.
The report said that unlike larger cities like New York and Chicago, smaller cities in the southern portion of the U.S. (the Sun Belt) have a higher concentration of retail employment “and face the greatest exposure to pandemic-induced default.”
“Despite record-breaking economic growth in recent years, high vacancy rates and tepid absorption pushed asking rents down in many metros,” according to the report. “Again, small metros in the South with a high concentration of retail employment … were already experiencing declining rents.”
Larger cities, conversely, are more diverse and less dependent on any one industry, and much of the retail sector in these places are occupied by big box stores with established e-commerce operations and more cash flow.
Although some tenants may use funds from the Paycheck Protection Program provided by the federal economic bailout in response to the pandemic, they are not required to, “and are in fact protected by moratoriums extended to both residential and commercial tenants,” according to the report.
“Commercial landlords may find some relief by working with their lender for a loan modification, but this is assuming that the property is leveraged and does not address the burden of other carrying costs not associated with the loan,” according to the report. “Of course, these stop-gap measures are designed to help business owners and, by extension, commercial real estate investors absorb the immediate shock generated by the pandemic. There is no telling what the long-term effects will be on CRE investment and the retail sector in particular.”
