Assumptions about the future are at the heart of valuation. Despite being a largely quantitative process, valuing a company or real estate relies on professional judgement and expectations about the future. The 2020 Global Pandemic is unlike any other economic crisis and poses unique valuation challenges. Sure, it has similarities to the economic impacts of the Spanish Flu, 9-11 terrorist attacks, Savings and Loan Crisis, and several other similar economic downturns. However, the Global Pandemic is widespread, impacts all industries, and lacks geographic concentration. Further, the makeup of the U.S. economy is more technologically advanced, global, and services-oriented than it was during the first half of the 20th Century. Given the novelty of this crisis, past recoveries are only modestly reliable predictors of the future.
Therefore, we consider the following data, behavior, and collective assumptions in the marketplace to understand how value is impacted since the onset of the pandemic during the first quarter of 2020:
• Some sectors are on the brink of collapse due to the 2020 Global Pandemic—specifically, hospitality, energy, retail, and transportation. While other sectors are thriving—such as supermarkets, certain online retailers, and off-sale liquor stores. The real estate associated with these industries have fared similarly. Further, sectors and property types that were considered more “recession proof” like student housing and senior housing, have not fared well during the pandemic.
• Forty percent of mergers and acquisitions (M&A) deals in progress at the beginning of the pandemic have been put on hold while only 14% of deals that were in-progress halted. Even so, M&A professionals believe that M&A activity will return to levels seen before the COVID-19 pandemic in 1-2 years (according to Alliance of Merger & Acquisition Advisors).
• As of June 2020, there was a record amount, $1.45 trillion globally, of “dry powder,” which is the money that investors have committed to private-equity funds that has not yet been spent. This is in spite of several private equity owned retailers that have filed for bankruptcy in the midst of the 2020 Global Pandemic.
• There has been a significant reduction in large real estate deal volume (deals $10 million or greater). As of July 2020, total deal volume in the U.S. was 30% lower than it was a year ago, according to Real Capital Analytics.
• Analysts report seeing 5-35% erosion in prices for commercial real estate, with residential and industrial classes being the least negatively impacted and retail, hotels, and central business district office classes being the most impacted, according to Real Capital Analytics.
These general trends cannot be applied universally. For example, in the real estate market, smaller, local-to-local transactions are occurring at generally normal paces and prices. Additionally, restrictions around travel make the due diligence process harder for institutional investors, which has caused deal slow-down and price compression in institutional grade investments. Another divergence from high-level trends are cap rates in strip mall retail, which have decreased in second quarter 2020 by 6 basis points, whereas cap rates for regional malls have increased 72 basis points. Furthermore, there is a high level of private capital reserved to pursue investments, indicating that money is likely to be deployed and may take advantage of distressed selloffs.
The impacts of the 2020 Global Pandemic must be analyzed on a case-by-case basis—not every asset is faring the same through this recession. Negative effects are temporary and the long-term economic consequences of this pandemic remain unknown. While the exact timing of a rebound is unclear, quality companies with strong fundamentals should be able to recover. Economic fundamentals were strong preceding the 2020 Global Pandemic and the negative impacts of COVID-19 could be repaired quickly if there is widespread containment of the virus. However, the longer the economic turmoil progresses, the harder it will be to achieve a V-shaped recover. The takeaway: the popularized phrase “COVID-19 discount” is a misconception, and while it may apply in certain transactions, it is not universal. A careful analysis of each valuation problem and the marketplace informs the valuation approach applied by Shenehon appraisers, especially during this unprecedented time.