Spring 2020: A Letter from the CEO

Spring 2020: A Letter from the CEO

April 23, 2020

I hope this letter finds you healthy and in good spirits as we collectively find our path through the COVID-19 pandemic. The world will forever be changed by this event, and I truly believe some good will come out of it in the long run. It is very possible that the pain that Americans are enduring, and will continue to endure, emotionally and financially, will lead to better decisions in the future about many aspects of our country, and the collective world society. But only time will tell. Once the short-term impacts of COVID-19 dissipate, we will have many choices to make about our economy, our health care system, our educational system…generally, and everything about the way we live. Hopefully we can make better decisions going forward and set America on a course towards renewed prosperity, as well as social and economic vigor. This will take strong and intelligent leaders who are willing to face up to previous shortcomings and be willing to lead us into a better future.

I had already written my CEO Letter for this newsletter, which was ready to go to print when the COVID-19 crisis erupted. My original letter focused on the growing danger of government debt in our country. With the recent stimulus bills proposed, and now passed and signed by the President, I was tempted to throw this letter in the trash can. Instead, I filed it away for an- other day. The debt monster has now only gotten worse, but the government had no choice. This is one of the problems we now face as a society, a heavy reliance on the government to solve our problems because of the economic system and environment we have collectively created. I will delve back into this at the appropriate time, but now is not the appropriate time.

In my second quarter newsletter last year I discussed the problem of consumer debt and who would be most impacted in a downturn. My conclusion was that “As is usually the case, those at most risk are the younger, less educated, and lower income Americans.” The current economic situation has exacerbated my conclusion in ways that I didn’t foresee. Significant job losses in the restaurant, leisure, hospitality, retail and other service industries are disproportionately affecting these groups. Time will only tell what longer-term impacts these immediate job losses will have on the overall economy, and any impacts could be mitigated by how long the COVID-19 crisis lasts, but it is hard to see any way that lingering effects won’t remain for the foreseeable future. Our most economically vulnerable, fellow citizens have fewer savings and will be quickly burning through what cash they have, even with the additional unemployment support from the Federal government. And recent college graduates have more collective and individual student debt than anytime in history. It is highly likely that many of the businesses that recently employed these now jobless workers, and now no longer employ them, will not survive, even with the government backed business loans that are available. According to Karen Mills, the former head of the Small Business Administration, small businesses average just 27 days of operating cash on hand, and restaurants average just 17 days. Even an SBA backed loan of 2.5 times the average monthly payroll may not be enough for many businesses to survive. And with forgiveness of the SBA PPP loans tied directly to maintaining payroll, many businesses may opt to shut down rather than risk taking on more debt that won’t be forgiven because they can’t maintain their staff. In Ms. Mills’ estimation, 20% to 30% of small businesses may fail “even in a good scenario.”

In ascertaining what impact all of this will have to investment real estate, it is critical to determine the connection from the impacts of the crisis to the type of tenancy in any particular property. Real estate has no intrinsic value, only the use of real estate has value. And this is dependent on demand. Trying to provide a crystal ball at this point is challenging, but here is what we foresee given the current situation:

• Apartments - The spike in joblessness will seriously impact occupancies. A 2018 National Apartment Association re- port provided that 50% of apartment renters are either “Starting Out Singles” or “Young Adult Roommates.” With job losses dis- proportionately impacting young adults, there is a likely risk of younger Millennials and Gen-Z’ers moving back in with mom and / or dad or sharing costs by sharing apartment units, with more individuals in each unit. Either of these trends would negatively impact apartment occupancy rates, and perhaps rental rates. Government support will help ease the disruption; the question is just how long this might last.

• Commercial - The decline in consumer spending resulting from “stay-at-home” rules will likely wipe out many small, median and mid-size retailers and restaurants, both local and national. Retail mall and shopping center owners are working with their tenants, they have no choice. But with the nature of retail continuing to change this will not be enough for many. The best insulated will be retailers that provide staple goods, such as grocery and liquor stores. Many restaurants will likewise be unable to survive. The longer the “stay-at-home” mandates stay in effect, the harder it will be for retail stores and restaurants to recover, and the more challenging it will be for their land- lords. And the effects will outlast the crisis as consumers, hit by growing joblessness, pull back on spending. We don’t see how the government can fix this problem.

• Hospitality - It doesn’t take a rocket scientist to connect the dots between stay-at-home mandates and hotel vacancy rates. I spoke with one associate who owns a hotel in Portland, Oregon that had one paying guest the previous night. Their plan now is to just shut the hotel down until the crisis is over. It is cheaper to sit on an empty hotel than carry the operating costs. This particular investor has the wherewithal to do this. Others likely won’t, and if their lenders aren’t willing to provide substantial ongoing support, this sector will likely experience fallout.

• Industrial - This sector may be impacted less than others, but with consumer demand projected to drop as unemployment surges, portions of the industrial sector will likewise be affected. With brick and mortar retail stores closed, the activity within the clothing industry itself has been severely affected. And this is not the only industry suffering. A brighter light will be distribution warehousing and logistics related to in-home delivery, along with the related manufacturing facilities, as needed goods are sent directly to people’s homes (i.e. Amazon et al).

• Office - Office tenants who already have virtual working abilities will likely not experience the same problems as companies whose operations are closely tied to their space, such as call centers. And coworking facilities will take a tremendous hit as government mandates imposing social distancing continue. The entire coworking model, which is based on short term tenant sublease commitments but long-term underlying lease obligations on the part of the coworking company, may prove to be unsustainable in its current form. The slow-motion train wreck that is “WeWork” is evidence of the problems with the model.

We will be monitoring these investment sectors closely. Our hope is that the COVID-19 pandemic passes as quickly as possible, but we do not see how negative medium-term impacts to the economy, and investment real estate, can be avoided. For this reason, we plan to ramp up our investing activity for the foreseeable future. We have been challenged to find great investment opportunities over the last few years. We believe this is about to change.

We encourage our readers to take social distancing seriously and take every measure to protect yourselves and your families. This is what we have done at Global, and will continue to do, until the threat has completely passed. Until our next newsletter, best wishes and take care.