Year-to-date transaction volume for U.S. assets is down 38% overall compared to volume measured during the same period in 2019. However, the impact of COVID-19 on U.S. capital markets became readily apparent during the second quarter. Volume for the second and third quarters was down more than 60% from one year earlier.
As we approach the end of the year, transaction activity remains largely frozen. There are several contributing factors, including a significant spread between buyer and seller expectations, a lack of price discovery, disruption in the debt markets, and logistical challenges to due diligence efforts. It is noteworthy, however, that despite limited transactions, the muted quarterly volume measured in 2020 still outpaces average quarterly volume during the Great Recession by 69%. This demonstrates that buyers with access to capital are still active.
All sectors have been impacted, but none more severely than hotels and retail, which have seen year-over-year transaction volume fall by 70% and 48%, respectively. Just eight hotels were sold in the U.S. in April, the lowest monthly level of activity ever recorded by Real Capital Analytics. While economy and extended-stay hotels are faring better than full-service operators in terms of occupancy, the overall sector faces a long road to recovery.
Meanwhile, in the battered retail sector, malls have been hit particularly hard. Bankruptcies and permanent store closures are piling up for major brands, pressuring mall occupancy and rent collections. Enclosed malls face stronger headwinds than open-air centers, particularly if co-tenancy clauses trigger an additional cascade of vacancies.
Office investment performance thus far remains mixed and variable by individual asset and region. Markets with significant exposure to the travel and energy industries are the most challenged thus far. Assets in large cities with severe outbreaks of COVID-19 are also struggling more in terms of rent collections, causing uncertainty in underwriting performance. Total investment volume is down 44% year-over-year; however, quarterly volume in 2020 has still been more than double the average quarterly totals during the Great Recession.
Industrial investment activity has exceeded all other asset classes, but year-over-year volume is still down. Some industrial investors—particularly those seeking assets tied to e-commerce—have experienced a surge in activity. Others have seen a sharp decline due to significant challenges in other industrial-occupying businesses, such as tourism.
Cap rates have remained largely unmoved despite broad operational challenges and the result has been a drop in overall investment volume. Hotel has been the notable exception. With the help of government stimulus, rents and collections across other asset classes have remained relatively stable throughout the year. If NOI continues to outpace property values with buyer and seller expectations beginning to align, this could lead to a continued uptick in CAP rates going forward.
Office investment performance thus far remains mixed and variable by individual asset and region.
Alternative asset types such as life science, data centers, and self-storage have all performed well and gained traction among investors.
Cross-border deal activity has shrunk in 2020 for various reasons, but its percentage of total U.S. investment volume has remained steady. It appears the dip related to the pandemic has been consistent in its impact on both foreign and domestic investors. Year-to-date foreign investment has accounted for 8% of total U.S. volume, down from 15% in 2015, but relatively unchanged since Q4 2019. Canadian investors remained the largest source of cross-border capital for the first half of 2020; however, their share of foreign capital in the U.S. has dipped from 65% to just under 40% in recent quarters.
While some opportunistic buyers are already looking for acquisition and development opportunities in select high-growth markets, most owners are currently focused on managing their portfolios and preserving liquidity. With markets across the U.S. in various stages of reopening their economies, some buyers may begin to come off the side lines. But until prices adjust to reflect the increased risk in today’s market, deal flow will remain constrained.
Going forward, yield-oriented investors are looking to diversify their portfolios. Investor preferences have shifted as a result of sector performances during the pandemic, with the once-overlooked industrial and logistics sector having become the “Cinderella story” of the year. Alternative asset types such as life science, data centers, and self-storage have all performed well and gained traction among investors. Multifamily, especially in areas of high inbound migration, offers further opportunities for portfolio diversification. Diversification across geographies will continue to be important as regions react different to COVID related changes in the workplace, and local government budgetary shortfalls.
As the economy regains momentum, U.S. capital markets are likely to normalize going into 2021, boosted by the low cost of capital and continued attractive returns for real estate versus other asset categories.
Cross-border deal activity has shrunk in 2020 for various reasons, but its percentage of total U.S. investment volume has remained steady. It appears the dip related to the pandemic has been consistent in its impact on both foreign and domestic investors.
