Stock Volatility and U.S. Commercial Real Estate

Coronavirus Outbreak

Stock Volatility and U.S. Commercial Real Estate

For now, we believe the coronavirus represents an exogenous shock rather than a "black swan" event and that the impact on U.S. private real estate should be minimal -- barring an extended crisis or severe impact on business operations and daily life.

The Coronavirus Outbreak

The COVID-19 coronavirus outbreak is a rapidly developing situation, and there are still many unknown facts about this new virus and its transmission. Based on published information, this virus belongs to the same family as SARS, is much more contagious, but has a lower fatality rate. At this point, we assume that it will be a severe global outbreak rather than a pandemic. However, clearly there are material downside risks to businesses if local outbreaks are not contained effectively in the international community.

While China has taken the hardest hit, its most recent data showed declining daily new cases and deaths. Many Chinese businesses and operations have partially resumed this week. It seems that the outbreak is under control within China. Still, China accounts for approximately 20% of global manufacturing activity. Global supply chains have already been negatively impacted, although we might have seen the worst. The disruptions will likely hurt the earnings of U.S. businesses in the near term.

Outside China, there have been new outbreaks in South Korea, Iran, Italy as well as new cases in numerous other countries. The question remains whether these countries have adequate measures and resources to keep the coronavirus from spreading further. This is a big unknown.

To date, the U.S. has had a limited yet rising number of confirmed cases, with signs of potential community-based transmission. As of February 28, there are 74 confirmed cases, three of which are from unknown origins. So far, business and daily life continue with almost no disruptions. Nonetheless, we should expect more cases in the U.S. given our tight global linkages. The risk of virus spread in the U.S. remains elevated. We hope that our public health system is prepared to deal with any further developments.

How could the coronavirus outbreak play out? Like the past virus outbreaks such as SARS, it is possible that the coronavirus will die off as the weather gets warmer in the spring. It could also stay with the global population sporadically for an extended period with lingering impacts. Then we will have to rely on new vaccines and treatments to fight the virus during each flu season.

Impacts on U.S. Real Estate

The bigger question is whether the coronavirus outbreak will impact demand for U.S. real estate space. We believe that this will depend on two factors: (1) how long the outbreak lasts and (2) whether the contagion is under control in the U.S. If the global outbreak peaks over the next month or two as the weather gets warmer, U.S. consumers and businesses will likely remain confident and continue to spend and invest.

The immediate impact on U.S. real estate is mainly on the travel and hospitality industry, especially in gateway cities, due to reduced international travel. The other negative impact is on luxury retail in popular tourist cities. If the outbreak doesn’t spread further or become a pandemic, the impact on the U.S. core property sectors such as office and apartment will likely be minimal.

Impacts on demand for industrial space could be mixed. On one hand, global supply chain disruptions may delay some shipments to the U.S. On the other hand, logistics managers may want to stock up more supply going forward “just in case” rather than “just in time.” This is precisely what happened after Japan’s strong earthquake and tsunami in 2011, which severely disrupted U.S. auto manufacturing.

If significantly more coronavirus cases develop in the U.S., consumers may temporarily avoid public places. While shopping malls may experience less traffic, people may increase online purchases and home deliveries. Another potential negative impact is on construction materials, if there are significant delays in imports. Shortages could push up construction costs, making development projects costlier or lengthier.

On the positive side, China and several other countries have already pushed monetary and fiscal stimulus into their economies. Now the financial markets also expect the Federal Reserve to reduce interest rates four times this year to provide liquidity and help mitigate any rising risks to the U.S. economy. It is possible that the Fed may cut its target fund rate by 50 bps at the FOMC meeting on March 17-18. In fact, long-term interest rates have already plummeted in recent weeks, with 10-year and 30-year at 1.13% and 1.65% respectively as of February 28. As a result, cap rate spreads over 10-year Treasury yield are now at the widest gap this cycle, making U.S. real estate even more attractive on a relative basis. If NOI growth can be maintained, there is an increasing probability that real estate cap rates will compress further from the current levels, potentially boosting total returns.

Stock Market Volatilities vs. Real Estate Returns

The coronavirus outbreak hammered financial markets last week. The steep decline in interest rates represents a flight to safety by global investors. Yet the 10-year/2-year yield curve remains positive, which doesn’t suggest a high probability of a coming U.S. recession. Nonetheless, the S&P 500 Index just experienced its fastest correction since 1928, declining 12.8% within the past week. Similarly, public REITs (the FTSE NAREIT Equity REIT Index) were also down by 12.4% during the same period. What about U.S. private real estate returns, then?

Unlike public REITs, private real estate investment historically has very low correlation with stock indexes because private real estate returns are determined by current income and property values based on discounted cash flow models and appraisals. They are not influenced by daily headline news. Therefore, the direct impact from a spike in market volatilities is minimal. Here we use three unexpected macro events to illustrate how private real estate performed when the stock market hit a steep correction:

Chart: Stock Market Volatilities vs. Real Estate Returns

Source: Bloomberg, NCREIF, Clarion Partners Investment Research, March 2020. Note: NPI = NCREIF Property Index (a performance benchmark for unlevered core private real estate investment); NPI values are determined on a quarterly basis. “This quarter” is the quarter when the macro event happened. “In a year” is calculated from the starting date (for S&P 500) or quarter (for NPI) of the macro event.Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Clearly, stocks overreacted to these unexpected macro events and recovered over the following several months. Private real estate typically showed steady returns and remarkable stability. Based on current available information about the coronavirus outbreak, we believe that private real estate will likely behave similarly this time.


Clarion Partners is watching COVID-19 coronavirus developments closely and may revise its view with the arrival of new information. For now, we believe that this is likely an exogenous shock, not a “Black Swan” event. Using past viral outbreaks as a guide, the global community should be able to work through this challenging crisis. Because of disruptions in businesses and operations, global GDP growth will likely take a hit during 1H 2020 before rebounding in 2H 2020 and next year. Unlike stocks or bonds, private real estate tends to be much less volatile. Unless the outbreak lasts for an extended period or severely impacts business operations and consumer daily life generally, we believe that the overall impact on U.S. private real estate should be minimal.

Investment in real estate entails significant risks and is suitable only for certain investors as part of an overall diversified investment strategy and only for investors able to withstand a total loss of investment.


The black swan theory or theory of black swan events is a metaphor that describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight.

The capitalization rate, often just called the cap rate, is the ratio of Net Operating Income (NOI) to property asset value.

Correlation is a statistical measure of the relationship between two sets of data. When asset prices move together, they are described as positively correlated; when they move opposite to each other, the correlation is described as negative or inverse. If price movements have no relationship to each other, they are described as uncorrelated.

COVID-19 is the World Health Organization's official designation of the current coronavirus.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The federal funds rate (fed funds rate, fed funds target rate or intended federal funds rate) is a target interest rate that is set by the FOMC for implementing U.S. monetary policies. It is the interest rate that banks with excess reserves at a U.S. Federal Reserve district bank charge other banks that need overnight loans.

The Federal Open Market Committee (FOMC) is a policy-making body of the Federal Reserve System responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The FTSE NAREIT All Equity REITS Total Return Index (“NAREIT Index”) is a free float adjusted market capitalization weighted index that includes all tax qualified REITS listed in the NYSE, AMEX and NASDAQ National Markets.

Gross Domestic Product (“GDP”) is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

Long-Term Capital Management L.P. (LTCM) was a hedge fund management firm founded in 1994. In 1998 it lost $4.6 billion in less than four months following the 1997 Asian financial crisis and 1998 Russian financial crisis. The firm's master hedge fund, Long-Term Capital Portfolio L.P., collapsed in the late 1990s, leading to an agreement on September 23, 1998, among 14 financial institutions under the supervision of the Federal Reserve. The fund liquidated and dissolved in early 2000

The NCREIF Property Index (NPI) provides returns for institutional grade real estate held in a fiduciary environment in the United States. Properties are managed by investment fiduciaries on behalf of tax-exempt pension funds. As of the second quarter of 2003 the index contains 3,967 properties with an aggregate market value of $127 billion.

Net operating income (NOI) is a calculation used to analyze real estate investments that generate income. NOI equals all revenue from the property minus all reasonably necessary operating expenses.

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.

Severe acute respiratory syndrome (SARS) is a viral respiratory illness caused by a coronavirus called SARS-associated coronavirus (SARS-CoV). SARS was first reported in Asia in February 2003. The illness spread to more than two dozen countries in North America, South America, Europe, and Asia before the SARS global outbreak of 2003 was contained.

A spread is the difference in yield between two different types of fixed income securities with similar maturities.

The yield curve shows the relationship between yields and maturity dates for a similar class of bonds.


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