A System Shock to the Real Estate Economy

weekend could spur a wave of new infections. Fauci said on NBC's Today Show that the country's upcoming Labor Day holiday on September seven may lead to a rise in US coronavirus cases, as has been the case with other holidays earlier this summer. Faucci said a surge may be avoided if people wear masks and avoid crowded places. College students should stay on campus, he said, as sending them

back home would help spread the virus. UK Prime Minister Boris Johnson announced another U turn on Wednesday, keeping lockdown rules in place as COVID nineteen cases rise. Johnson is pushing to get Britain's Back to Work and School and his team had previously decided restrictions imposed in some areas of Northwest England should be eased, but political opponents in the area condemned the plan and warned infections were rising again,

causing the government to back down. Finally, Johnson and Johnson halted the development of a new flu drug after a study suggested it wouldn't work. It's a sign of how difficult it is to create treatments for viral infections, as

the world racist to contain COVID nineteen. The drug promotive here was in the final stage of testing for patients with influenza A, the most common cause of the flu, when an ingim look at the data showed it was unlikely to be better than standard care in helping hospitalized patients.

While the decision to shut down this drug trial doesn't have any bearing on the fate of drugs and vaccines being developed for coronavirus, it highlights the risk of failure as the world counts on the pharmaceutical industry to help safely return it to normal life. And now for today's main story, the future of the commercial real estate market has been under serious question that's thanks to the virus itself, a potential mass migration out of cities, and the new

realities of working from home. For Bloomberg's Odd Lots podcast hosts Tracy Allaway and Joe Wisenthal spoke with Mosaic Real Estate Partners managing partner Ethan Penner, who has been described as the father of c mbs, or commercial mortgage backed securities. They discussed the stakes for commercial real estate in the US and what role the government should take to safeguard the billions of dollars worth of assets on the line.

Here's an excerpt from their conversation. So, practically speaking, right now in New York, obviously for all kinds of issues, there's questions about office buildings, there's questions about areas that are retail and very tourists dominated we're just guessing at this point because we really don't know what the future looks like. We don't know when there will be a

vaccine and so forth. How is it playing out right now as retailers tried to renegotiate with landlords and landlords tried to renegotiate with lenders, what is the discussion and the tension, what's happening right now in those rooms. It's not fun for anybody. You're talking about retail real estate, which is the most uncertain of all. You know, you've got retailer, you've got office hotels. To a certain extent, are the three areas where you've got the greatest uncertainty

in that order, I would imagine. And and as it pertains to retail real there's existential issues that retailers themselves are facing. So you know, I think, uh, it'll it will be some lawyers who do very well in this process because I think that you're gonna see heightened litigation. You'll see bankruptcy lawyers doing very well, and I think

a lot of it will be centered around retail. The counterbalance so far is that the easy monetary policy, and that's playing out not just with historically low interest rates, but also directs straight from the Fed to the banking community to be kind to borrowers and uh and not press them. You know, the old me might have not been too happy about that, because I'm a fairly strong market advocate, but I actually think it's it's the prudent

thing to do. You know, the system itself is so today I had to say, historically fragile that it's the wise thing to do and is creating whatever audicum of stability that allows us to kind of breathe as easy as we can be breathing today considering how grave the crisis we're facing it. I'm curious about, you know, the sort of knock on effects, like I, let's say some of these assets really do they don't bounce back for years, prime real estate and hotels and offices and big cities

like New York and other, Chicago and elsewhere. What are the then following effects, like who are the pools of owners of this dead and what does it do to them if they really have to take in the end sort of massive marks down markdowns on their holding. It's going to be very exciting to that play out because they're clearly, you know, one would suggest they're they're clearly going to be big losses that have to be born

by someone, you know, some group of someone. There's always been a tug of war as to the allocation of those losses between the equity owner of party and their lender. It's a it's a it's an old kind of tradition in real estate when when things go well the property creates sufficient cash flow to pay and repay the lender, you know, when the loan tourers. But when things don't go well, the borrower calls a lender and says, we've got a problem. You know, instead of a kind of problems,

we've got a problem. How are we going to fix it? Of course, the way it's supposed to be is the bob is supposed to lose everything because the lender has taken this safer position in lieu of upside. But again, as I go back to, because most lenders, even whole own lenders like banks, are just not set up to

own property. There's been a long edition in real estate where when things don't go well, the lender recreates value or economic value because they don't have the will or the capacity to enforce their lean and take the borrower out. And so the lenders do lose money when they don't necessarily you wouldn't think they should because of the hierarchy of the capital structure. So how that all plays out will be very interesting to watch, But unquestionably there are

losses in the system. I'm curious. So, you know, thinking back in two thousand two nine, that was truly a national prices and basically hit everywhere at the same time and arguably to the same severity this time. I mean, you know, I'm in New York and obviously people think it's going to be pretty bleak here for a while. But I was just in Austin, Texas for a while, and people this is booming and a lot of people

are moving there. And so I'm curious how you see the sort of bifurcation of the economy where it's not just not necessarily a national recession or a national depression, but as simultaneous boom in one place, boom in some real estate market, boom in some office market, and crash another that that is a very accurate assessment of the way things are right now, which makes it very interesting in the center that there are definitely going to be

winners and losers. Were in an impossible position and no one if you really predict exactly where things are. I have my opinions, but but I don't think the government can walk away because we're as close to anarchy as we've ever been in modern times. We're in a depression. So I'll tell you this, I think that we're in a depression like the nineteen thirties. But the difference between

the nineties and now is the federal government's response. Right, in the nineteen thirties, there was no response, so nobody got helped. The banks were allowed to fail, everything was allowed to kind of go go under, and where there were breadlines and there was massive homelessness. Today you have massive government response, right, and so the massive government response is masking over some of the natural symptoms of the depression. And you know what, it's hard for someone subertarian leaning

to say this, it's the only right choice. There is no other choice, and we're just going to have to get used to it. Those of us who are grew up lovers of the free market, we're just gonna have to suck it up and just say this is this is the new world that we're living and it's not going to change. And can't to just sort of describe the challenge. I mean, a, we've had this extraordinary government

response so far. We'll see what further is going to come, but we also sort of describe the sort of sense of anarchy. Does that exacerbate it? The fact that different parts of the country are experiencing this moment, So differently. I think that what's likely to occur its rational. The rational things will occur, meaning investors, companies will go to places that they feel it can deliver things that benefit

companies and the and their constituents, primarily their employees. Right, So, companies will move from places where perhaps physical safety is not as u not as certain, or fiscal imbalances create a need for higher taxation, and they're going to move to places where physical safety is perceived to be better and taxation lighter. And uh, that's true for employers, and it's true for the wealthiest of the communities who pay

a lot of the taxes. As you know, New York its budgets paid for by one percent of the tax payer. So that creates this downward spiral it's very very hard to undo. And uh, and then a very bullish spiral for the kind of recipients of these movers and the states that people are coming to. How that ultimately plays out, because if you play it out to its logical conclusion, you're going to have dystopian cities around this country and it's going to be really, really weird, and the federal

government is have to make a decision. I think about what is the United States? Right? I mean, there's there's some really big questions that really have never been asked for a couple hundred years in this country that will need to be asked if this plays out the way I think that was Joe Wisenthal in conversation with Ethan Penner. For the full interview, listen to the Odd Lots episode, available now on Apple Podcasts, Spotify, or wherever you listen.

And that's it for our show today. For coverage of the outbreak from one and twenty bureaus around the world, visit Bloomberg dot com slash Coronavirus and if you like the show, please leave us a review and a rating on Apple Podcasts or Spotify. It's the best way to help more listeners find our global reporting. The Prognosis Daily edition is produced by Topher foreheads Jordan Gospore, Magnus Hendrickson, and me Laura Carlson. Today's main story was reported by

Joe Wisenthal and Tracy Alloway. Original music by Leo Sedrin. Our editors are Francesca Levi and Rick Shine. Francesca Levi is Bloomberg's head of Podcasts. Thanks for listening.