The Breakdown - Surveying the Carnage: How Real Estate, Travel and Music Are Faring During the Crisis

Episode Date: May 7, 2020

The second order effects of the COVID-19 crisis are here, and they’re painful. In this episode, NLW looks at how COVID is impacting three industries: Travel and tourism 100m lost jobs expected globally  $2.7 in lost GDP  Airbnb lays of 25% of employees  Music & Concerts From a record $12.2B concert year to a loss of $9B Expectations of concert prohibition lasting up to two years Industry organizing to be included in relief  Real Estate Commercial real estate expecting 2.5% default rate for 5+ years  Negotiations around sales-based payment instead of traditional rent  Residential sees cratering demand but home prices remain up year over year

Welcome back to The Breakdown, an everyday analysis breaking down the most important stories in Bitcoin, crypto, and beyond. This episode is sponsored by ArisX.com, the Stellar Development Foundation, and Grayscale Digital Large Cap Fund. The Breakdown is produced and distributed by CoinDesk. Here's your host, NLW. Welcome back to The Breakdown. It is Wednesday, May 6th, and today we are following up on a conversation we've been having in some way for weeks. which has to do with second order effects. What it means to the world that the economy of basically everywhere around the world has been shut down for so long to fight this virus. I wanted to actually have a chance to go look at a number of different industries and

rather than just talk theoretical second order effects, actually look at what's happening. This crisis has been going on long enough now that we actually have numbers and more estimates coming in, and it's really bleak and crazy, and in some cases, even surprising. So what we're going to do is, I think this is going to end up being a couple days at least, a series called Surveying the Carnage. Today we're going to look at travel tourism and transportation, we're going to look at the music industry, and then we're going to look at real estate. Travel tourism and transportation first.

This is a sector which I think everyone knew right away that the COVID-19 shutdowns, the COVID-19 pandemic would have an outsized impact on. This is the first set of actors, the first set of businesses that are forced to shut down in any sort of situation like this. And obviously, this was going to be a hugely impacted industry. Just for reference, tourism is 10.3% of global GDP. So this is a significant part of the world's business. And the first estimates that have coming in, which may even be low, to be honest, are that

we're likely to see 100 million jobs lost in this industry, a $2.7 trillion decline in travel tourism GDP around the world. So these really staggering numbers that, again, just looking at how those numbers are broken down between Asia and the U.S., it's clear there from a few weeks ago or even longer when it was not clear just how bad this was going to be in the U.S. So overall, we're seeing a huge, huge, just destruction of that industry. But let's look at some specifics. flights. Airlines are obviously one of the most impacted industries. They were the vehicle by which this virus was able to spread everywhere and as fast as it did. We saw over the weekend, Warren Buffett had made a major disinvestment from the American airline industry. Berkshire Hathaway sold something

like $6.5 billion in airline stocks, their entire stake in major American airlines. And the reason that they did that is that they don't believe fundamentally that this industry will recover in a way that looks approximate to what it was before. They think that even if it comes back, 70 or 80 percent, that might be good. Those airlines are still going to be dealing with all of the planes, right? They still have all of their capital expenditures, and that makes it just unattractive for them. That was a pretty big indicator to a lot of people about how Buffett was thinking about the economy as a whole. Overall, we've seen the average number of commercial flights daily fell from more than 100,000 in January and February to 78,500 in March to 29,400 in April.

So one quarter roughly of the flights that were happening in April that happened in January. Passenger revenue for airlines is estimated to plunge something like $314 billion in 2020, a 55% drop from 2019 levels. That's according to the International Air Transportation Association. Airlines for America testified before Congress and said that U.S. airlines are at risk of bankruptcy if they're forced to refund non-refundable tickets or tickets that were canceled by passengers. So even after these bailouts, there are huge structural issues for the airline industry. Now, what about hotels? This is another industry that is obviously hugely impacted by the coronavirus and shutdowns.

Average daily rate is down something like 17% in the U.S. while revenue per available, room is down 50%, and it's worse in basically every other region. That's just the U.S. Speaking of hotels or at least residential travel, let's talk about Airbnb. Airbnb was in the news yesterday when they announced that 25% of their workforce, 1900 jobs were being cut. This is a company that people have been watching in the context of the crisis for a while, and the numbers are just terrible. They expect revenue to be less than half of what it was in 2019. They saw bookings per week go from upwards of 550,000 in February to less than 100,000 at the end of April. 1.5 billion in bookings simply evaporated in March. And there's just so many problems here.

One dimension of this has to do with Airbnb's own financing. We have lived in a context of very cheap growth capital for a very long time. It's one of the byproducts of low interest rates. And the push among public market investors to move to private markets to find yield. In that context, what companies were supposed to do was outspend to see growth. They weren't supposed to race to profitability. They were supposed to race to growth. Airbnb hasn't gone public yet, and because of that, they have to rely on private markets for capital. Last month, they went to those private markets to get $2 billion to shore up their finances. Part of that, about half came from a five-year loan from institutional investors that pays an interest rate of 7.5% plus the benchmark London Interbank

Offered Rate or Libor. The other half came from private equity firms, Silver Lake and Sixth Street Partners, and was much more expensive than their recent valuation. So they are paying an interest rate of 10% plus LIBOR as well. And they also get warrants. Those private equity firms get warrants. that can be converted into shares at a valuation of $18 billion. The last valuation that Airbnb raised at in 2017 was $31 billion. So you're talking about 60% of the value of the previous high raise. So this is a great deal for private equity firms. Once again, it proves that having cash available when the markets go bad is always a great

place to be. But either way, Airbnb has had to aggressively shift to get money on worse terms than they might have expected. But it isn't just Airbnb itself. Airbnb is an ecosystem of small entrepreneurs who are making money through the platform. AirDNA estimates that Airbnb has about a third of the properties are single properties, so single property owners who just have one listing on Airbnb. One third are 25 plus. So these are usually larger companies, or at least medium-sized companies that own lots of properties that do this as their business model. But then a third of Airbnb listings are people who

have between two and 24 properties. And that's a lot of where the biggest pain is being caught. A lot of those folks are just regular people who started renting one and then took out a mortgage to offer a second and then took out a second mortgage to offer a third because it's a good business model. When everything is going right and you can make 2x what you would make from a regular long-term rental, it can make sense to have those extra mortgages can be a good business model. But these super hosts are in real, real trouble. An article in the Wall Street Journal profiled a number of those medium-sized renters. Jennifer Keller Hatslets of Michigan spent $380,000 to buy two Michigan properties in 2018.

She and her husband had cashed out their financial instruments and borrowed $100,000 from employers to furnish them. They were expecting to net $7,000 a month after mortgage payments, which is a huge supplement to their income. She was a pharmacist, her husband is a school teacher, but now because of this, they can't make mortgage payments. No one is booking, so they either have to borrow more or simply default on those. And there are so many more stories like that. Now, Airbnb has tried to help host in some way they'd said they would pay host 25% of what they would have received for canceled bookings. They created a $17 million fund to help top-rated hosts cover their mortgages, but it's capping those grants at $5,000 per host.

So if you have 10 properties, that's not going to necessarily make a huge dent. Finally, there's another issue, which is that there's going to be questions around demand and regulatory viability of this going forward. These sort of short-term rentals were already in a difficult regulatory space, and you're seeing temporary bans on them in a lot of places. Florida, Pennsylvania, Vermont, Delaware have all created temporary bans on Airbnb properties and other similar listings from similar companies. Sonoma County, Myrtle Beach, South Carolina have similar restrictions.

Who knows what it's going to look like after this? Who knows when Airbnbs will be allowed to operate again in these different places? It could very well be that hotels or the hotel lobby or just old-thinking, old-school kind of minded politicians just try to blame this type of engagement, this type of economic activity, and single it out again. So I think that there are real structural questions within the context of home shares. We could talk about travel and tourism's destruction ad nauseum. It could be multiple, multiple shows. But one other dimension that I wanted to hit on really quickly, just because it again came from news this week. Disney's quarterly earnings came out, and they reported a 58% reduction

in operating income in their theme parks. It's their worst hit business line, obviously. And the interesting thing is that that's to be expected, right? Things are shut down. Now, obviously, they're not operating. However, I think that the bigger question is demand and capacity going forward. In May, Shanghai Disneyland was allowed to reopen, but forced to operate at 30% capacity. It wouldn't at all be surprising.

In fact, it seems like the most likely outcome that any sort of public space business is going to be forced to operate at lower capacity. and that could change fundamentally the business model and the business viability of these different types of entertainment companies. Speaking of entertainment, I want to shift now to the music industry. The music industry is just brutalized by this in a way that makes some of these other economic plights look like nothing. I mean, the concert industry loss is basically total.

So Polestar was predicting a record year this year of 12.2 billion in. in concert sales, it's now likely to drop 8.9 billion. So you're talking about basically 75% of the industry wiped out, all of the industry wiped out from the moment these lockdowns went into effect. Basically, there's not going to be a concert from the middle of March to at least through this year, and some industry insiders are starting to plan for 18 to 24 months at least of no concerts. Not until a vaccine or some major medical breakthrough that makes it more viable. What's more, this is likely the industry that's going to be the absolute last to open. You're talking about a super congested space for a completely voluntary service, right?

This is the opposite of an essential service, even if it's so at the heart of so many people. Joe Spalding is the president and CEO of Boston's Box Center, which operates a 3,500-seat Wang Theater and the 1,500-seat Schubert Theater. He said, we are going to be the last industry to open, and there are a lot of reasons for that. We are an organization that has crowds, and it is impossible in our theaters to self-distance, period. And not only is it impossible for the audience members, it's impossible to lower the capacity to try to do that. So his point is that this isn't a restaurant where you just have the tables farther away. People crowd into where they're going to want to see the artist from.

It's just not possible. Toby Mamies, who's a rep for Alice Cooper, said, there is no best-case scenario right now that I can see for the live event world. The best case scenario in the real world is that people stop dying from this thing. Clubs are shutting down permanently. There's more than 1,200 venues and promoters have formed an advocacy group, the National Independent Venue Association, and they're trying to figure out how to get access to some of this federal stimulus.

This is a group for whom the PPP loans didn't really fit. They didn't work with their model. You're seeing this supported by a number of different politicians. You have 28 congressmen and women who have signed a letter about it who are asking for musicians to be included in the next stimulus bill. And the music industry as a whole, rather, not just musicians, but musicians, live event venues, etc. You have issues of when to put out albums. The logic of albums often has to do with when you can get to tour, how you can promote it

in person. The problem is that there's no real good option. You can't just have everyone wait and put out music at the same time when this is all over. Rob Light, who's the head of music at CAA, said, If everyone waits and then drops a record in January, have you created more of a problem? You may have more outlets, but you also have 50 pieces of product out there. So what are you competing against?

Smart people are stepping back and looking at each project and saying, what are the tools I have and how do I use them? It's the same for all these tours and festivals who are planning on reopening in Q4. This may be solved simply by them not being allowed to, but imagine that every festival tried to crowd into a single quarter. It's going to be so much competition. There's going to be market oversaturation. Then finally, there's the question of shifts in consumer demand and consumer preference and consumer

willingness. A recent Reuters poll found that only 40% of Americans would be willing to attend sports or entertainment events before a vaccine was available. Who knows how that changes when we have totally had it up to here with staying inside and being stuck in? It may be that that is a reporting bias right now that has to do with how people are feeling as they're scared, and that might double. But even if you have 70% or 80% of people who are willing to go back to it, you still have a significant loss to the industry, right? There's still significant economic harm in moving from a record-breaking year to a year that didn't exist at all to basically a year that's set back five years or 10 years.

And I think one thing that's really important in all of this is one of the real powerful and problematic knock-on effects of this virus and the shutdowns, is that it just absolutely destroys the weakest. And in the context of music, music isn't a natural selection like other types of capital markets might be. Music is an industry that is extraordinarily difficult and extraordinarily centralizing, right? It concentrates resources and promotion around a very small number of artists and a very small number of sounds, a very small variety of sounds. But music and why it's so important to people is that there are genres for every taste, there are blends for every taste. Small artists are only viable because they can tour. You can't as a small artist sell enough

of your music to have a career. You have to tour. Even before all of this, one of the biggest challenges in the music industry and the way that it's designed is that artists couldn't make a living without touring hundreds and hundreds of shows per year, which can be just absolutely destructive to relationships and health and all this sort of things. So musicians as small businesses are just absolutely destroyed through this. And there is a huge and uncalculable cultural loss to that sort of destruction that I think is hard to rock as we're sitting here. As someone who loves music, loves this diverse panoply of different types of sounds that we have available to us, who loves the fact that in the modern world, everything is discoverable. This is an industry that I'm

really concerned for, and it's really, really hard out there for right now. Support for this podcast and this message come from Eris X. With ErisX, you can trade spot and regulated futures on cryptocurrencies through a licensed, U.S.-based exchange. ArisX believes in fair access for all. Sign up today to take advantage of zero fees and learn more at ArisX.com slash consensus. This episode is also sponsored by the Stellar Foundation. The Stellar Network connects your business to the global financial infrastructure, whether you're looking to power a payment application or issue digital assets like stable coins or digital dollars. Stellar is easy to learn and fast to implement. Start your journey today at Stellar.org slash coin desk.

Our final sponsor is Greyscale Digital Large Cap Fund. In times like these, diversification is key. Consider gray scale digital large cap fund, ticker symbol GDLC. It's the only publicly traded investment product that offers diversified exposure to large cap digital currencies. all from your brokerage account. For more information, visit grayscale.co slash coin desk. That's g-r-a-y-scale.c-o-co slash coin desk. Last up, let's look at real estate,

and real estate could absolutely be its own category. In fact, it could be multiple categories, right? So we're going to talk about both commercial and residential real estate. This is another area like travel and tourism where I think people have groked the second order effects much more quickly than perhaps in other areas. Let's talk commercial real estate. One obvious dimension of this is that as stores and retailers are forced to close down, they're not going to be able or they're going to be unwilling to pay their rent, and we're seeing that in tons and tons of

different ways. Just by one little example, Empire State Realty Trust, who owns the Empire State Building and another 13 commercial properties in the New York region, said that it collected only 73% of its April office rents and 40% of its retail rents. So less than half of retail rents and less than three quarters of office rents. You're seeing issues coming up between retail tenants and their landlords around trying to rewrite leases to include pandemic escape clauses. So this is obviously something that landlords often oppose and is setting up for protracted legal battles there. You have some really interesting things happening where the fundamental structure of the way rent works is changing. We've been in a system where landlords want predictability of rent revenue over

anything else, any potential upside, but in lots of cases, that model is shifting. So Ross Stores said last month that it would pay a rent equivalent to 2% of sales when its stores open. So it's basically exchanging a fixed rent for shares of commercial revenue. WeWork, which has been one of the most hampered businesses by this, had already been looking to switch to more revenue-sharing agreements and has tried to accelerate that shift. It's even hired two brokerage firms to renegotiate its real estate deals along those lines. This was already happening in some places. Neiman Marcus and other retailers at New York City's huge Hudson Yards mall. They pay their landlord a percentage of sales rather than a fixed rent, but this wasn't the norm. And now you're seeing

more and more this shifting. Now, for some landlords, this could be an interesting and dynamic opportunity. But what it does is it's going to be hugely culling to retailers that can't perform, right? Michael Phillips, who's the president of a real estate investment firm called Jamestown, said, the days of being the landlord as an overlord to collect rent are over. And then there's the potential for banking spillover. Commercial real estate is a huge part of the business model of banks. Real estate in general, commercial real estate debt is $3 trillion. Residential mortgage debt is 1 trillion, if you start to see significant defaults in that area, that could be significantly impacting two banks. TREP research estimates that over the next five years, we can expect 2.5% loss

rate defaults compared to 0.1% last year in commercial real estate. Now, the good news is that this is lower than the defaults at the peak of the great financial crisis, which was 4.4%. Still, you're talking about billions and billions, tens of billions of dollars in losses for banks. In the context of that. Overall, commercial real estate is going through a revolutionary moment. It's impacting retail, it's impacting office space, and we're just going to see more of that. But what about residential? Residential is really weird, and in fact, in some ways, this whole set of pieces surveying the carnage was inspired by an article I read yesterday why home prices are rising during the pandemic. First, let's talk about what you would expect. Sales for new homes fell 8.5% in March. Redfin home

buying demand was down 15% in April. Mortgage applications are down 20% in April. But home prices are up 8% year over year. So what gives? Why is this happening? Well, there's a few different reasons. First is that sellers aren't cutting prices. They believe that because people can't see their house, there's no way for them to know how good it is or how valuable it is. So there will willing to wait, basically, for people to be able to come back to the normal home buying process. Effectively, they're making a bet that this is a temporary shock. There's also a supply issue. There was already a supply issue and a shortage of homes before this crisis, and there's a lot of

reasons for that that, again, deserve their entire own episode. One of the more salient points that I've heard over the last few weeks is I asked Preston Pish about why we weren't seeing inflation show up in a big, way, although we'll come back to that perhaps in tomorrow's episode in the context of food, but why we weren't seeing inflation show up when we were seeing so much money printing. And his argument was effectively that the places that you see inflation aren't just the normal stuff in the consumer price index, which is how inflation is measured. You see it in asset prices. Homes are one of those. Homes are an asset where, especially boomers,

will often buy a second home as an investment asset that just keeps going up in price. because of that, it's created a dampening effect on the market as a whole because millennials and other homebuyers can't afford those houses and it's not worth it to those boomers until they need that revenue to actually sell them. So you have these structural issues in the real estate industry in general, but then that's exacerbated by the fact the supply issue in this context where if you are thinking about selling your house, if you have any choice right now, why would you list your house? Why when people can't even come see it? When everything is shut down, when there's so much economic insecurity. You just wouldn't sell it. You don't want to sell it right now.

So basically, you do have a demand shock, but you also have a supply shock, and that is keeping home prices buoyant. The other piece of this is mortgage forbearance. All of these policies in different states and around the country have impact on preventing basically a wave of distressed sales. Something like 7% of mortgages were in forbearance in the week ending April 30th, according to a mortgage data company Black Knight, and some homeowners can get forbearance for up to a year. So basically, you have this suspended issue where if everything goes back and people can catch up on their payments, maybe we won't see an impact, but it maybe is more likely that we see the impact on home prices and distress sales coming months down the line or even year down the

line when these forbearance periods end. But then again, there's a political dimension. In a widely retweeted tweet from Monday of this week, Representative Ilhan Omar from Minnesota wrote, Suspend with a line crossed out through it, cancel rent and mortgages on Twitter. She didn't go on to expand this in Twitter, and it was certainly designed to engage a reaction up in here. And it did. 70,000 people liked it. 10,000 people retweeted it, and probably an equal number actually responded to it. we're having a national conversation about totally restructuring the economy. And when you see an elected

representative be able to simply suggest canceling, not suspending, not providing forbearance, but canceling rent and mortgages, who knows what the hell is going to happen next. So the point of this is that we are in a weird moment. The second order effects are starting to happen. We're starting to be able to see them, track them, understand them. And I think it's really important to look at all of these different industries to see how they're interconnected, to understand what happens next and what we can do about it. That's it for today, guys. Tomorrow I'm going to get into a number of different issues, assuming that you like this. If you all tell me you hate it, I won't. But I think tomorrow we're going to look at maybe education, the film industry, sports, restaurants, meatpacking and food prices,

which is having a huge challenge and advertising. And maybe we'll go through those a little bit faster. but let me know at NLW on Twitter, is this type of episode helpful? Are you enjoying these economic follow-out episodes? I think it's really important, but I want to make sure it's serving you too. Thanks as always for listening, and until tomorrow, be safe and take care of each other. Peace.