- 2020 was a year of unprecedented change in the commercial real estate industry. Between the COVID-19 pandemic and the acceleration of work from home and online shopping trends, markets and property types saw significant disruption.
- As we look towards 2021, there is a significant amount of uncertainty about how deeply rooted these changes will be and how they will affect the future of commercial real estate assets.
- Widespread manufacturing and distribution of a coronavirus vaccine is perhaps the greatest impediment to a return to normal. It is expected that it will not be widely available until fall/winter.
- It is likely that office, retail, and hotel property types will continue to see some headwinds while industrial, data centers, and cell towers will continue to thrive.
- In response to shifting market dynamics, it is likely that CRE owners will accelerate their adoption of digital tools and rely more heavily on the data they produce to make investment and management decisions.
- Finally, in the wake of work from home trends, CRE operators will have to reconsider the value proposition of their properties and pay close attention to each property’s cost structure to maximize operational efficiency.
To say that 2020 was a tumultuous year for commercial real estate (CRE) assets is an understatement. Between the COVID-19 pandemic and the accelerated e-commerce driven disruption in retail, 2020 was a time of great change. There were clear beneficiaries of the shift in market dynamics and clear challenges for the companies on the wrong side of them. These changes are expected to last well into 2021 and beyond. For commercial real estate investors, it is important to understand how they impact the investing landscape and to allocate their capital in a way that takes advantage of them.
The Great Unknown
As of the beginning of the year, the United States has approved two vaccines, which both appear to hold promise in preventing coronavirus infections. While this is great news, the country now faces the challenge of manufacturing and distributing them on a never before seen scale. This is the great unknown. Until the vaccines have been injected into the arms of enough citizens to achieve herd immunity, there is little chance of returning to any sort of normalcy. By most estimates, this may not occur until late fall if everything goes smoothly. Realistically, it will likely be all of 2021. Until there is more clarity, there will continue to be some level of uncertainty surrounding the commercial property outlook.
Winners & Losers
As with any major event, there are clear winners and losers. With regard to commercial real estate, pandemic driven changes have been a major tailwind for the industrial, healthcare, data center, and cell tower asset classes according to the Deloitte 2021 Commercial Real Estate Outlook.
On the other end of the spectrum, office buildings, retail, and hotels have not fared as well. To illustrate this point, consider the fact that retail and office price indices declined 4.1% and 0.5% YoY (respectively) in August according to IBID. In contrast, the industrial property index rose 7.4% YoY.
In the short term, it is expected that these trends will continue. As vaccine adoption becomes more widespread, there may be some return to regular working and shopping habits, but it is uncertain how much. Will remote work and online shopping be the standard going forward? Or, will they return to pre-pandemic levels? These are also unknowns that will continue to reward/punish CRE asset classes going forward.
In Deloitte’s 2021 Commercial Real Estate Outlook, they surveyed 200 CRE executives about how they planned to weather current market conditions and prepare for recovery in 2021. In the responses, 56% of the executives strongly agreed that COVID-19 exposed digital shortcomings in their business and affected plans for transformation.
They state: “The pandemic has made enhancing agility and nimbleness a top priority for CRE organizations. These goals require companies to focus on digitization of key CRE business processes and the tenant experience. And while many CRE companies have taken a reactive approach to digital transformation, developing a more structured plan, including the implementation of various technologies and data analytics, would likely yield more meaningful results. Along with this, to enhance resilience, companies should double down on their cybersecurity and data privacy investments.“
Cost Containment / Operational Efficiency
With rents for office space and retail properties expected to continue their modest decline in the near term, operational enhancements and cost management take on added importance. This may be especially difficult given the added cost of pandemic related safety measures, but operators and investors will need to take a hard look at their income statement to determine where costs can be conserved while not impacting the tenant experience. For many, this may involve the adoption of automated technologies that can be deployed at scale.
Reconsidering a Property’s Value Proposition
Assuming a more permanent shift in working and shopping dynamics, CRE owners and operators need to consider each property’s value proposition. Deloitte states:
“The pandemic is also creating longer-term, evolving shifts in tenant and end-user preferences, which will likely influence leasing demand. Because of this, CRE companies will need to reassess the value proposition of properties. About one-third of our banking, insurance, and investment management respondents say their companies plan to rationalize their CRE footprint over the next six to 12 months. More and more companies are rethinking how and when they use office spaces. Increasingly, offices will be reserved for face-to-face interactions and team-based activities, and enhancing collaboration and innovation, while employees would continue to work remotely for more individualized tasks and assignments.”
Shift Away From Crowded Markets
While they offer much in the way of working, dining, and entertainment options, cities like Los Angeles, New York, Dallas, San Francisco, Seattle, and Washington D.C. are crowded, expensive, and difficult to live in. With the pandemic driven adoption of remote work, many are now asking themselves “If I can work from anywhere, where do I want to live?”
There are early indications of a shift away from some of the primary markets listed above and towards secondary markets that offer space, sunshine, and ample outdoor recreational opportunities. For example, Tesla recently announced a relocation from Silicon Valley to Austin, TX. Or, Palantir, a major technology company announced that they are relocating from Silicon Valley to Denver. These companies appear to be following their talent and the CRE implications could be significant. Again, there will be winners and losers and the primary beneficiaries of this shift appears to be secondary millennial boomtown cities like: Denver, Austin, Nashville, Orlando, and Miami.
Capital Markets & Lending
The Federal Reserve has indicated a willingness to keep interest rates at record low levels and to let inflation run unusually hot for an extended period of time to provide the economy with a needed boost. On the whole, this is beneficial for all CRE property types and for tenants who will rely on debt financing to keep their operations running. In their 2021 US Real Estate Market Outlook, CBRE states:
“…as underwriting and financing normalize, the ultra low cost of borrowing will help offset potentially low growth of rental income. To date, the pandemic’s impact on rent levels has been small, thanks to strong fiscal and other policy support that effectively reduced financial distress. However, these conditions could change if the government reduces its balance sheet with tax increases.“
What Does it All Mean?
While there continues to be a significant amount of uncertainty surrounding vaccine distribution, additional governmental stimulus, and whether or not remote working is here to stay, it is near certain that there are some fundamental changes that will stick for the long term. CRE owners need to accelerate their adoption of time saving technologies, they need to implement additional safety and cleanliness procedures, and they will need to pay close attention to operational costs so they can offset flat or declining rental revenue.
In addition, there may be a number of opportunities to reimagine how retail and office space is used and those who bring the most creativity and vision stand to benefit.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.
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