What might the post-Covid commercial real estate market look like?
Q: With the coronavirus crisis accelerating the demise of brick-and-mortar retail, raising fears of hotel and Airbnb stays, encouraging more remote working and work/life away from city centers, what might the commercial real estate (CRE) market look like after the pandemic?
At this point the only certainty is that CRE will look very different, with the magnitude yet to be determined. In the retail space, malls may face the most disruption as stores and brands that were already on life support are pushed over the edge. In just the past 10 days, long-term stalwarts of the industry such as J.C. Penney, Lord & Taylor, Neiman Marcus and J. Crew, just to name a few, all announced their intent to enter some form of bankruptcy. Ironically, the very “experiential” solutions to the demise of big box department stores that mall operators were turning to, such as theaters, entertainment venues, health clubs and restaurants, are the very businesses most challenged in a world of social distancing.
Health concerns about air travel and general demands for increased cleanliness (hard to feel comfortable staying in a stranger’s home) introduce meaningful impediments to both the hotel and Airbnb model. Leisure destinations reachable by automobile seem likely to be the first to recover, with business transient somewhere further off. But it is difficult to imagine the giant 1,000+ room group hotels seeing their convention business returning anytime soon.
The questions surrounding the future of urban office buildings are even broader. Will the need for more space per person in an office setting lead to increased demand (the opposite of the WeWork co-tenancy model that reduced the square footage, and therefore cost, per employee)? Or, more likely, will the efficiency of working from home and relative inefficiency, risk and cost of public transportation, along with new, inconvenient building health security measures, hurt future demand? One alternative solution is a hub-and-satellite approach that reduces health concerns by diversifying a firm’s employee base across a broader geographic area. Another twist is the ongoing migration toward lower-cost, less-dense Sunbelt states that seemingly have had a less severe experience with the virus than some highly urbanized Northeast cities.
Q: What has been the impact on the REITs?
Real Estate Investment Trusts (REITs) as a whole were far better prepared for a downturn than they were entering the Great Recession, with improved liquidity, less leverage, more undrawn credit lines and near-peak operating results across property types. The sudden, full-stop of the economy dramatically impacted some, including hotels and retailers, while the single- and multi-family properties’ operating results were less extreme. Others like offices with longer-term leases, are shielded in the near-term but may face more meaningful challenges to the demand for space as the world adjusts. Despite the relative general health of the industry when the virus concerns hit, the disparity in REIT equity performance has been enormous and volatile across sectors including those we have mentioned and others such as gambling (casinos all closed) and health care (senior housing residents being among the most susceptible to the virus).
Q: Where do you see opportunities going forward?
The clear beneficiaries are the property types at the heart of the e-commerce supply chain, where positive trends have been accelerated by the reaction to the virus threat. These include data centers, cell phone towers and industrial warehouses. Another, less direct, beneficiary is the single-family rental sector since it is much easier to shelter in a freestanding suburban home with a yard than a 1,000 square-foot urban apartment with no outdoor space. Finally, this is also a good environment for manufactured housing and RV parks that offer the desirability of being outdoors, suburban locations and typically no requirement to travel by air.