By Taylor Williams
It shouldn’t come as a surprise that most commercial real estate professionals expect a year that follows a global pandemic to be an improvement from the previous one.
But the anticipation of a drastically strong rebound across an entire region seems a bit unusual, especially given that mass vaccination and herd immunity are still months away, ensuring that much of 2021 will to some degree be marked by similar COVID-19 headwinds to property types like office, retail and hospitality.
Yet in the true spirit of the commercial real estate industry, optimism is prevailing, at least according to the results of Northeast Real Estate Business’ annual forecast survey of brokers, developers/owners/managers, as well as lenders and financial intermediaries. The survey encompassed approximately 150 professionals throughout the region across these three groups.
Based on majority responses, brokers expect leasing activity to pick back up to varying degrees across all asset classes. Owners see major opportunity to grow their portfolios, particularly with regard to distressed assets whose pricing levels have come down due to occupancy and cash flow concerns. Piggybacking on the elevated opportunity for more investment volume are greater opportunities for lenders to finance new developments and acquisitions — though of course, some property types remain more attractive than others.
Among commercial brokers polled in the Northeast, approximately 80 percent stated that they expected their volume of business — as measured by the combined dollar value of leases and sales — in 2021 to either hold steady or increase relative to 2020.
Again, this finding is not particularly shocking given the events of the past year. But the magnitude with which brokers believe the recovery will unfold is the real story. Among those that indicated expectations of growth, roughly half predicted that their firm’s aggregate business would grow by at least 20 percent year-over-year.
Within the developer/owner survey, 60 percent of investor respondents said that they expect to be net buyers in 2021.
On a national level, investment sales activity is certainly due to reverse course. According to New York-based research firm Real Capital Analytics, total transaction volume decreased by 19 percent across all commercial property types in the fourth quarter of 2020 compared with the same
period in 2019.
Annual deal volume declined even more sharply, dropping 32 percent across all asset classes on a year-over-year basis. In both cases, however, investment sales volume for industrial properties showed the smallest decrease compared with other property types.
The logic behind this strategy is clear: as leasing for retail, office and hotel assets has slackened, valuations have come down, resetting the price bar for bids on new deals. And with plenty of uncertainty in terms of how long it will take the businesses of these users to return to pre-pandemic levels, it stands to reason that many sellers will want to dispose of their properties before valuations decrease even further.
Lenders expressed the most confidence out of the three groups that their 2021 volume of commercial loan closings will either grow or remain the same relative to 2020. Just 10 percent of these respondents indicated an expectation for a year-over-year decline in loan production. Similar to their broker counterparts, the majority of optimists within the lender group also said that they expected their annual loan production to grow by 20 percent or more.
Retail, Hotel Struggles Linger
While overall deal volume across all asset classes is expected to increase this year, there’s no question that some asset classes will be pulling a lot more weight than others.
Broker and lender respondents were practically unanimous in their selections of industrial and multifamily as the asset classes most likely to experience an increase in valuation as well as high sales velocity in 2021.
This finding, while not terribly shocking, speaks to just how much the pandemic has widened the gap between the haves and have-nots. According to the survey results and various free-response answers, the jury is still out on the long-term fate of office properties. But there’s no question that before the crisis, traditional office buildings still faced threats from a growing segment of coworking and flexible office concepts.
Thus, the survivors of the office market are likely to be newer buildings whose mechanical systems and other design features can accommodate mechanisms that promote greater health and wellness. This could also extend to buildings with outdoor amenity space, socially distanced lobbies and common areas, HVAC systems that filter and circulate fresh air and modern windows that maximize natural light.
The fate of properties that are linked to the service industry are less promising. Prior to COVID-19, brick-and-mortar retail was under siege from e-commerce, creating a landscape in which only the most innovative concepts survived.
After watching Airbnb chip away at its market share for over a decade, the hotel sector saw drastic overnight dips in occupancy and an exodus of labor when the pandemic hit. The industry essentially saw its fears come to a head in December 2020, when the San Francisco-based hospitality concept went public, debuting at more than twice its pre-IPO price.
As part of the survey, participants were invited to speculate on how long it would likely take the retail and restaurant industry to return to pre-pandemic levels of business (see chart at bottom left).
Across all three surveys, the overwhelming consensus was that such a recovery, on a national level, will take somewhere between one and two full years. The same question and answer choices were posed with regard to the hotel industry. Respondents were less optimistic with regard to these properties, mostly selecting “three years or longer” across surveys.
Many states will keep public health guidelines for shopping and dining in place until most Americans have been vaccinated — a feat that likely won’t be accomplished until the second half of the year at the earliest — suggesting that retail, restaurant and hotel users may have to operate on skeleton budgets this year as well. These users typically pull their labor from similar pools. Consequently, they may end up competing with one another for that critical factor of production.
“Banks and special servicers need to have a reality check,” says Adam Lubkin, president of Ibis Development Group, which is based in Florida but active in the Northeast. “Nobody wants to take losses, but the faster the market can clean up the damage caused by the pandemic in retail, hospitality and office, the quicker we can all go back to stability and eventually to growth. But within that movement, there will be an inherent flight to quality.”
While retail and hospitality represent the two riskiest asset classes for short-term investment, there is a clear difference between the type of struggles each of these sectors is facing, says Simon Rubinsohn, chief economist for the Royal Institute of Chartered Surveyors (RICS), a London-based business valuation and economic research group.
“While there is a major shadow hanging over the hotel sector, it’s one that could be seen as more cyclical rather than structural,” he says. “We’re hearing very negative sentiments regarding the hotel sector — double-digit declines on capital values and occupancies. But without knowing when, we should eventually get back to some form of normalcy that will provide a lever of confidence that hotels can emerge from the downturn in ways that may take longer for retail to achieve.”
Research findings from RICS indicate that the “structural” or institutional challenges that the retail sector is facing are likely to be further exacerbated by e-commerce in the short term.
“There will always be some physical retail, but there’s still plenty of room for digital shopping to eat into physical retail,” says Rubinsohn. “Over the next year, we could see capital valuations for these assets decrease by 13 percent, and rents could fall 15 percent. The negative investment sentiment for retail is not lessening in response to the changes we’re seeing in the sector in terms of e-commerce and online shopping, and we don’t expect that to change over the next 12 to 18 months.”
Reasons for Optimism
Despite some of these grim-yet-realistic responses, commercial real estate is an industry marked by upbeat optimism. To that end, some professionals are already spotting opportunities for retail concepts hit hard by the pandemic — food, fitness, entertainment, etc. — to begin mounting the comeback.
“On the retail services side, we will see steady increase in rightsizing and relocations, as well as re-entry to the market on the local side with restaurants, bars, gyms and entertainment,” says Brian Katz, CEO of New Jersey-based Katz & Associates. “This is a great chance to build new market share and secure locations that have not historically been available or economically viable previously.”
“There is going to be a high level of transactions due to the economic collapse caused by COVID,” concurs Nicholas Orlov, president of The Orlov Company, a full-service firm based in metro Boston.
“The opportunities will be in assisting sellers and buyers in recognizing value and blocking out wasteful noise. Opportunities will also abound in terms of assisting owners and tenants in achieving a survivable balance that works for them and for the community as a whole.”
Some broker participants cited elevated demand for second-generation restaurant space that could be leased at relatively affordable rates by new, innovative concepts as a key trend to monitor in 2021.
The International Council of Shopping Centers (ICSC) has a slightly rosier perspective on the immediate future of physical retail. The New York City-based association recently released the results of a survey that found that 55 percent of brick-and-mortar retailers expect business to return to pre-pandemic levels by the end of 2021.
The survey also highlighted the fact that brick-and-mortar retailers have made greater strides in pivoting to omnichannel sales and distribution than generally realized.
According to the summary of the report, 88 percent of shopping centers are being used to fulfill online orders and that 99 percent of retail respondents reported that their stores fulfilled online orders to some degree.
“For retail and retail real estate, the COVID-19 pandemic hasn’t spurred a total reinvention, but a rapid acceleration of trends that were already taking shape,” says Tom McGee, president and CEO of ICSC.
“Stores were already offering curbside pickup, ramping up click-and-collect and rethinking store formats. What we’ve seen since March is a remarkable expansion of that, which will create a better experience for consumers as they return to stores and shopping centers.”
In addition, some brokers anticipate that small office users will target suburban buildings that can still offer some of the newer amenities. Rates for these office spaces should be more attractive to tenants than those of office buildings in dense urban cores, mainly because older suburban buildings don’t typically carry debt loads that dictate higher rents.
In terms of the long-term predictions that end users and investors have for their asset classes, only time will tell whose expectations were correct. But the common denominator among all survey respondents seems to be that major change is upon us and will continue to be for some time.
“Coronavirus is a game changer and change will have to come because our economy cannot afford to be shut down every time a new sickness arises,” says Heather Kreiger, brokerage advisor at ROCK Commercial Real
Estate of Philadelphia.
“While we may return to a version of ‘normal’ at some point in the next 12 to 24 months, it will still look very different than the normal we left behind. The greatest opportunities are going to come to the businesses and individuals who are looking forward instead of backwards, being flexible and thinking outside the box.”
— This article first appeared in the January/February issue of Northeast Real Estate Business magazine.