Exclusive Survey: New Administration Worries Texas Real Estate Professionals

by Taylor Williams

By Taylor Williams

At a time in which politics pervades nearly every facet of life and business, and in which ideological divides are wide and getting wider, commercial real estate professionals in Texas have some concerns about how the Democrats’ newfound control of two of the three branches of the federal government will impact business.

President Joe Biden has been sworn into the nation’s highest public office, and Democrats now hold control of both houses of Congress following the Senate runoff elections in Georgia that flipped two seats from red to blue. That chamber consists of 50 members on each side of the aisle, with Vice President Kamala Harris representing the tie-breaking vote as head of the Senate.

In conducting its three annual forecast surveys for brokers, developers/owners and lenders, Texas Real Estate Business received a multitude of opinions on how and to what extent the new political regime will impact deal volume and velocity. Respondents also weighed in on how the changing of the political guard will affect ancillary issues such as taxes, regulation and marketplace confidence.

Unsurprisingly, out of all the brokers, developers and lenders who provided written responses on how the political landscape will affect commercial real estate, most chose to remain anonymous. While there is some short-term optimism that additional coronavirus relief funds can provide a quick boost to retail and restaurant sales, the majority of the viewpoints on how the outcomes of the presidential and congressional elections will impact business tended to be pessimistic. This holds particularly true with regard to how new policies could potentially hurt owners of commercial properties.

To illustrate the sentiments within an industry — and state — that typically prefers as little government involvement and influence as possible, we offer a smattering of responses to the following question: “What impact, if any, will the results of the presidential and congressional races have on the commercial real estate industry over the next 12 months?

Responses have been slightly edited for grammar and syntax.

Brokers Are Most Concerned

We received a comparable number of free-response answers to this question from brokers (42) and developers/owners (36). Responses were submitted after the presidential election but before the two Senate runoff races in Georgia.

Between the two groups, brokers generally espoused greater concern, citing standard Democratic tenets like higher taxes and heavier regulation as hindrances to a strong rebound from COVID-19 in 2021.

“Tax changes or proposed changes will likely cause investors to take a ‘wait and see’ approach, which will slow down deal velocity,” said one broker. “That, combined with higher interest rates due to market volatility and potential inflation due to quantitative easing in the form of stimulus packages, may cause values to go down.”

Multiple broker respondents maintained that had Republicans won one of the two Senate runoff races in Georgia and thus retained a majority presence in that chamber, the damage to the industry would have been minimized.

“If the Senate had stayed Republican, there would probably still have some impact, even though Biden is talking about raising capital gains and other personal taxes,” wrote another broker.

“Confidence will decrease tremendously with a Democratic win in both the presidential and Senate runoff elections,” added a third.

As previously noted, a couple of developers expressed cautious optimism that the Biden administration and Democrat-controlled Congress would pass additional coronavirus relief legislation, which would ostensibly trickle down to users in the retail and restaurant sector that are still hurting. But the majority of these respondents emphasized the potentially harmful long-term effects that the new regime would usher in on these types of businesses, subsequently hurting leasing activity and rent collection in the process.

“Biden’s agenda will squash small- and medium-sized businesses and healthy capitalism in general,” wrote one developer.

Several developers pointed to the Biden administration’s proposed changes to 1031 exchange laws, and by extension capital gains taxes, as the main areas of concern. A push to abolish the 1031 provision within the U.S. tax code would preclude investors from deferring capital gains taxes on investments in which proceeds are reinvested in similar assets within 180 days.

On the flip side, some noted that such a move could also stimulate investment activity in the short term as buyers rush to close deals and minimize their tax liability before new legislation is passed.

“We’ll see an early surge in activity to try and get ahead of any anticipated changes to regulation,” one developer postulated. “However, life should return to business as usual within four to six months of the inauguration due to the realization that actual change really isn’t that dramatic.”

For their part, brokers expressed similar concerns over what the elimination of 1031 exchanges would do to overall investment activity, citing the ability of a newly empowered Democratic Congress as the key mechanism that could make that point of policy a reality.

Among the 13 lenders who weighed in on this question, sentiments were generally the same: power resting in the hands of one party across both branches could easily hurt deal volume. As one lender noted, however, “cap rates may rise somewhat as a result of 1031 exchanges going away, but low interest rates may serve to keep cap rates in check.”

Unusual Opportunities

The rollout of multiple COVID-19 vaccines goes a long way in bolstering the notion that multifamily and industrial assets present the greatest and most attractive  investment and financing opportunities. Sources across all three survey groups were consistent in their evaluation of the strong performances of these two property types relative to the rest of the pack.

Real estate professionals also contend that most consumers are eager to make up for lost time in terms of eating out, socializing, travelling and perhaps even staying in hotels. Some also believe that there are a decent number of office-using companies itching to get employees out of their homes and back into their buildings.

“We are bullish on the office sector for 2021, mainly because we see the vaccine as a total game-changer and believe people want a place to go to work, though the workplace may be different than it was prior to the pandemic,” says Grant Pruitt, SIOR, president and managing director of Dallas-based Whitebox Real Estate.

“We have already seen an uptick in office interest, and we believe that this year, companies will have the confidence to make the long-term decisions about office usage that they deferred in 2020,” he continues.

TREB-Developer-Property SectorOn the flip side, if  a high number of office users opt to reduce or eliminate their footprints to save on overhead costs, some office buildings will be hurt in terms of cash flows. This will inevitably cause prices and valuations for those assets to drop, which could be a boon for some investors.

“There will be some buying opportunities in the office market should the pandemic continue through the second quarter relatively unchanged from where we are today, as it will be challenging for office-using businesses to return to profitability,” notes Scott Morse, managing partner at Citadel Partners.

Allen Gump, SIOR and executive vice president at Colliers International’s Dallas office, adds that while some headwinds will persist in 2021 until society is essentially fully vaccinated, the new year is loaded with opportunities.

“The seismic shift we’ve seen over the last year in several areas of commercial real estate will continue to reveal opportunities, from underperforming malls transforming into industrial distribution space to large blocks of office space now being offered as lower-cost sublease space,” he says.

While the jury is still somewhat out on how strong and fast a recovery in the office market will be, there’s no question that many retailers, restaurants and hotels have not and will not survive the pandemic.

In terms of the first two categories, the majority of respondents from the broker, developer and lender pools all indicated that it will likely take at least one, if not two full years for retail and restaurant industries to return to pre-pandemic levels of business.

TREB-Brokers-ValuationsOn the hospitality circuit, the lion’s share of respondents across all three groups also agreed that a full recovery in the hotel business was likely to take a minimum of two, if not three full years to materialize.

To that end, some professionals are closely monitoring opportunities to occupy vacated spaces on the leasing front and pricing drops that could stimulate demand on the investment front.

“Since many hotels will close forever, there will be opportunities for survivors in this industry, not only to continue to own and/or operate properties, but also to grow their portfolios once business returns to 2019 levels,” notes Tandy Lofland, president of Houston-based Intergroup Cos.

Daniel Hartnett, senior director of capital markets at Greysteel, agrees with these takes, noting that depreciations of asset classes that have been overlooked due to pandemic-related concerns on cash flows could represent the biggest investment opportunities of 2021.

“Hotel and core retail assets will rebound once the vaccine has been fully deployed and the market comes back, as these deals represent the best yield pickups if the basis is correct,” says Hartnett. He adds that his firm is also bullish on the emerging  class of single-family rentable product as an alternative to hotels.

Other respondents stated that, in keeping with previously established trends, the retail and restaurant markets will continue to favor the most innovative concepts. Repurposing or backfilling vacated spaces with these concepts will likely be most challenging for big box retail stores and traditional sit-down restaurant spaces, the developer added.

“Borrowers will need to envision entirely new uses and concepts for their assets and invest heavily to reposition properties for success in a very different world,” says Charles Krawitz, vice president and head of commercial lending at Alliant Credit Union.

More Deals Coming

Political influences aside, respondents across all three groups resoundingly believe that their firms will do similar or greater volumes of deals, projects and loans in 2021 than in 2020.

Among brokers, just 13 percent said they expected their company’s deal volume to be lower in 2021 relative to the prior year, while only 7 percent of lenders indicated that the expected a lower volume of loan production in 2021 versus 2020. About half of those lenders who anticipated higher loan production in 2021 indicated that their volumes could realistically grow by 20 percent on a year-over-year basis.

Approximately 54 percent of developer/owners who participated said that they plan to be net buyers in 2021, which lends credence to the inclinations of their brokers and lenders that a rebound is imminent. Among that group of net-buyers-to-be, industrial and multifamily remained the most attractive asset classes for new investment in 2021, similar to past years.

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 relative to that period in 2019.

Annual deal volume declined even more sharply, dropping 32 percent across all asset classes in 2020 on a year-over-year basis. In both cases, however, investment sales volume for industrial properties showed the smallest decreases compared to other property types.

Survey results among developers/owners also suggested that certain leasing trends that were brought on by COVID-19 will persist in 2021. For example, owners of office and retail properties generally expect to have less leverage in negotiating lease terms with tenants given the extent to which the pandemic has drastically reduced the number of retail and restaurant concepts — as well as office users — that need physical space.

On the flip side, industrial landlords expect to have more leverage with tenants and to subsequently command higher rents as more people make purchases online and drive demand for warehouse and distribution space.

With this trend entrenched and getting stronger, it comes as little surprise that brokers once again rated industrial as the property type most likely to experience increases in valuations in 2021. Developers and lenders both agreed, citing multifamily and industrial as the asset classes for which the most attractive investment and financing opportunities will exist in the new year.

— This article first appeared in the January 2021 issue of Texas Real Estate Business magazine.

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