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What an Uncertain Commercial Real Estate Outlook in 2021 Means for Financing

300-Third-Ave.-Waltham

The new life sciences building at 300 Third Ave. in Waltham, Mass., totals 139,000 square feet. In 2020, development of new life sciences facilities was expected to total 4.5 million square feet, double the five-year average, according to Newmark Knight Frank.

By Steven Caligor, BHI

In these early days of 2021, there appears to be some cautious prospects of hope.

A COVID-19 resurgence both internationally and domestically, further lockdowns, and even a new variant of the virus create uncertainty. However, the vaccine rollout has sparked market rallies, along with hopes of returning to a degree of normalcy toward the end of the year. We now have a stimulus package and a new presidential administration. Yet this scenario is tempered by a focus on the predicted winter COVID activity, thus creating further question marks.

Steven Caligor, BHI

Even the economic forecasts present a mixed picture. The base case from the Conference Board calls for a 3.4 percent annual expansion of the U.S. economy in 2021. Yet the Congressional Budget Office (CBO) projects that GDP will increase 4.2 percent in 2021, and the CBRE Real Estate Market Outlook forecasts 4.5 percent GDP growth this year.

The ambiguity of where we are in the COVID crisis — whether there is an end in sight and when — will determine prospects for the real estate sector. In 2021, the real estate story will be all about asset class, density and geography. For each of these aspects, to paraphrase Charles Dickens, it could be the best of times or the worst of times, depending on multiple variables.

Outlook by sector

The market will continue to be very asset class specific in 2021. For office, retail and hospitality, the big question will be how lasting the COVID changes will be and the magnitude of the return.

Retail and office are likely to constitute a W-shaped recovery, with ups and downs based on individual sub-markets, job growth and how quickly workers return.

Medical office properties remain attractive, as they have maintained high occupancy rates and are expected to see new levels of consumer demand with vaccinations continuing throughout the population.

We see hospitality likely as a U-shaped recovery, driven first by pent-up leisure demand and light domestic travel to destinations considered relatively safe. We have already begun to see increased activity over the past few weeks, both in vacation and family travel.

The new COVID trends have also created multiple bright spots including multifamily, industrial and life sciences. According to the CBRE data, multifamily investment will increase 33 percent to $148 billion in 2021. The life sciences sector has demonstrated robust growth even before the onset of the pandemic.

In 2020, development of new life sciences facilities was expected to total 4.5 million square feet, double the five-year average, according to Newmark Knight Frank. JLL forecasts that demand for lab space will increase with a 16 percent rise in pharmaceutical manufacturing through 2025.

Allied to asset class is the issue of density, once considered a good thing, enhancing the vibrancy of urban centers. Now the pandemic has made closeness a critical issue that extends across all bricks-and-mortar assets. Social distancing impacts design, office and residential efficiency, and safety. New models will emerge over the next few months and years.

For example, the office of the future may encompass smaller buildings with reduced floor plates and one or two companies per floor, as well as separate elevator bays, more outdoor space, private gyms and other amenities. Geography is closely related to density, but adds weather, public transportation options and lifestyle to the mix that will determine the rate of recovery across the country.

These new factors created by the COVID phenomenon have added more underwriting considerations likely to be used to evaluate projects. As the world has become more complex, so has the financing scenario. Here are some insights on how key COVID criteria could be viewed from a financing perspective.

There will be a flight to quality. It is important to demonstrate experience and the financial wherewithal to support projects’ capital needs. Loan-to-value (LTV) ratios may decrease, so as not to stress the asset from a cash-flow perspective and to ensure owners have skin in the game. Contractors will be scrutinized more closely, and project execution with bonded and well-established companies will be evaluated. Generally, land loans and select construction may help spur activity, as these are “to be delivered” assets that may not hit the market for a few years, providing time to assess and re-assess market conditions.

Local markets will matter. You should assess the local market closely. What are the long term economic drivers and what brings people to the location? Pinpoint whether the draw is tourism, sports, retail, weather, job growth or lifestyle. Is there heavy reliance on public transportation?

A COVID plan is critical. If you are seeking financing, you need to have your COVID plan ready. Be prepared to discuss your business plan up front and demonstrate the COVID impact on your model. You should show the effect on revenues, costs, the target market, and how and why you can manage it effectively. Issues of density, commute, population and office location will all come into play, and you should include details such as geography, asset use and exit strategy. You should have a fallback position or alternative uses that clearly define an exit if the project does not hit forecast.

If you do secure financing, you should consider locking it in long-term to take advantage of historically low interest rates. Most of all, stay close to your lender and work with a bank that understands your business needs and values personal relationships. It is during unforeseen, black swan times when open communication and trust become most important.

In 2020, COVID changed the CRE sector in fundamental ways that no one predicted. Going forward into 2021, the outlook still is opaque in many facets. But one thing is clear in the new year: the potential of those changes will shape the industry for its post-pandemic future.

 

Steven Caligor is executive vice president and division executive of the Structures Finance Group – CRE, Healthcare, Technology and Treasury Services at BHI, a full-service commercial bank and the U.S. division of Bank Hapoalim.

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