COVID Commercial Real Estate

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Update: COVID-19’s Impact on Commercial Real Estate

The economy has been devastated. We’re facing depression-level unemployment and all of us are wondering what our new normal will look like. While the stock market has recovered slightly it tells an uneven story of e-commerce, the expansion of tech and the devastation in retail, travel and experience businesses. Last week, Yardi Matrix updated us on how COVID-19 was affecting commercial real estate. Below are highlights from the webinar.

The Shock is Over, but the Pain is Just Beginning

The initial shock of COVID-19 may be over, but the aftershocks will affect us for months, if not years. In just two months, 36 million people filed for unemployment, and it’s estimated that up to 25% of restaurants won’t reopen. Energy has fallen off a cliff as oil prices have collapsed, and Q2 GDP is projected to be around -20% to -40%. Nevertheless, the financial system has been remarkably resilient — due, in no small part, to the support from the Federal Reserve, Treasury and Congress passing multiple stimulus packages.

However, fully climbing our way out of this won’t occur without a medical solution and political will. In fact, the recovery is likely to resemble the Nike swoosh as opposed to the V-shaped recovery we were all hoping for. It’s also going to look different depending on where you live as states relax stay-at-home measures differently.

Regardless of Sector, Small Businesses are Hurting

Indeed, small businesses felt the brunt of the pandemic, and much of the Paycheck Protection Program (PPP) went to non-core city businesses through community banks. Although the program did stabilize concerns to some extent, it didn’t help everyone equally. Roughly 85% of small business, coworking and retail tenants paid their rent in April. A smaller percentage is expected to do so in May. Despite the fact that e-commerce has helped industrial assets immensely, it’s not completely immune, either. Small businesses were still struck hard, which influences the smaller industrial spaces, as well.

Meanwhile, businesses are already rethinking the densification of office space. Many companies have announced that their work-from-home measures will continue through the end of the year. This will put downward pressure on the size of office footprints in the near- to medium-term. And as businesses assess the situation and landlords look to retain tenants, concessions and more flexible leasing terms are just a few of the many avenues that may be explored.

As expected, retail has been hit the hardest, especially restaurants and places that sell experiences. Across the country, an average of 45% of rents were collected for these spaces in April. Unfortunately, retail will also recover more slowly than other sectors because of ongoing social distancing measures. As a result, these spaces are likely to be the best place to look for distressed deals. The outlier in the sector is grocery-anchored retail, which appears to be fairing all right and should continue to perform in the short-term but may face pressure from accelerating e-commerce trends.

Industrial Prospers as the Future of Coworking & Retail Remains Uncertain

The simple fact is that the longer businesses stay closed, the harder the hit will be. Companies are already rethinking how well their space was being used and how it will likely be used going forward. Well-capitalized companies should be able to meet the terms of their lease requirements, but smaller companies remain on uncertain ground.

In the same way, listing prices have begun to show a slight decline, but there’s not enough activity in the space to get a solid understanding of what’s happening. It will likely take more than a year to see the true effect on office leasing rates and asset valuations.

On the other hand, look to industrial to keep performing well going forward, with e-commerce leading the way, followed by cold storage. Logistics and storage also might increase as the “just-in-time” model of distribution starts to decline, and inventories rise.

While retail continues to be the worst-hit sector — along with travel — coworking has also felt the brunt of the pandemic. That’s because the traditional coworking model is to take on long-term leases and then sign on users for short-term leases, which is difficult in this environment. As expected, many locations have not been able to pay their April rents. Going forward, a new model — which creates a partnership between the owner of the building and the coworking company as the operator of the space — may show promise. The owner would then get pass-through income from the tenants, rather than a fixed rate from the lease.

Likewise, commercial lending policies have become more stringent, as well. Deals that were in the pipeline may be able to be renegotiated, but new projects that don’t have a high percentage of lease-up completed aren’t doing as well, nor are loans approaching maturity. Refinancing in this environment is difficult.

Transit & Energy Sectors to be Affected

Clearly, long-term demand for office space is up in the air. Many companies will be evaluating their use of space. Some may even explore the idea of satellite offices to avoid employees using mass transit and long waits for elevators in tall buildings, which face more restrictive capacity requirements. Conversely, new social distancing designs and protocols for offices may increase the amount of space necessary, so there may be a leveling effect that supports demand.

This could have huge implications for the energy and utilities markets. Much of the energy usage in large cities is used by offices and transit systems. So, shifts in travel patterns and office concentration could have significant effects on how these companies operate.

Another unforeseen problem is how companies are going to maintain their individual cultures through remote teams. Even if the satellite office model becomes more widely adopted — with workers having a smaller office to go to when necessary — businesses would still be working with a decentralized workforce, which would influence the culture of those companies.

COVID-19 Accelerating Existing Trends

Ultimately, we don’t know exactly how the recovery will play out — or what our new normal will look like. The pandemic and shuttering of economies has only accelerated trends that were already happening. Automation and remote business tools will continue to play larger roles in business. And, as retail continues to feel the pain, those that can leverage e-commerce will step in and gain market share.

As our country ages, we’re likely to see a flight from the urban cores to the urbanized suburbs, as Millennials start families and search for housing that’s more affordable. Many will also look to the southern and western states.

But, we’re all still social beings. We will gather together again and the re-emergence of travelling and entertainment will happen — albeit slowly.

Listen to the entire commercial real estate webinar, as well as webinars covering multifamily and self storage.

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