Will the Commercial Real Estate Market Crash?
This is a question that keeps circulating among many professionals in the commercial real estate industry, and it is a question that comes up daily with my clients.
The short answer is, it depends. Wow, that is really thoughtful, Anthony. The reason it depends is because first off, each sector of commercial real estate (CRE) is affected differently and second, each property is affected by location.
As I write this article, California is heading into its 8th week of quarantine. Now, there is a lot we could say about eight weeks of quarantine, but this article focuses on its impact on commercial real estate and the larger sectors of the CRE market.
Clearly this area is already affected. Hotels are running nearly vacant today and are taking one of the largest beatings ever seen. I’m not sure how long they can sustain; it certainly depends on their balance sheet and how fast we recover from Covid-19. More than that, I believe the general psychology of people’s behavior has changed and will be changed for a long time to come. Let’s think about it, the hospitality industry is by and large dependent on leisure travel and business travel. I am sorry to say, but I don’t know anyone looking to book a vacation anytime soon. Furthermore, business travel is clearly non existent and is likely to remain limited once we get back to some sense of normalcy. Companies will start to ask “do we really need to jump on a plane and travel for that meeting, or can this be done on Zoom instead?” Even if the answer is yes 50% of the time, that represents a significant drop in business travel.
Let’s also consider the level of cleaning that will be required of hotels and lodging going forward. What are the new policies? Is it financially feasible to clean a room to the level a guest would be comfortable? What happens with the bed covers? This is getting into the weeds a bit, but these are things consumers are talking about that will need to be addressed.
Retail was slowly declining pre Covid-19. The writing was on the walls. The retail industry has been going through a major shift, which in turn affects commercial real estate. Add the quarantine to this and the impact is even greater. The data is not yet in to see how many retail tenants have paid or will pay May rent. Furthermore, the longer we all are affected by Covid-19 the harder it will be to purchase goods and services. There will be less discretionary income to spend and likely some ongoing concern about walking into stores or malls with large groups of people. Additionally, with so much inventory produced in and imported from China, there may be uncertainty about the availability of some products. Will consumers always support some level of brick and mortar retail? Of course. Humans like to touch, feel and smell things, but I believe there will be a major shift.
Everyone needs a place to live, not everyone can afford to own a home, and not everyone wants to own a home. For these reasons, multi-family housing has been one of the most desirable assets to own in the commercial real estate world. However, with recent years of low supply and low CAP rates, it has been difficult for new investors to enter this market. One impact of Covid-19 is that some tenants are struggling to pay rent. If this continues long term, it may impact landlords’ ability to pay their lenders and service providers. The result is that we might see a small dip in sales and valuation. On balance, however, I see the multi-family sector remaining flat going forward.
Going into the quarantine the industrial market in the greater Los Angeles area was running at 2-3% vacancy with high demand and little product. Values for industrial properties (warehouses, distribution facilities, and manufacturing facilities) have been going up since 2010. There are several reasons for this: supply was cut down due to new uses of the real estate; e-commerce has picked up; and the pre-made food delivery industry has grown. Additionally, the cannabis industry has absorbed a significant amount of industrial real estate space.
I predict that the industrial real estate market will hold up well during this new economic time we are experiencing. More and more product will continue to be shipped to consumers; traditional retail tenants will take less square footage in malls and depend more on warehousing goods; and food delivery/food preparation services will go up, as will the manufacturing of PPE (personal protective equipment).
The office market has seen a lot of change over the past decade. Tenants have been moving away from traditional office space toward a “creative office” environment that includes more open space, shared work environments and greater simplicity. With heightened hygiene concerns related to Covid-19, I have a hard time believing that shared work environments will be sustainable going forward, and I think we will see a major shift in the way people work. Companies such as WeWork that promote shared work spaces currently lease out millions of square feet of office space in the US. Furthermore, many large corporations have spent millions of dollars transitioning their traditional class A office space to shared work environments. What will happen to this space if people don’t want to a shared office environment? Over the past eight weeks of quarantine, most of us have established productive remote working habits using videoconference and other enabling technologies. I believe that many employees will want to continue to telecommute permanently, and at the same time this will allow companies to reduce real estate costs.
Of course, not everyone can telecommute and many still need or prefer to work in an office for various reasons. The question remains whether we will see a shift back to more private offices and private cubicles, which might require companies to procure more square footage to accommodate these privacy needs. Like all other commercial real estate property owners, office property owners will need to respond to their tenants requirements and build the best environment to support their tenants’ future success.
Whether its retail, multi-family, industrial or office, changes are forthcoming on how we conduct business, reach our clients and engage with our tenants. No doubt Covid-19 will have long term repercussions for all areas of commercial real estate. I believe that some, such as the industrial sector, will fair well, while others such as retail and hospitality, could face longer term challenges.