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Commercial Real Estate – A Rocky Investment during COVID

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Welcome to the crazy world of commercial real estate (CRE) in the age of COVID. Some wise person once said, “I finally figured out how to make a million dollars in the real estate business. You start out with two million.” That may be a somewhat cynical view of the current state of the CRE world, but in this environment, it may not be far from the truth.

Start a real estate studies degree at American Public University.

As we all know, COVID-19 has changed the landscape of everyone, especially in business. Nowhere is that more true than in CRE. There are basically eight types or subcategories of CRE. Let’s review these subcategories, the effect that COVID has had on them, and a possible future for each:

Multifamily – Over 45 million Americans filed for unemployment because of the COVID-19 pandemic. Many of those employees also are apartment renters, many of whom have been protected from losing their home by national moratoriums on evictions. At some point soon, those moratoriums will expire and apartment dwellers who have benefitted from the mandatory landlord forbearance will find themselves being evicted. That could result in a glut of apartments, which will also drive down the price of multifamily units as an investment (See what the Motley Fool says about multifamily units). On the other hand, people who have lost their homes through foreclosure due to not being able to make their mortgage payments during the pandemic could become multifamily renters. (These homeowners have also been protected from foreclosure by various pieces of legislation, but they too are also temporary.)

Office – The pandemic has forced employers to allow many employees to work from home (WFH). When that happened, corporate offices emptied out. Employers continued to retain office space, but they have learned that with WFH, there is not as great a need for large amounts of leased office space. The jury is still out on whether employers will bring their employees back to the office and under what circumstances. But according to Fortune magazine, the likelihood is that in-office populations will be significantly decreased. Tenants will be giving space back to landlords either through lease expirations or renegotiations. That will result in a glut of office space, concomitant price and rent reductions, and a major impact on cap rates for these investments.

Industrial – One of the big questions in the industrial sector is what effect will the recent presidential election have on manufacturing? Former President Donald Trump’s focus was having companies invest in or return to manufacturing in the U.S. According to Colliers, that led to growth in the domestic industrial sector. President Biden has indicated a more global approach to markets and this could result in manufacturing moving offshore once again.

One area of the industrial real estate market that is poised for seemingly huge gains is the warehouse segment. Focusing Future says with the WFH phenomenon, the trends toward “cocooning” and consumers becoming more comfortable with home delivery of an ever-increasing variety of products, ecommerce is going to drive the logistical real estate market to greater importance. But companies, particularly retail establishments, are also fulfilling customers’ orders directly from their stores. In the opinion of CBRE, a leading commercial real estate firm, “Industrial has been one of the most resilient real estate sectors amid the COVID-19 crisis, buoyed by ecommerce demand.”

Retail – Brick-and-mortar retail has taken a beating in the age of COVID-19. According to the consumer and market data company Statista, the retail industry has faced substantial shifts because of stay-at-home orders, closings, and other factors. For instance, consumer spending on certain items such as groceries continued to increase. In contrast, spending on apparel, restaurants, jewelry, and out-of-home entertainment has substantially decreased.

But certain segments and retailers, particularly in the discount sectors, such as Burlington, TJX Companies, Ross Dress for Less, Walmart and Dollar stores all thrived. Among them particularly were athleisure wear outlets, as people worked from home and did not need even dressy casual clothing. Furniture sales and home improvement stores such as Home Depot and Lowe’s also made substantial gains as people upgraded their homes, particularly home offices for WFH.

The news organization Marketplace reported e-commerce was up 32% in 2020, as consumers shunned brick-and-mortar stores and did their buying by clicking. But consumers are planning to shop again in person now that vaccines are becoming more widespread.

Restaurants were particularly hard hit in the pandemic. According to Statista, the coronavirus  pandemic severely affected the restaurant industry in the United States in 2020. Due to social distancing measures and overall caution, consumers dined out less. Meanwhile, quick service restaurants were not quite as badly affected. In its Year in Review, Food Business News found off-premises orders from carryout, delivery and drive-thru increased by 22% during the third quarter (July, August and September) compared to a year ago, while on-premises/dine-in declined by 62%. 

Special Purpose – These include amusement parks, bowling alleys, stadiums, parking lots and other properties that do not fit into one of the other CRE categories. Here too the stay-at-home movement gained considerable traction with a decrease in out-of-home entertainment like sports contests, live concerts, theme parks and other public gathering attractions.

Another area significantly affected has been the movie industry. The Federalist reported that AMC theaters lost $4.6 billion in 2020 due to lockdowns.

With an ever-increasing variety of streaming services such as Netflix, Hulu, Disney Plus, Apple TV, among others, movies and other entertainment that people went out for in the past are now being piped directly into the home. As consumers get more and more comfortable with at-home entertainment, there will be fewer and fewer reasons to go out to see movies, with an even greater negative impact on theaters.

Hotels/Hospitality – The American Hotel and Lodging Association (AHLA) reported that as of March 2021, given current and projected travel demands, 71% of hotels will not survive another six months without federal assistance and 77% say they will have to lay off more workers.

Preliminary findings of a study by the Journal of Hospitality Marketing & Management suggest that reopening sit-down restaurants and easing travel restrictions will not immediately bring customers back.

What about investing hotel stocks or building or buying a hotel? In August 2020, the National Real Estate Investor stated: “For well-capitalized investors who can afford to ride out the storm, material discounts to 2019 asset values are available. Historically, investing in the lodging sector during market resets such as the one we’re in at the moment has been a profitable venture.”

Mixed Use – In order to maximize the density and hence the utility of CRE properties, many developers and redevelopers are turning to mixed use where a number of purposes discussed are incorporated. A development may have a retail component, restaurants, hotels, multifamily buildings, offices and special purpose units all in one location to achieve a symbiotic state.

Some struggling malls are trying to reinvent themselves with medical offices, apartments, schools, Amazon fulfillment centers, and other compatible components morphing into a mixed-use redevelopment.

Land – With the lowest mortgage rates in history in 2020, demand for land for residential development skyrocketed. According to Fortune, “The COVID-19 pandemic, the loss of millions of jobs, a weaker economy — none of it stopped millions of house hunters from flocking to Zillow, Redfin, and other online platforms to browse, plan their move, and, in many cases, purchase their first home.” 

But these generally have been existing homes, not new builds. Residential developers have been selling their existing inventory and have taken orders for additional homes. The Associated Press said, “Many builders tapped their own supply of construction-ready land parcels much faster last year than the anticipated in order to meet the strong demand.” 

So single family home lots development appears to be a growth area for the land segment of CRE. As real estate services firm Cushman & Wakefield noted, overall land sales in the U.S. were up 7.4% led by agricultural land transactions because people need to eat even in a pandemic.

As I wrote recently, “May you live in interesting times” sounds like a blessing, but it most frequently has been viewed as a curse. These are interesting times for CRE. We need to face the realities of what the pandemic has wrought.

Famed military strategist Sun Tzu said, “In the midst of chaos, there is opportunity.”

Dr. Mark Gambill is an adjunct faculty member at American Public University. He has his DBA from Nova Southeastern University, a J.D. from Capital University Law School and an MBA from Xavier University. He teaches courses in management, law, ethics and real estate. Dr. Gambill has over 25 years of law practice and real estate development with several major shopping center owner/development companies and two major department store chains.

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