The full impact of the coronavirus outbreak on commercial real estate markets is just beginning to take shape. What do investors need to consider going forward?
In March, the Federal Reserve cut its key interest rate to near 0%, creating a potential opportunity for commercial real estate buyers. At the same time, stay-at-home orders to battle the pandemic have had a devastating impact on retail businesses, hotels, restaurants, offices, and more.
“The owners, the tenants, the lenders—everybody right now has their nose to the grindstone to try to get over this near-term shock to real estate cash flow,” says Craig A. Zuelke, Real Estate Advisory Specialist with Wells Fargo Private Bank.
Zuelke and fellow real estate advisory specialist Scott Bennett say that the pandemic’s impact on consumer and business behavior could reshape commercial real estate in the long run. But the news isn’t all dire. “For investors who have cash and are willing to take risks, there could be opportunities in the next few months,” Zuelke says.
Adds Bennett: “We’ve gotten through downturns in the past; I believe we’ll get through this one.”
With that in mind, what should commercial real estate investors know about today’s market—and how can they prepare for possible future opportunities? Here, Zuelke and Bennett share their perspective on four major property classes: apartments, industrial, office, and retail.
Apartments could present opportunities
“In our view, while rent delinquencies will undoubtedly rise in the short term due to job losses, multifamily properties will likely remain strong performers over the long-term,” Bennett says.
“On a long-term basis, apartments have typically outperformed the other three commercial real estate asset classes,” he says. Everyone needs a place to live, and apartment properties usually have many tenants, reducing the overall impact if some miss rent payments.
New legislation related to the coronavirus pandemic protects tenants from eviction while also helping landlords who have mortgages backed by the federal government.
Although the outlook looks strong, Zuelke and Bennett caution that people’s desire to live in high-density residences could diminish as a consequence of the pandemic because those areas have been hit hard in the initial weeks of the outbreak.
Certain industrial properties could remain a good investment
Bennett says, in the near term, the pandemic is likely to have a negative impact on industrial properties with tenants that are not deemed essential, such as certain local and regional businesses.
However, the pandemic is likely to accelerate the growth of e-commerce, Bennett says, making certain tenants valuable assets. That includes distribution and logistics centers responsible for keeping the supply chains of food, medical materials, and other essential products flowing.
“Owners of industrial properties whose tenants are tied to the food, medical, and online retail chains have found that those are very strong properties to own,” he says.
In the longer term, shifts in supply chains could boost the value of industrial properties.
“For example, retailers could require more supply on hand given shortages we’ve seen at the grocery stores,” Bennett says. “The other supply chain impact could be that U.S. companies reconsider where they’re doing business. It could be that some U.S. companies will look globally outside of China, or even within the U.S.”
Retail properties are a ‘mixed bag’
Many businesses in the retail sector have suffered greatly during this crisis. The effects of forced closures of nonessential stores, bars, restaurants, and other service businesses, like salons and barbershops, are going to be felt for some time, Zuelke and Bennett say. Landlords may also face further attrition in the big box retail space, as well as with the smaller businesses that typically occupy neighborhood centers and strip malls.
Many smaller shops can’t pay their rent while they are shut down; however, essential businesses, such as grocery stores and pharmacies, remain open and have even seen a meaningful uptick in activity. Aside from the importance of tenant mix, property owners with reasonable debt and who are working closely with their lenders may come through in better shape, Zuelke and Bennett say.
“It’s a pretty mixed bag,” Zuelke says.
Office properties could see some downsizing
The long-term impacts of the pandemic on office buildings are unpredictable. While some companies will eagerly want employees to return to their offices, others may see an opportunity to reduce (or even eliminate) the office space they rent if the pandemic showed them that employees can work from home effectively. Regardless, some companies may decide to downsize by cutting branch locations or services, and staff.
As a result, it’s possible that a greater percentage of office buildings may serve different purposes than dedicated offices and cubicles in the future. This could include more dedicated space for team collaboration, client meetings and experiences, and office hoteling, where employees reserve a space on an as-needed basis.
“Everybody is now figuring out this whole thing about being productive working at home,” Zuelke says. The trend for less square footage per employee will likely continue, and offices will need to deliver up-to-date technology in a comfortable and flexible environment for them to remain attractive.
There are special risks associated with an investment in real estate, including possible illiquidity of properties, credit risk, interest rate fluctuations, and the impact of varied economic conditions.
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