The pace of reopening and its effect on real estate markets
- November 1, 2020: Vol. 7, Number 10

The pace of reopening and its effect on real estate markets

by Russ Devlin

After peaking in late February, U.S. REITs entered a sharp downturn in the second quarter of 2020 as the full impact of the COVID-19 outbreak began to be felt across the economy. As measured by the FTSE NAREIT Equity REITs index, U.S. REITs fell more than 44 percent on a total return basis over the next month.

People usually fill offices, hotels and retail stores, and suddenly those people were not there: foot traffic in malls was essentially zero in April. Since mid-March, office buildings have been essentially empty (particularly in high-rise central business districts); conference activity was largely halted; and both business and personal travel largely vanished. According to Smith Travel, industrywide revenue per available hotel room was down 80 percent in April — and by more than 90 percent for top-tier luxury hotels. For these sectors, it was the most abrupt end to an expansion in history.

People need a place to live, so COVID-19’s impact on residential properties was less abrupt but acutely felt in certain segments of the multifamily market, both on the downside and upside. Upscale urban apartments suffered as many tenants realized the amenities and workplaces they were paying prime rents to live next to were closed. Not having a car and relying on transit became a drawback. Luxury urban high-rise complexes in New York, Boston, Los Angeles and San Francisco saw a spike in vacancies and rent declines in the high single digits or more. Conversely, many suburban apartment markets saw stable or even increased rents. Meanwhile, the single-family rental REITs that sprouted after the previous downturn saw demand surge as urban refugees flooded into the suburbs. Rents in this sector are up substantially over year-ago levels.

Properties filled with data and goods have performed best since the pandemic began. Through September, four NAREIT subsectors had produced positive returns year-to-date — industrial, data centers, self-storage and cell tower-dominated infrastructure. Industrial demand from ecommerce sales was robust, as goods still need to be stored and shipped to consumers, even if they bypass stores. Further, an ecommerce sale requires three times as much warehouse space as a traditional retail supply chain. Self-storage demand surged as consumers put goods away while they adapted to changing living arrangements. Data centers were growing quickly before the outbreak, but network traffic still accelerated this spring as traditional office workers came to rely on collaboration platforms such as Zoom and Microsoft Teams. And, even with people sheltering in place, they are still on their cell phones.

Geographic differences were stark, too. The hardest hit markets were central business districts in dense coastal cities in the Northeast and Pacific Coast regions, the places that bore the brunt of the epidemic in March and April. On the other hand, less dense markets in the South and Midwest never shut down to the same degree and more aggressive timetables for reopening gave them an early start in the recovery. For example, mall foot traffic surged in southern states when restrictions were lifted in May, while Northeastern states opened more cautiously and were a month or two behind. These disparities narrowed as the easy gains from reopening were made, and progress has been much slower in recent months. Data from suggests that most malls were still seeing foot traffic 20 percent to 30 percent below year-ago levels entering October.


First and foremost, the state of the pandemic is the most important factor in the recovery, especially for the people-focused sectors. At this point, most offices, stores and hotels are open — however, a substantial cohort of the population is simply not visiting them. A safe and widely distributed vaccine or other reason to believe the pandemic is fading would do more to stimulate a full demand recovery and a rebound in rents than anything policymakers do. It is difficult to imagine a complete recovery without it.

When the pandemic subsides, some changes will be durable. More than half of all millennials are now over 30, and many married and with a child or two. When they moved to the suburbs, they likely moved there to stay; all the pandemic did was accelerate their timetable. Urban multifamily markets will inevitably recover as cities lure new and likely younger residents, but it will take time before the tenants who replace those who left are willing to pay the same rents that landlords were accustomed to receiving.

The largely successful work-from-home experiment will also leave permanent marks. Most office workers will be back in the office eventually, but employees’ ability to be productive at home has undermined the argument that they need to be in the office five days a week. As leases roll and companies assess space needs, that could take a slice out of office demand, although it may be partly offset by social distancing requirements that have reversed the office space densification trend of the past 20 years. Some business travel may also prove unnecessary if routine meetings can be done virtually. Similarly, ecommerce has made further inroads into consumer spending that it won’t completely forfeit as normal life resumes, which is good for the industrial sector and a negative for brick and mortar retail.

These changes will likely slow the recovery in harder-hit sectors but will not stop it. Office employment levels, population growth and retail sales will continue to rise, and this will translate to an eventual recovery even if the landscape looks very different than before the pandemic. At the same time, the sectors that have proven resilient during the pandemic are still growing and represent an increasing share of the overall REIT universe. U.S. REIT valuations remain more attractive today than normal versus other asset classes, whether they be private real estate, bonds of similar credit quality or stocks. They are likely to look even more attractive as incomes work their way back to pre-COVID levels. Given this backdrop, REITs are at an interesting entry point for medium- to long-term investors.


Russ Devlin is a director of research at AEW Capital Management.

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