- October 1, 2020: Vol. 7, Number 9

What the pandemic has wrought for real estate: Five property types and their prospects

by Mike Consol and contributing executives

Roughly 8 billion people on planet earth and not a one successfully predicted this most recent economic collapse. All can be forgiven for not having foreseen the blackest of black swan disruptions, a once-in-a-century viral pandemic. It struck almost without warning, and with such speed and ferocity, there was no time for any industry to prepare. Among the economic victims has been the real estate industry, to greater or lesser extent depending on the property type.

The deck has been stacked against some real estate sectors for years. Clearly, the housing sector is charging ahead, unimpeded by the pandemic. But retail has been contending with both swiftly changing consumer tastes and the onslaught of ecommerce, which saw accelerated adoption by consumers during the pandemic.

The office sector’s demise was predicted many years ago, with the advent of the internet and telecommuting, and yet it has continued to hold its own. Now, however, telecommuting has become compulsory for much of the knowledge-based workforce, and employers have realized some new efficiencies and even the prospect of significantly reducing the square footage of their office leases. Add to that grand advances in videoconferencing and the time savings from not having to brave daily traffic congestion, and the virtualization of the workforce keeps looking and sounding more practical.

The hotel sector — which was sailing along with the best fundamentals in the lodging industry’s history, despite strong competition from Airbnb and other sharing-economy lodging options — has been one of the most severely affected, as travel has all but ceased.

Even entertainment venues, such as movie theaters and concert halls, face unprecedented technology challenges from high-fidelity home entertainment systems and streaming-on-
demand services, as well as being forced to sit empty or with limited capacity.

The pending question is this: Has the real estate business been damaged in a way that it will never fully recover from?

The challenges facing the built environment are manifold, and yet there is reason for hope, according to experts in the five major real estate property types.

Brian Lindenberg, vice president, asset management, Black Creek Group
There’s good cause to remain optimistic about the resilience of office real estate. In general, employers experienced relative success with their COVID-19 work-from-home strategies, although a number of trends suggest most employees will return to offices, at least part-time. Office real estate will certainly change, but most employers will continue to see value in office settings that foster collaboration and culture. Here are five reasons I believe office real estate will continue to prove essential:

The sector is built on long-term foundations. Property sectors with shorter-term leases, such as hospitality, and high-traffic enclosed properties such as shopping malls, have felt the brunt of COVID-19. However, the current economic picture for high-quality office properties remains strong, as most companies are expected to fulfill their contractual obligations under long-term leases. As leases expire, expect to see landlords gradually adapting to future space needs.

Workers want the office experience. Research continues to confirm that most employees want to work in an office, at least part of each week. Remotely collaborating with colleagues is more difficult and staying current on projects is harder. This is especially true for jobs that place a premium on company culture, require creative interactions, and provide mentoring and training.

Space requirements should remain unchanged. Offices will likely see reimagined work and common spaces, new ventilation systems, additional sanitization stations and greater integration of technology. Businesses may have fewer employees in the office at any one time, but they will likely need more space per employee due to social-distancing requirements. In the end, space needs for fewer employees may be offset by more space per employee, resulting in total office square footage remaining fairly constant.

The appeal of suburban properties. High-quality suburban properties should become increasingly appealing, given they are closer to where most employees live, would require less reliance on crowded public transportation and generally offer more space for a lower cost than properties located in downtown areas. Larger tenants may respond to the new conditions by moving to a hub-and-spoke model. Based on job function, they could occupy a smaller centralized office and then relocate employees across multiple smaller satellite offices.

The cost calculations. Lower cost-of-living and lower-tax cities with significant concentrations of educated and creative workers, such as Atlanta, Charlotte, Denver and many Florida and Texas metropolitan regions, will likely draw many businesses away from high-cost, high-tax cities such as Chicago, New York and San Francisco. Investors owning multi-tenant office buildings that provide flexible configurations in desirable, lower cost-of-living cities or desirable suburban markets should benefit.

Regardless of when or how we emerge from this pandemic, businesses are likely to need a balance of work environments. Ultimately, that need will be met by high-quality office properties that offer a variety of experiences to support convenience, functionality and well-being.

Warren Thomas, managing partner, ExchangeRight
Retail sales were at historic highs when the COVID-19 pandemic hit the United States. Based on CoStar’s national database, the average net operating income for general retail had steadily increased following the global financial crisis, quarter after quarter, until reaching 30 percent higher than the prior peak. Then, as a result of the COVID-19 crisis, retail sales declined sharply for the first time since 2008. But focusing on retail in general provides an incomplete picture, since different sub-classes of retail have performed quite differently during the pandemic. Though discretionary retail was affected negatively by the shutdown orders that resulted from COVID-19, there were other types of retail that performed exceptionally well during this same period. For example, necessity-based net-leased retail has been resilient throughout the pandemic and has seen record demand and growth during — and even as a result of — this period of turmoil.

Many retailers operating in industries designated “essential,” including grocery, pharmacy, dollar stores, etc., have actually performed better throughout the pandemic than they did beforehand. Retailers with investment-grade credit ratings, including Kroger, CVS and Dollar General, have experienced record-breaking demand for their goods and services as they were among the only types of businesses that were allowed to remain open in the midst of shelter-in-place and shutdown orders. These companies and others have expanded inventory and accelerated their distribution to meet this increase in demand, as evidenced by material increases in same-store sales and operating incomes.

By contrast, government-mandated shutdowns across the country have had an outsized impact on discretionary retail and other non-essential industries. Real estate investors with exposure to tenants operating businesses such as theaters, gyms and restaurants have had difficulty collecting rent. Realty Income Trust, for example, the world’s largest net-leased public REIT, experienced firsthand the divide in performance between its essential and non-essential retail tenants. When COVID hit, Realty Income’s collection rate across its total portfolio fell to 88.4 percent in April and 84.9 percent in May. It partially recovered in July, achieving collections of 91.5 percent.

Among the top 10 tenants of Realty Income are fitness centers and movie theaters. Collections for these non-essential businesses went from nearly 100 percent in March to 0 percent in April, and have recovered to around 40 percent to 55 percent during the past few months. In contrast, Realty Income received 100 percent of its rents from investment-grade credit tenants operating essential businesses such as grocery stores, pharmacies and retail healthcare businesses.

No one knows how the COVID-19 crisis will continue to unfold, or how various state and local governments will respond. Should there be a “second wave” of COVID-19 this fall, additional shutdown mandates could wreak havoc on an already fragile economy and the discretionary tenants that depend on a robust and open economy. For investors who require stable income, it will be important to seek out real estate that is leased to investment-grade credit tenants operating essential businesses that are likely to remain open regardless of whether there will be a second wave and additional potential economic fallout.

Scott Sealy, Sr., chairman, Sealy & Company
The industrial real estate sector has a unique set of qualities that has historically and consistently positioned its assets favorably in the wake of economic downturn. Benefiting from limited obsolescence and limited capital exposure from tenancy and re-occupancy, industrial assets fare well in various economic climates. Regardless of their age, industrial warehouses and distribution centers offer the same utility value. Unlike commercial office or retail investments that are costly, time-consuming to build, and greatly affected by rapid technological upgrades, industrial warehouses continue to stand the test of time throughout the years.

Industrial assets with broad and valuable utility, low risk, high return, and constant appeal have attracted investors for decades, and even more so in recent years as ecommerce continues to propel warehouse necessity. This ecommerce trend has greatly changed the sleepy warehouse of yesterday to a vibrant distribution network of goods. In decades past, distribution centers of 250,000 square feet were considered large and, gradually, distribution warehouses have become larger and more specialized to encompass today’s typical 1 million square-foot asset. In the future, additional expansion in size may be realized in even larger inventory still.

As the COVID-19 experience has changed consumer habits and accelerated ecommerce by roughly five years, industrial assets — specifically infill distribution centers — will remain paramount in real estate. Barring the continued trend toward delivery services and expedited shipping, companies will likely continue to adopt multisource supply-chain strategies while retailers rethink just-in-time inventory levels to accommodate the changing consumer shift. Due to the economic atmosphere in place resulting from COVID-19 consequences, there will also likely be significant trends for onshoring within larger facilities, as we can anticipate manufacturing migrating from distant facilities in China to more closely-linked ones in the United States, Mexico and Canada.

Josh Hoffman, managing director, Bluerock
During the 10 years prior to the current coronavirus-led economic downturn, the U.S. multifamily sector exhibited very healthy fundamentals with 51 percent cumulative effective rent growth and near-record-low vacancy rates dropping below 4 percent in 2019.

While real estate has been tested by the 2020 recession and ongoing pandemic, the multifamily sector has remained relatively resilient despite the spike in unemployment. Due in part to timely and effective government stimulus with enhanced unemployment benefits and the essential nature of needing a place to live, the vacancy rate has held mostly steady, increasing less than 1 percent to roughly 4.7 percent nationally during the second quarter. Effective rents have halted their decade-long ascent but have declined less than 1 percent while lease renewals are near all-time highs. Rent collections have exceeded expectations, tracking within 1 percent of prior-year collections as of July (95.7 percent), according to the National Multifamily Housing Council. To most prognosticators, these collective performance results are much better than could have been expected.

Perhaps multifamily’s performance should not be all that surprising. For context, during the global financial crisis (2008–2009) the multifamily sector handily outperformed the other major real estate sectors exhibiting the smallest decline in rents (–7.9 percent) over the shortest period of time, and subsequently experienced the largest cumulative rent growth through the end of the prior economic expansion.

While the sector’s performance and appeal has been remarkably durable thus far in 2020, there are remaining headwinds to navigate. Most notably, the reduction or elimination of enhanced government unemployment support could put significant financial stress on many renters who are unable to re-enter the labor market, making it difficult to pay monthly rent. Additionally, the continuance of eviction moratoriums may reveal higher vacancy rates once lifted and potentially result in growing bad-debt collections that may need to be entirely written off by landlords.

The pricing impact on multifamily is still in flux. While reported transactions indicate a slight upward pricing trend for the sector — driven, in part, by the significant build-up of dry powder sitting on the sidelines anxious to invest — transaction volume is down as much as 60 percent to 70 percent year-over-year. Lower transaction volume hampers price discovery; thus, it remains to be seen if buyers in a post-COVID-19 world will succeed in their quest for price discounts or whether sellers will be the victor.

Today, owners and operators are focused on the health and safety of residents with enhanced sanitizing protocols and restrictions to high-traffic common areas, revenue preservation and retaining tenants by offering short- and long-term lease extensions, and conducting a significant portion of leasing by using virtual means and other social-distancing tools.

To a large extent, multifamily has strong fundamental drivers that are unlikely to recede. The long-term demographic drivers and social trends including more than 67 million people in the prime renter age group, a widening gap between the cost of owning and renting, and a growing renter-by-choice cohort, are expected to lead to improvement beginning in 2021 and continuing steadily thereafter.

Rob Woomer, president of equity capital markets, Peachtree Hotel Group
Performance of the hospitality market is generally consistent with the broader economic climate. With 10 straight years of economic expansion since the lows of the global financial crisis, hotels were operating at all-time-high occupancies and daily room rates through 2019. However, even before the government-
mandated pandemic lockdowns, the hotel sector was facing some headwinds. Hotel occupancy across the globe had started to slow in January because room supply was outstripping demand in many markets.

The government shutdown of certain economic activities, in an attempt to lessen the spread of COVID-19, had an immediate impact on the hotel industry. Seemingly overnight, revenue per available room, a key measure of hotel performance, fell by 60 percent to 100 percent, depending on the hotel segment and submarket. Full-service hotels that are often dependent on group business such as conferences, meetings and other events, were hardest hit by the bans on social and business gatherings, with many of them closing their doors entirely.

The hospitality sector never experienced anything like it. While previous recessions dampened revenue per available room by an average of “only” 20 percent to 30 percent, the impact from COVID-19 is still being felt by all stakeholders — lenders, investors, owners, operators, employees, the sector’s supply chain, as well as adjacent sectors, such as the events and transportation businesses. Hotel owners had to quickly adapt by reducing staff; limiting food and beverage options; shutting down amenities such as fitness rooms and spas; and creating contactless and touchless customer experiences, in addition to other health and safety measures.

The CARES Act passed by the U.S. Congress on March 27, 2020 promised timely relief for the hotel sector. Understanding terms, assessing eligibility and applying for the Act’s SBA Paycheck Protection Program and market loans temporarily required industry participants’ full attention. This legislation allowed some much-needed government intervention to breathe life back into the industry, along with most lenders’ willingness to grant some form of forbearance to hotel owners.

Looking ahead, we expect the hotel sector to return to pre-pandemic levels as the lockdowns disappear and the economy recovers. Limited-
service and select-service hotels that seek “heads in beds” from the transient business traveler will recover at a pace in step with the broader economy. Better demand and lower operating costs suggest that limited-service and select-service hotels should recover profitability faster, consistent with previous cycles, while full-service hotels, which depend on a high-touch customer service model and large groups, will take longer to recover.

The return of the corporate transient traveler — think sales, consulting, etc. — a large driver for the midscale and upscale hotel segments, is dependent on companies turning off their travel restrictions, which should come in phases. Larger companies are developing
decision-making processes and more-agile travel policies to account for safety before authorizing travel. This return to normalcy is difficult to accurately anticipate because the industry is seeing extremely short planning cycles driven by gradual lifting of travel restrictions, as well as very short booking windows as travelers monitor the situation. In the meantime, disciplined containment of further spread, the continued expansion of viral and antibody testing, the rollout of efficient contact tracing and, ideally, the development of effective treatment will have reassuring effects on travelers.

Mike Consol ( is editor of Real Assets Adviser. Follow him on Twitter @mikeconsol to read his latest postings.


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