The Outlook on Commercial Real Estate Post-COVID-19

July 9, 2021  |  By James Fleet  |  4 Minute Read

It’s been more than a year since the start of the COVID-19 pandemic in the U.S., and the economy is now beginning to rebound even in industries that were hit the hardest. The mass distribution of vaccines is boosting optimism and encouraging Americans to return to their normal shopping, traveling, dining, and working behaviors.

As we explore the effects of COVID-19 on various industries, let’s dive deeper into the pandemic’s impact on commercial real estate. Surprisingly, while commercial real estate faced projections that forecasted it to experience a devastating blow, it appears to be faring far better than expected.

Why Commercial Real Estate is Performing Better Than Anticipated

Even with many office buildings remaining unoccupied and malls struggling to attract shoppers, commercial real estate is on the rise and the market is stable—and resilient. According to the Wall Street Journal, this is due to the federal government’s efforts to support the economy and keep landlords from suffering losses. Banks have also offered delinquent property owners help, rather than aggressively acting on foreclosures. Pension funds and private-equity firms are once again spending record sums on buildings.

Prices also didn’t fall as much as they did in the 2008 financial crisis, and they are already rising again (see chart). Between March and May 2020, commercial real estate prices fell 11%, according to commercial real estate analytics firm Green Street. But prices since July 2020 have increased 7%, erasing more than half their pandemic declines. That turnaround is in sharp contrast to the 2008 financial crisis, when commercial real estate prices in the U.S. fell 37% and took years to recover.

Although the trends are positive, cautious optimism is needed. The prices of malls and hotels are down significantly. Loan defaults and foreclosures are expected to increase as forbearance periods end in 2021. And overall property returns would be worse without booming warehouses today, which are up 25% over the past year.

A Look at Current Lending Data

As residential real estate cools off, commercial real estate is heating up. Funds such as the $42 billion Vanguard Real Estate ETF and the $6 billion iShares U.S. Real Estate ETF have been steadily climbing since early May 2021, and are acquiring assets as they rise, while housing exchange-traded funds have struggled to find new highs.

Investors have embraced this opportunity. Vanguard has acquired more than $3.5 billion in fresh net assets in 2021, while iShares, which was losing assets this year, saw its assets under management (AUM) jump more than 30% in early June 2021, following $1 billion in inflows.

Let’s explore some specifics areas in commercial real estate for the rest of 2021 into 2022.

• Offices: Organizations are Downsizing or Moving to Hybrid Offices
  
  Many employees are now returning to the office after over a year at home. While the pandemic showed that some employees are able to successfully work 100% remotely, others remain unproductive at home, or they may prefer to work on-site part-time. With so many factors to consider, workplaces are now implementing varying forms of a hybrid office/remote model, which will look different at each organization.
  
  As a result, many companies may downsize to smaller offices to fit their working models better and to reduce overhead costs, leading to improved profitability. According to a recent survey by the American Institute of CPAs, more than 20% of company executives expect to reduce their office space in the coming year.

• Retail: Small Businesses Doing Well, While Class B and C Are Not
  
  Retailers were largely shut down when the pandemic began, but have since reopened. Small, local businesses like nail salons and specialty shops are seeing a return of their customers. Class B and C malls were already declining prior to the pandemic, and are not faring well.
  
  According to PwC, the next few years are likely to be retail’s great transition period, as the demand for larger retailers and department stores declines in favor of discount stores, fast fashion, and online retail. More than 80% of participants in the PwC study agreed that COVID-19 accelerated the shift in retail that likely would have occurred over the next few years regardless of the pandemic.
  
  Department stores are likely to experience the worst effects. Since peaking in 2000, department store sales have declined an estimated 40%. COVID-19 accelerated this, and many storefronts remain empty. These sales declines were slightly offset by increased eCommerce sales, but still affect real estate. Merging physical storefronts and digital retail was already underway pre-COVID, but the acceleration to digital means retailers that lacked a mature digital strategy faced especially negative ramifications.

• Fulfillment: More Warehouse Space Will Be Needed
  
  As e-commerce spending and demand for fast shipping grow, so too does the need for warehouse space.  According to CBRE, a record 104 million square feet of industrial space were added in the fourth quarter of 2020, bringing the total to 223.5 million for the year. The total leasing for the year was 11.8% higher than it was in 2019—and these numbers are expected to keep growing.
  
  Retail stores and third-party logistics businesses are not only growing their fulfillment center footprints, but many are also switching from a just-in-time inventory model to a just-in-case approach to prevent shortages. As this trend continues, many online stores will need to lease warehouse space for their growing businesses. This will spur an increase in leasing opportunities in the commercial real estate market that investors can take advantage of.

Actions Investors Can Take Now

As the economy picks up and performs better than expected, there are a few commercial real estate opportunities for specific property types. Investors might want to consider:

• Portfolio expansion. It may be a good time to buy apartment buildings, especially with today’s competitive housing market. Class A retail spaces may also be worth the investment.
• Build to suit projects. It’s unclear what the workplace of the future will look like, but some companies do have a clear idea of their post-pandemic offices, so developers behind BTS projects can make their vision a reality.
• Property refinancing. The rest of 2021 is an ideal time to refinance. Real estate investors can take advantage of the current climate and lock in historically low interest rates.

Clear Opportunities Ahead

With low interest rates, unemployment rates dropping, vaccination numbers rising, and possible infrastructure investments, there are clear opportunities ahead for commercial real estate investors. Turning to an operationally-focused advisory firm like Phoenix Management can help organizations navigate real estate complexities post-COVID-19. Contact Phoenix for more information.