Cautious Optimism Is the Best Path Forward for Investors

While transaction activity is rebounding, COVID-19 variants loom, warns Jonathan Hipp of Avison Young.

Jonathan Hipp

We live in a strange time. While on one hand, the commercial real estate market seems to be in a state of healthy revival, the nation and the world are tracking the direction of COVID-19 variants, and an understandable caution still overhangs the industry.

Here’s the good news: “This recession was not caused by the familiar sins of corporate, consumer or financial recklessness, and thus household savings rates and financial sector balance sheets were in reasonable shape when the economic shock hit. “

So says J.P. Morgan Asset Management in the 2021 edition of its “Long Term Capital Markets Assumptions.” Given the nature and cause of the recent downturn, and of course barring a COVID 2.0 at the hands of the Delta variant, we find ourselves halfway through 2021 in fairly robust shape, especially in terms of the capital markets outlook. 

Drilling down specifically to commercial real estate, Morgan states: “(R)eturns have held up remarkably well. Our forecasts for core real estate rise by 10 bps in the U.S. and in Asia-Pacific, to 5.90 percent and 6.60 percent, respectively, while Europe ex-UK core real estate is unchanged at 5.00 percent, and UK core real estate rises from 5.50 percent to 5.90 percent.”

Closer to home, it appears that, despite the unprecedented nature of the past 18 months, the capital markets performed pretty much as they always do in recessionary periods. While some investors held back in the face of growing risk, others shifted their bets and flew to less risk-laden property types. Prime among these were the industrial, multifamily and medical office markets, all of which were buoyed either by ongoing need or shifts in consumer habits (i.e.: more online shopping).

This last dynamic also impacted the net lease market as we witnessed certain sectors feeling the pinch (such as restaurant formats that couldn’t adjust to curbside pickup or delivery service) and others that flourished, or at least held their own (pharmacies are an obvious example as are internet-proof retailers).

Commercial Property Executive reports Q1 investment volume was at $92.4 billion overall. While this was down by more than 25 percent over Q1 of last year (prior to the spread of the virus), “it was nonetheless on par with the average first-quarter volume from 2011 to 2020.”

But it is clear that the second half of the year bolstered any post-pandemic drag. According to Real Capital Analytics, the six major food groups saw the following increases in investment volumes:

  • Office                         $47.5B             (up 6% YoY)
  • Retail                          $22.8B             (up 22%)
  • Industrial                    $51.9B             (up 10%)
  • Hotel                          $20.4B             (up 253%)
  • Apartment                  $92.1B             (up 64%)
  • Seniors Housing/Care $6.8B             (up 36%)

As for the rest of the medical office sector, CIRE Equity cites demand that clearly exceeds supply, and a continued push toward off-campus leasing where hospital systems can access more of the public, especially seniors.

No matter the sector, the overall caution that pervaded the market last year has lifted, at least so far. The result is an overabundance of capital looking for deals. We expect a feeding frenzy to relieve that buildup, especially as we approach the year-end rush to get deals on the books.

But note that we said the caution has lifted “so far.” Depending on the path of Delta and other looming strains, we might be in the eye of a storm or we might be facing blue skies for the foreseeable future. No matter which direction the economy takes, reliance on the sectors that have proven themselves through the recent upheaval will serve investors well.

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