Pandemic Accelerates, Rather Than Starts, CRE Trends
Paul Fiorilla of Yardi Matrix on key takeaways from the Urban Land Institute's virtual conference.
COVID-19 is changing the way Americans live and work, but industry experts say that in many ways the effect has been to accelerate existing trends rather than start new ones.
Among the trends the pandemic has impacted include the use of offices, movement to suburbs and secondary markets, the digitalization of the economy and media, affordable housing and the government’s support for solutions. Most of these and other secular lifestyle and work trends have been evolving for years, if not decades, but the pandemic has hastened their development.
“This year’s trends are (an) acceleration of trends we’ve been talking about (for years),” said Andrew Warren, director of real estate research for PwC Management Services, during a panel at last week’s virtual Urban Land Institute conference. “There are some new elements, but it’s kind of that boost that these trends needed going forward and they now are getting.”
How these developments play out is of enormous significance for commercial real estate. At stake is the amount and location of demand for all property types and investors’ returns. Early on, the signs are that some commercial real estate segments will come out ahead while others have a more uncertain future.
Lifestyle, Work Trends Evolve
Warren, who spoke at a panel to introduce the annual Emerging Trends in Real Estate report, listed three trends that have been exacerbated by COVID-19:
- The live/work/play concept. Working from home has become more acceptable in recent years, but corporations were reluctant to allow employees too much flexibility … until the pandemic. Now companies know that employees can work effectively and be productive remotely. How much employees work from home will determine population and office-using trends.
People aren’t just living and working from home, though, as shopping and entertainment are on the rise as well. Online shopping has grown exponentially, putting many retail centers in jeopardy and increasing the demand for industrial and warehouse space. Streaming media has grown at the expense of real estate-centric venues such as movie and concert theaters. How permanent these changes are is up for debate, but the landscape is likely permanently altered.
- The urban/suburban divide. High-cost gateway cities—particularly New York City, San Francisco and Chicago—have lost occupants during the pandemic, as people have lost jobs and amenities such as theaters and restaurants are unavailable. There has been a decades-long population relocation toward more affordable Sunbelt and western metros such as Charlotte, Austin, Denver, Nashville and Dallas, but the pace of that shift was hastened by the pandemic.
A more subtle shift involves households with children moving to suburbs to find more space. The real estate industry has been talking for years about the demographic implications of Millennials reaching their late 30s and 40s and starting families. The shift of that cohort from cities to suburbs has been slow, but possibly the pandemic has kicked it into high gear.
- The evolution of cities. Urban centers traditionally have been the hubs of finance, entertainment and commerce. In recent years, however, secondary and tertiary metros have begun to compete for—and attract—technology companies and other types of businesses by emphasizing affordability and developing livable amenities.
Inner-ring suburbs also have grown, abetted by the desire of people to work and live in places with city-like features, but also closer to suburbs with quality schools, shorter commutes, and access to transportation. How cities and suburbs within a market continue to develop and navigate this divide will go a long way to determine which metros succeed over time.
Those aren’t the only trends accelerated or changed by the pandemic. Others include the demand for affordable housing, level of government support in the economy and social justice issues. The pandemic has exposed the high number of people living on the edge, as jobs losses have been concentrated in low-wage industries such as leisure and hospitality and retail. The U.S. economy remains down by 11 million jobs from before the pandemic.
Affordable housing has been talked about for many years but very few resources have been allocated to solve the problem. While the details depend on the outcome of the national election in November, there seems to be increased willingness to spend money on housing, either through aid to renters or government assistance or tax breaks for housing development. Government support would be welcomed by the multifamily industry, which for years has been lobbying for solutions to increase affordable housing stock.
Capital Forces Support CRE
The pandemic is also accelerating some technical factors that are working to the industry’s favor. The long decades-long slide toward lower interest rates—and the Federal Reserve’s determination to keep rates low for an extended period into the future—have left institutions scouring for yield. That helps commercial real estate to draw investors looking for dividend returns above the typical investment grade bond yield.
The industry is seeing “an influx of capital from institutions,” said Chris Lee, partner and head of Americas real estate for KKR, said during a panel at the ULI conference. Lee noted that there is $400 billion of dry powder on the sidelines looking to acquire assets, which has helped demand stay high and keep acquisition yields from rising, even in an economic downturn.
Low interest rates have kept debt costs low, which is another technical factor inuring to the benefit of property values. Commercial mortgage coupons are as low as the mid-2 percent range for stable assets, and most properties can get debt in the 3 percent range. The 10-year Treasury rate has hovered in the 0.70 percent range since the spring. Speaking at another ULI panel, With the 10-year Treasury rate likely to stay below 1.5 percent for an extended period, a 3 percent capitalization rate on institutional-quality real estate “is not outrageous,” said Susan Mulvee, senior vice president of research and strategy at GID, during another ULI panel.
How commercial property is impacted by the changes brought about by COVID-19 ultimately depends on factors such as property type and location. Multifamily and industrial assets have favorable long-term demand drivers that make them attractive to sponsors, while the retail and hospitality sectors have red flags over the short- and long-term. In terms of geography, some investors prefer higher long-term growth prospects of faster-growing metros, while core metros with high liquidity will remain popular with others. Whatever happens, the industry will continue to evolve to adjust to reality on the ground.