Potential outcomes and opportunities for commercial real estate assets following a pandemic
In the coming months, we will be entering into a global recession, unemployment will rise, liquidity will decrease and insolvency will be the ultimate looming presence. In the short-term it will be brutal for many as uncertainty and change surrounds us, but in the medium term, it will be okay. The world will go on, the business cycle will slowly rebound, and we will look back on this moment as a learning opportunity.
Below, I briefly outline where I see this going for the various commercial asset types as they all will be affected uniquely and respond differently in the coming months. As always, I encourage and welcome feedback.
Capital Markets
The Capital Markets sector will experience a pull back in the near-term (one to two quarters) as businesses try to cope with and understand the uncertainty of the coming months, conducting more extensive due diligence and implementing longer time frames. On the sale side, many vendors will likely hold off on bringing investments to market until there is more clarity and appetite. However, in the longer-term as the year fills out, the demand in capital markets will grow as real estate historically has been viewed as a good investment vehicle and a more stable option than the volatility of the stock markets.
Hospitality and brick-and-mortar retail assets will be affected the most due to the shutdown of many businesses where higher density is typical, including hotels, tourism and food & beverage facilities. Logistics, data centres and multi-family assets will continue to be the golden children as they represent and contribute to essential services in the time of social distancing and at home quarantine.
Hospitality
With federally mandated border closures, travel restrictions, event cancellations and human density guidelines in full force around the world, it is little wonder that the hospitality sector has and will be one of the hardest hit at all levels. The RevPAR (Revenue per Available Room) is expected to experience drastic declines to the tune of -40% to -60% over the next two quarters. This immediate downward trend will also be replicated in airlines, stadiums, festival providers, and in major tourism destinations around the world. Long-term, there is the potential that this market will rebound with a flourish as pent-up demand for travel takes hold following resolution of this health emergency. There will likely be minimal long-term structural changes to this asset class, beyond what’s already occurring with consumer shifts to alternatives such as Airbnb.
Industrial
Supply Chain & Logistics
Initially, there will be a “wait-and-see” mentality by occupiers on new lease deals as the pandemic plays out. However, the industrial asset class is the epicenter of e-commerce and therefore has the potential to perform very well through this crisis. This asset class was already proving to be a favourite over the past 5 - 10 years for the same reasons, but this pandemic is accelerating the buying patterns of individuals and businesses towards online. This shift to online shopping for perishable and non-perishable goods could be a permanent fixture in consumer day-to-day life going forward. The supply chains will become more high functioning due to higher inventory demands, which will ultimately increase the demand for industrial real estate. Furthermore, cold storage and last mile warehouses will continue to see strength through this pandemic as more demands are placed upon them and online grocery shopping spikes.
Manufacturing
Short-term, we are already witnessing product shortages caused by manufacturing disruption in China. However the good news is that economic activity is already starting to improve in Asia, which will assist on the supply side of essential goods. Many North American manufacturers will pivot throughout this pandemic to produce goods that are in low supply and high demand, such as protective masks and sanitizer. This will also support the transition to more low-cost, “made-from-home” alternatives in the supply chain to lessen future blows from global crises. For those that are not able to adapt to this “white swan” event in our economy, it will likely be a strenuous year with both liquidity and solvency being prime issues. Small and medium size manufacturers will suffer the most as work dries up for the foreseeable months. In Alberta, manufacturers are experiencing a pile-on as this pandemic is combined with an overseas oil war, bottoming out prices in a market where most businesses are one degree of separation from the oil sands.
Multi-Family
The multi-family asset class is one that is extremely important right now as more and more individuals are confined to their homes through social distancing. This asset class is differentiated from the rest in lease term as most tenants sign short-term leases (generally one year). The multi-family market provides an essential service, however in the short term as a growing number of individuals are out of work, there will be some pain as tenant’s request rent reductions and rent deferrals. Larger Landlords will be able to weather this storm through larger portfolios, however smaller landlords with local holdings will struggle if their tenants go dark and they are unable to defer their expenses. Longer term, renting may become a more desirable option for individuals and families as household debt creeps up and equity needs to be drawn from residential holdings.
Office
The current office lease structure will ensure most assets in this class will be fine short-term, unless there is an imminent expiry or renewal. Over the past 5 or so years, the office model began shifting towards a higher space utilization and densification model. With the work from home conditions that are being encouraged, if not mandated, large and small corporations are accelerating the potential permanency of this model for some workers on a go-forward basis. As employees and employers work through the pinch points of de-centralized working, when we come out on the back side of this health emergency, we may be in an environment where more employees have this option, which in turn would further reduce the demand for large office floorplates.
Retail
Small & Medium (Brick & Mortar)
Undoubtedly, small and medium sized retail businesses will suffer the most in this epidemic. Many of these businesses (restaurants, gyms, bars) have been required to shut-down by their respective governments, and so overnight, their revenues went from healthy to non-existing. What this means for the retail market is that strip centres and enclosed malls will face a growing number of closures as most small businesses have less than 30 days cash on hand to weather this storm. Many local consumers are doing their best to continue to support their favourite shops, but if this economic shutdown lasts as long as predicted, that will not be enough. In order to avoid the extinction of many small businesses across our country, and to ensure there are jobs to come back to, it is imperative for the federal government to implement fiscal and monetary policy as the lender of last resort. There must be aggressive assistance for the small businesses that makeup 41.7% of our GDP and whom are by far the largest private sector employer (73.5%) in the country (The Globe and Mail).
Large (Multinational)
Retail is a distribution mechanism; its function is to move goods from producers to consumers. In light of this pandemic, large retailers are accelerating their online sales model to capitalize on the growing e-commerce demand from consumers who are confined to their homes. They are realizing the importance of having a strong, omni-channel framework and flexibility to shift between models no matter the market conditions. What we’re buying isn’t changing, but how we buy it is, and this pandemic will speed up the transition and solidify the online behaviours of consumers providing the potential to permanently change components of the retail structure. However, a few large brick and mortar retailers have come out on top through this, being the in-line grocery and pharmaceutical leaders, as well as the Costcos of the world.
I hope this provides some insight into the direction that many asset classes will be taking in the coming months and year. Ultimately, there will be structural changes to how many asset classes operate, and unfortunately some businesses will get left behind. However, there will be opportunities for those who seek them and for those who are flexible in adapting to the new norms.