Covid 19: Is it Time to Buy or Sell Commercial Real Estate?
The last three months have certainly been an interesting time to be in commercial real estate. With the uncertain and constantly evolving outlooks surrounding Covid-19 and the current political landscape, the questions I get almost daily are:
How is the commercial market? (And) Do I know of any good deals yet?
Well the answers are yes, no and maybe! To dig in thoroughly as to the potential of our Richmond market, we must look at the individual sectors and their trends. Interestingly, one of the biggest shifts seen nationwide is the relocation from CBD (central business district) to suburban office areas. According to Marcus & Millichap, one of the largest commercial agencies in the country, more than half of major trades are now taking place outside of primary metros (primary metros include major cities such as New York and Atlanta). The shift in purchasing has been towards secondary (such as Richmond, Virginia) and tertiary (even smaller) markets. This trend was already starting pre-pandemic and has risen significantly during the last few months, largely due to the reduction of costs. To further analyze the market, we must look at each respective commercial category and its corresponding impingement.
Prior to the pandemic, only 8% of the US labor force worked from home one day or more a week (per the Bureau of Labor Statistics in 2019). Over the last two months various surveys from NAR, Colliers, and Hired.com have all been consistent that between only 7% to 10% of respondents indicated a desire to return to the office full time. In all surveys, the vast majority of people (over 50%, and some up to 70%) preferred to have the flexibility to work from the office or home a few days of the week.
Initially, the broad thought was that offices would shrink in size due to more people working from home. That evolved with the realization that office space may increase due to personal space requirements. However, the current consensus is that the space dedicated to personal workspaces will likely decline. Instead, offices will have more ‘collaborative’ areas. This will mean redesigning offices for face to face meetings, brainstorming, and informal meetings as solitary tasks will be done at home. The vast majority of people do not want to work solely from home; rather they prefer the face to face contact part of the week.
Those offices already set up will likely see the best return and least amount of capital improvements needed. Important to these spaces will be improved air quality and ventilation, a relaxed density for workstations, and the incorporation of video conferencing. Local trends toward the ‘open-collaborative’ style may position some companies and areas well. Given the number of Class B and C office spaces here in Richmond these buildings will likely require renovations.
In line with the trends above, suburban office appears to be fairing quite well while the CBD sector (characterized by elevators, close contact, and high-rise buildings) is slowly taking a hit. It remains to be seen if the upper floors will decrease in leasing rates but this is certainly a possibility and one that industry experts are debating. Still, office is seen as a necessary component of industries and this current forecast is not as dire as originally viewed and this appears to be true here locally in Richmond as well.
Certain sectors of retail are tied very heavily to the office sector above. Downtown Richmond has a high amount of mixed-use properties where the retail is on the first floor and dependent on the offices in and around the building for a customer base. As workers transition to a flexible schedules and less days in the office, these restaurants and retail spaces will be affected. Less office use also means less time on the road. Traffic congestion could ease up as more workers work from home. Unfortunately for businesses that rely on this traffic the bottom line may be affected.
Still, due to the government stimulus and Phase 3 of the state opening back up, spending at retail and restaurants has been slowly increasing. Certain investments such as shopping centers that have a grocery store, as well as single net lease tenancy in fast food, drug stores and dollar stores (thought to be less affected by the shutdown) are more attractive retail investments. The increase is cautioned as a second pandemic wave appears to be more and more likely. If this should happen, how the government responds will likely have a large impact on if these stores can remain open and sustainable.
Late rent is increasing though it is in the best interest for landlords to work with the struggling retail and restaurants through these hardships. The memory of what a recent pandemic can do to a retail business will likely making attracting new tenants particularly difficult. It is likely that vacancies will continue to increase in the retail sector throughout 2020.
Personally, I stayed in a hotel last week for the first time since the pandemic started; to say it was a ghost town would be an understatement! The restaurant was shut down, there was no room service and a 4-person maximum per elevator was imposed-not that there was any wait for the elevator! This echoes what the industry has been saying would happen. The hotel sector was predicted to be the hardest hit and the predictions were not far off. Occupancies dropped by as much as 95% in some sectors and locations. Within the hotel market there are differences in product type. Economy and extended stay hotels, fueled by traveling workers and travelling families, maintained higher than expected occupancy rates. Luxury hotels were at the low end of occupancy. These trends are expected to continue in luxury and high-end hotels, especially in those that rely on conventions and large meetings which continue to cancel, at least through the end of 2020.
Interestingly, there were bright spots in the hotel market, however. Per the latest Costar report, Norfolk-Virginia Beach, Virginia, once again was the only market out of the largest 25 hotel markets tracked by STR that topped 60% occupancy, rising to 63.4%. This was a little bit of good news for the local region!
Multifamily shifts also continued with the trend towards suburban life. The perks of living in a high-priced central business district are starting to seem less appealing, especially as bars and restaurants are not as readily available. The lack of conveniences plus the pandemic financial impact especially has young professionals, typically one of the highest groups of renters in the CBD, question the choice of living in a downtown area. According to a recent Costar report, all asking rents took a dive in March, but as of July most markets have suburban rates nearly recovered to the March rates.
This has translated into worries for landlords, especially in the luxury market. It is not just the luxury market; the expiration of the increased federal unemployment benefits, set to expire at the end of July, is concerning for all landlords at every rent level. The NMHC reported the first week of July that that 77.4% of renters nationwide made a full or a partial payment for this month’s rent. That is down from the collections of 80.8% during the first week of June, and down from the 79.7% rate the first week of July last year. The smaller landlords seem to be suffering more. The largest indication will be in August when the extended benefits end and rent is still due, unless there is interaction by the government.
The upside is that vacancy was at an exceptionally low, providing some cushion against moveouts, especially in suburban areas. Most are predicted to renew, though the renewal rates may be flat, and concessions are expected to be offered. Construction still appears to be active, especially here in Richmond, and investors are still interested in the market.
The industrial sector continues to be the healthiest and most in-demand property type in the commercial world. The health crisis has bolstered demand for warehouse and distribution space. The expansion of e-commerce activity during the economic shutdown as well as the buildup of inventories by retailers, suppliers and manufacturers following initial shortages have all made further demand for industrial properties at an all-time high level. In addition, disruptions to global supply chains are also likely to aid storage facilities near ports as exports wait for a smaller number of container vessels to arrive. Interestingly, cold storage industrial facilities are especially in demand as these supply chains continue to be interrupted and the surge in grocery and food demand, complicated by a shortage in distribution channels, have increased demand for cold storage.
Here in Richmond this continues to be one of the most in demand sectors, with a low amount of inventory and high demand. This has put upwards pressure on pricing, lowered cap rates and lowered the days on market. I have personally seen a much higher demand than supply for industrial properties with multiple competing contracts in some situations. Investors are also recognizing this trend and are especially interested in industrial properties with long term leases in place.
SO WHERE ARE THE ROCK BOTTOM PRICES?
So back to our question number two, where are the good deals? Many buyers are under the impression that this is a repeat of 2008 and there will be rock bottom prices. The reality is this is not 2008 and this is a much different market. Most markets were performing well prior to this sudden interruption. Unlike 2008, when there was no clear ending, most agree that there is an end to this (a vaccine) which is likely to be in place by 2021 and will end the acute shock of this pandemic. Finally, government forbearance, regulations for tenants and financial stimulus to owners has helped to keep the volumes of distressed properties to a minimum.
The 30-day delinquency of CMBS (commercial mortgage backed securities) loans has varied along sectors. Not surprisingly hospitality and retail are showing the biggest decline in ability to pay their mortgages. However multifamily, office and especially industrial properties are showing very little decline at all and these are the markets that had been performing well going into the pandemic.
As an agent or investor, the biggest miss will not be losing out on a distressed property. It will be losing out on attractive, non-distressed properties, that can continue rising in value in the future, post pandemic. Waiting for a distressed industrial property will likely leave investors missing out on properties that could have really brought a good return over the long term. Some properties, such as hotel and retail certainly stand a better chance of seeing distressed opportunities. However, these sales often have a limited number of banks willing to finance them and a potentially high vacancy rate that will take much longer to recover.
The Richmond market is poised and positioned well on a national basis. The national outlook brightened in May as job growth grew beyond expectations. The local market is a strong secondary market positioned to recover well. The affordability, location and linkages are just a few ways that the Richmond market has and will continue to attract national corporations. The recovery for commercial properties will depend on the specific sector. The effects of the PPP loans exhausting, and enhanced unemployment payments ending are being watched closely. The most important advice for buyers is to speak to a professional that is versed in the local market. While we can’t predict the future or what will happen if a second wave hits, we will be better prepared for it. I am optimistic that Richmond remains one of the best positioned markets for recovery!
Heather Placer, CCIM, MAI, SRA, ASA