After a seismic shock, surprising resilience
From the beginning, the COVID-19 pandemic has defied almost every economic prediction. In March 2020, stores, restaurants and offices emptied out with astonishing swiftness. The stock market tanked and jobs quickly disappeared. But what many Americans feared would be a long and devastating economic downturn didn’t happen. The economy—along with the real estate sector—bounced back in record time. Output’s already above pre-COVID-19 levels and jobs could recover to previous levels by early 2022.
To many, the property sector may look remarkably the same as it was before the pandemic. It isn’t. Some markets and sectors may have changed forever. Some buildings and other assets are obsolete, and property managers now have to imagine how they can be repurposed. Other economic hurdles include supply chain bottlenecks that slow or halt production. Labor and product shortages also bring fears of inflation, a major economic risk.
What to expect now? The virus will have a major say in that. The delta variant took hold and COVID-19 infections spiked. Many jettisoned travel plans and hesitated to eat inside a restaurant or go to a movie unmasked. Employers delayed return-to-office plans. One certainty: Companies must build flexibility and the capacity to adapt quickly to market changes.
The spring and summer of 2021 may be remembered as the time much of the world finally began to take climate change seriously. The theoretical turned terrifyingly real for millions around the globe. Devastating wildfires, record heat and drought plagued the US West. Massive flooding inundated New York City, Louisiana and elsewhere, including China and Europe. And a United Nations climate change report concluded that nations must act now to save the planet from even worse weather disasters.
What does that mean to the property sector? A lot. The sector is the largest contributor to greenhouse gasses and global warming. Buildings account for upwards of 40 percent of global energy use and carbon emissions. Sector leaders and investors are ideally positioned to play a leading role in muting climate change’s worst effects. But many aren’t convinced. Executives and investors often talk up ESG values, but many executives remain skeptical that ESG pays off in enhanced returns.
Climate change can seem to be an intractable problem, too big to solve. But the property sector is ideally positioned to help reduce impacts and increase resilience to environmental risks.
It’s time to stop talking and start taking concrete steps to battle climate change. The goal is not simply to tick a regulatory box, but to create sustainable advantage and value. One way to encourage that is to set performance-based standards in ESG and zoning codes and then let developers and other stakeholders work out the specifics.
Before the pandemic, the average commuter’s slog to the office clocked in at just under half an hour. But COVID-19 whittled that down to the time it takes to trundle from bedroom to home office (or the kitchen table). Now, as the pandemic grinds on, many employers grapple with new issues: Who needs to come into the office and how often? What kinds of spaces can make employees feel safe?
The uncertainty has taken a toll. Long the bedrock of commercial real estate portfolios, the office sector suffered the steepest drop in sales transactions of any sector relative to pre-pandemic volumes. Many major investors are on the sidelines or have pared back holdings of office assets, especially those that aren’t in choice locations.
Most firms want employees to return to the office, but WFH has changed attitudes. Bosses now know that many workers can be productive at home, and many employers offer permanent remote working arrangements. That means most employers will likely need to lease less space per worker in the future. Tenant preferences will also drive changes. Many will gravitate to newer buildings with better ventilation systems, flexible floorplans and modern amenities like touchless systems. Employees also want increased flexibility on not just where but how they are working.
The end result is likely a hybrid model for a large section of the office workforce. Only time will tell how the different pieces will come together.
After a pandemic-induced pause in mid-2020, real estate deal-making is back—with a vengeance. Investment cash, domestic and foreign, is surging into US real estate. Several factors are driving this demand, including low interest rates and attractive returns relative to risk. Institutional investors who need to keep their portfolios of stocks and other assets in balance, for example, often turn to real estate when stock values fluctuate, throwing portfolio concentrations out of whack.
Where’s all that money going? No surprise that buyers are snapping up industrial assets and housing, both single- and multifamily, a trend that hasn’t wavered in a decade. And we’re seeing a scramble for alternative properties like data centers, self-storage facilities and studio space to produce streaming content and student housing. More investors are plowing capital into these properties because they offer generally higher returns, often at no greater risk.
Is a bubble coming? Only if investors lose their discipline. Fund managers raised huge amounts of cash to pick off a predicted wave of distressed and foreclosed properties as the pandemic raged. But those predictions fell flat. Market fundamentals held up remarkably well. Lenders cut borrowers a lot of slack — and that paid off for the most part. Most investors and lenders maintained restraint during the pandemic, limiting leverage and generally not overbuilding.
The big question: Will that discipline last, especially as more investors turn their capital toward real estate?
COVID-19 transformed daily life from a high-touch to virtually no-touch. And that has catapulted the innovations of the property technology (proptech) industry to center stage. Anyone in the market for a home or apartment knows how different the experience is now. Instead of face-to-face tours, you can take a 3D self-guided virtual tour of a home. You can be connected to a real estate agent via chat or get FAQs answered by bots. Some companies have put their entire leasing and renewal processes online, creating a friction-free experience for the pandemic wary.
And there’s plenty of room for proptech to grow. Tenants now demand more communication and transparency on health and ESG-related metrics. In some properties, data about air and water quality are shared with tenants through an app or on lobby displays. Other companies are using climate data risk to guide investments by studying where flooding, wildfires, hurricanes and other weather events may pose the greatest risk.
Proptech still has a lot of room to grow. The goal is for companies to combine people and the right technologies, apply an innovative mindset to help drive the right business outcomes, and use data, automation and analytics to design space better and ensure greater safety. Some already use it to improve day-to-day operations, reduce risk and better manage renewable resources. We expect companies that master proptech and its tremendous potential to gain a huge competitive advantage not just in attracting tenants but in making smarter portfolio investments.
The pandemic will shape the decade ahead in ways that we can’t even imagine yet. That will require one trait that has been in abundant supply so far: flexibility. In only a year and a half, trends in real estate have accelerated that many thought would take years to play out. Rapid change is becoming the norm. Retailers, for instance, will need to upgrade their e-commerce abilities to meet customer demand for ease of purchase, delivery or pickup. Shopper’s expect the experience between a store and its online site to be seamless. Many restaurants already are planning to make temporary outdoor dining facilities permanent.
Firms will need to upgrade their infrastructure to accommodate remote working. At the same time, many employers who want office workers back at their desks will have to improve facilities’ health and safety standards to provide for social distancing and other anti-virus measures. As offices go, so do hotels, restaurants and other businesses that depend on the patronage of office workers.
The Biden administration’s infrastructure bill may —or may not—help the property sector. Congress is still having discussions over funding to help improve energy efficiency in commercial and residential buildings.
As time goes on, the unpredictable repercussions may become more predictable. But investors shouldn’t count on that. They’ll need to be agile to thrive in what we all hope is soon a post-COVID-19 era.
“People want that 15-minute lifestyle if they can get it. They want walkable, amenitized, real places that allow them to live fuller lives without having to get into a car and transition from one segment of their life to another.”
Even though the pandemic has spared no state or city, its impact on US property markets and sectors now diverges in ways significantly different than in the last recovery. That divergence means that some sectors, like industrial properties, have barely paused because a surge in online spending spurred tenant demand. The same is true for multifamily properties, with tenant demand still increasing and rents back to record levels throughout much of the country.
Meanwhile, however, the pandemic accelerated the retail property sector’s long slide, with store closings and vacancies rising. The only exception is grocery-anchored centers, dollar stores and home improvement retailers, which are thriving. The office sector is, unsurprisingly, in the midst of a major reset—with vastly different outcomes based on location and whether a building has flexible layouts and better ventilation systems. Even so, vacancies are likely to keep rising.
Vacation travel is recovering, with hotels within an easy driving range of population centers appearing set to reap among the greatest benefits. But business and international travel may not return to pre-COVID-19 levels for years. That would take a toll on hotels, luxury retailing and upscale dining that’s often fueled by company expense accounts.
The pandemic magnified an ongoing shift away from expensive downtown markets and toward smaller, more affordable ones. All this means is businesses need to stay nimble. Uncertainty can be a curse, or an opportunity.
The pandemic stopped a lot of people in their tracks, but also set many in motion. People freed to work remotely realized that they could beam into their meetings from 1,000 miles away just as easily as 10.
No wonder, then, that almost all of this year’s survey of top-ranked real estate markets are in faster growing southern and western regions and away from the coasts. The two top-rated metro areas in the Emerging Trends survey, Nashville and Raleigh/Durham, each have fewer than 2.5 million people.
But they are growing explosively. And they’ve shown impressive economic staying power even in a pandemic. They regained jobs lost in the downturn much faster than other cities. By year’s end, cities like Phoenix, Charlotte and Nashville are expected to regain nearly all lost jobs, while the US as a whole is projected to be down almost 2 percent.
Meanwhile, the large cities that dominated the list for years are now slipping. Several expensive markets, including Los Angeles, San Francisco and Washington, D.C., all failed to break into the top 10. Ratings for traditional investor favorites like San Francisco and Manhattan are tanking as high cost of living drives jobs and job-seekers to more favorable climes. Seattle was the last large or coastal metro area to top the list, in 2018.
5. Tampa/St. Petersburg
7. Dallas/Fort Worth
“The impact from the pandemic was less than the real estate industry expected at this point last year. Now the industry should use its good fortune toward both preparations for continued uncertainty and making strides toward ESG improvement.”