The ripple effect of the pandemic’s impact on the commercial real estate (CRE) market is going to have a lasting effect on several market sectors. The remote workforce genie isn’t going back in the bottle, and the reliance on e-commerce and advances in technology for home delivery will continue to disrupt retail. However, there is reason for optimism, but not across all sectors, and there’s still a lot of emperors without clothes out there talking about how everything is going to be just fine. There are thriving CRE sectors, some that need only pivot to adjust to the new normal, and others that will have to completely reinvent themselves.
Multifamily Real Estate: On The Rebound
As a leader in providing property management technology to the apartment industry, my company has seen firsthand how the multifamily real estate market has made a faster recovery than expected compared with other real estate sectors. It’s arguable that some markets felt almost no impact at all, and some sectors are actually stronger coming out of the lockdown. Yes, government aid has helped, but the overall market has gotten back on its feet quickly and will continue to do so in 2022. The multifamily market is seeing strong growth with low vacancies, steady rental rates and robust development for next year.
Investors agree: Recent data puts sales volume of market-rate apartments at $46.6 billion in the first half of 2021, which was up by 35% from a year ago. This is on pace with the average growth rate for the past five years. Apartments in secondary markets or further from major cities may benefit from this remote work trend since employees no longer need to be near their physical office location.
Industrial Real Estate: Thriving During Distress
The industrial market saw a huge boost during the pandemic due to the growth in e-commerce, and it looks like this will keep rolling through 2022. Year-over-year e-commerce growth surged to 44.5% in Q2 from 14.8% in Q1, which put pressure on retailers, wholesalers and third-party logistics companies (3PLs) to lower transportation costs. There is still healthy demand for industrial real estate, with 367.8 million square feet of industrial property under construction. Completions for 2021 are forecasted to top 250 million square feet, slightly above 2019’s total.
Rent increases were most significant in or adjacent to port areas where there was increased demand due to shipping problems exacerbating supply chain challenges. Vacancies remained steady at 6.1% compared to March 2020. Strong vacancy and rent growth figures show new space has easily been absorbed.
Office Real Estate: In Dire Trouble
Since approximately 50% of U.S. workers worked remotely during the pandemic, flexible work location is no longer a nice-to-have but often a requirement. Businesses have shifted from “always in-person” to a remote workforce, and a vast majority of that workforce likes it. In my opinion, this trend isn’t going anywhere; about 74% of the workforce is planning to permanently be working remotely. This spells a significant reduction in demand for office space. Companies are not re-upping leases and are significantly reducing their square footage, all signals of troubling trends for the CRE market. Not surprisingly, I’ve noticed that CRE owners aren’t talking about this exodus and are telling all who will listen that everyone’s coming back. They may even talk about the need for flex space but not about how flex space will require less space overall.
An overwhelming 72% of companies anticipate modest office space reductions, and 9% of large companies plan to make their office space “significantly smaller” in the next three years. Perhaps some CRE owners are working behind the curtain to stem the tide of companies leaving their buildings or designing new uses, but they have a cash crunch ahead to meet loan payments. Loans to keep CRE businesses afloat can be difficult or impossible to service because a reduction in 20% of topline revenue due to loss of tenants severely impacts a commercial loan, which is typically levered at 75-80%. Cash is only going to get tighter.
Adaptive Re-Use Will Be Key
One of the saving graces for the struggling office and retail real estate markets is the shift to a mixed-use property because apartments in a mixed-use environment command 13.9% higher rents than apartments that are not. I believe that this is the most significant opportunity in CRE and where one strong sector can bolster the struggling one.
There are a number of creative ways that CRE real estate executives can reuse a vacant structure to give a neighborhood a boost. Converting unused office space or retail buildings into apartments or nursing care facilities, for example, can make the best use of space and tap into needs in the market. You can add apartments on top of malls or earmark warehouse storage on the back of office spaces. Key factors that determine optimal reuse in a property include location, building structure, cultural significance, sustainability and ROI.
Cities and counties have also put into place adaptive re-use ordinances making permitting easier and construction easier and cheaper. In Los Angeles, for example, where my company is headquartered, CIM Group took advantage of the new adaptive re-use ordinance to renovate a downtown high-rise building.
One component to assist with the success of adaptive repurposing commercial real estate property is technology, which has grown by leaps and bounds over the course of the pandemic. Once considered a “tech-hesitant” industry, it is now embracing everything from automation software for remote property operations to AI that scans for changes in state and local code and compliance regulations. A recent survey showed that 80% of real estate owners and operators claimed new technology was already having a positive impact on their operations.
While some office building owners are awaiting a mass re-entry of people back into offices, others are thinking creatively to re-envision a future that combines the best of both worlds, solving a housing shortage and enlivening office and retail space.