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How COVID-19 is changing commercial real estate

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For fund managers and investors alike, the pandemic presents short-term challenges, long-term opportunities, and lessons to be learned. Preqin spoke to RSM Partner and Senior Real Estate Analyst Troy Merkel for their annual real estate report to discuss the impact the pandemic has had on commercial real estate.

Preqin:  How has the commercial real estate market fared so far in 2020?

We’ve seen a really challenging market for some property types in 2020, in particular retail and hospitality.

We’re expecting the pandemic to accelerate the drive to e-commerce and omnichannel retail that we’ve seen in recent years. Grocers and essential-needs retailers have held relatively strong – we’re seeing rent continue to be paid and consistent footfall. But outside of those sectors, rent collection rates in retail have been hovering around 25-30%, which is extremely low.

That said, there is some good news for retail. In June we saw consumer spend in the US spike up about 14% – or even higher in sectors like clothing retail – which shows that people still shop in brick-and-mortar stores. An indication that physical retail will still play a part in consumer habits in a ‘new normal.’

Hospitality – and in particular upper-end hospitality that caters to conferences – has been decimated. And with travel bans continuing and conferences still being canceled, they're not seeing a rebound in occupancy. One area of strength within hospitality is in the lower end hotels, those around 1-3 stars, which are exposed to key industries and the parts of the economy that have kept moving. Hotels along key trucking routes, for example, have kept their occupancy up and been able to keep their rates pretty steady.

The office sector has been fairly insulated. Yes, the offices have been empty, but many firms are
successfully operating with a remote workforce, and continue to pay their rent. Going forward, we expect most people will still want at least a mix of office work and that the office will remain a crucial part of a company’s culture.

From an industrial standpoint, if you're a logistics center operating in the supply line of essential or e-commerce goods, you're probably doing quite well.

Preqin:  How has the pandemic shaped commercial real estate operations?

On the fundraising side, we’ve seen large players continue to close funds. Rockpoint Group closed its Rockpoint Real Estate Fund VI on $3.82bn in June 2020, exceeding its target of $3.25bn. So it’s clear that there is still appetite for investment. I think we’ll see a continuation of the consolidation trend of recent years as capital flocks to the big names with track records. On the deals side, there have been challenges. Working through the process of closing deals when the required parties can't get together to sign the necessary paperwork has caused issues. Off the back of this, we may see more technology in the deal-making process. Solutions like blockchain may help with deeding, online appraisal facilities, and electronic document submission, but not all state or local agencies utilize these solutions.

A lot of people see this as a great opportunity because it's an existential stressor that didn't really exist before – the pandemic is truly a black swan event. A lot of property will be fundamentally strong but the price of that property may have decreased. So if you have capital or if you’re not tied to certain debt parameters, there will be opportunities out there.

The commercial real estate industry is saying we want to re-invest in these buildings, but we need this
technological support to operate in a touchless or distanced market.

Preqin: What lessons are emerging from COVID-19 for the industry?

We’ve seen fund managers reviewing their banking relationships. There were situations earlier in the
pandemic timeline when GPs were trying to take on debt, but some of the banks – and this is some of the larger banks too – were not as accommodating as fund managers needed. So in order to add more resiliency in terms of accessing debt, fund managers are now seeing that operating with multiple banking partners is a better practice.

On the reporting and data side, real-time reporting has been shown to be really important. As an investor, if you receive quarterly reports from your investments, as is traditional, then from March to June – which is when we saw the real impact of the pandemic in the US – you didn’t know how your investments were faring. Your last communication may have been in March or early April when rent was still coming in. So there were cases where LPs and GPs were in the dark and didn’t know how badly they were impacted.

I think there's going to be a push for solutions that provide integrated information systems, investor portals, and monthly reporting.

Preqin: Where are the best opportunities in the current market?

I think there’s opportunity in suburban areas. In a general sense, and for a number of reasons – remote
work, more space, and improved hygiene – there seems to be a migration pattern emerging from cities toward suburban areas.

There are housing affordability issues in cities. If commutes can be cut to a couple of days a week as remote working becomes more commonplace, then we may see places 30-50 miles outside of the city become a bit more attractive. This trend will then play out across commercial real estate. There may be more demand for hospitality in the suburbs, and offices may downsize in the city or be turned into satellite spaces for remote workers to meet.

For example, suburban retail property tends to be in great locations with fantastic transportation
connections, and this kind of property is ripe for increased foot traffic and mixed-use redevelopment.
There’s also opportunity in the infill industrial market. As more firms focus on their online presence – and the recent Wal-Mart and Shopify partnership is a great example of this – there’s going to be much more competition for infill industrial property and logistics property that serves urban market consumers.

A lot of these trends existed before the pandemic, but the outbreak of COVID-19 has accelerated and put more focus on these trends. Something perhaps being born out of the pandemic is ‘clean investing’ in commercial property. We’ll see things like UV lighting, air filtration systems, and cleaning processes come into a lot of property as employees, shoppers, and consumers put more focus on their own health and safety at work and out on the high street.


This article was originally published in Preqin.  

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