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The new sectors of real estate in a post-pandemic world

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From industrial to office and retail to hotels, COVID-19 is leaving its mark on property. We spoke to RSM Partner and Senior Real Estate Analyst Laura Dietzel on how sectors will evolve and which assets will be in demand.

Preqin: How have you found the real estate market in 2020?

Dietzel: The market has been really tough, but hopefully it’s becoming less tough. Ultimately, the slowdown in transactional activity we’ve seen has been driven by uncertainty injected into the market by a virus; investors are sitting on the sidelines, with large gaps between buyer and seller expectations, waiting for further clarity around several questions.

How long will this pandemic last? What will the ultimate impact be? No-one has a crystal ball. And while some people now hold a view that we may be on the other side of the outbreak as businesses reopen, there's a big question mark about what real estate looks like in a post-covid world. While there is no real political appetite for another round of shelter-in-place actions during an election year, the pandemic has served as an accelerant for real estate trends that were already underway. We find ourselves in the throes of defining the “Next Normal” for real estate investment.

Preqin: Which sectors will see increased deal flow as a result of the current market environment?

Dietzel:  Demand for industrial remains strong. And this is a case of retail’s pain being industrial’s gain. Industrial has truly benefited from the drive to e-commerce activity as retailers realize that they need to operate as omni-channel companies, with multiple streams of revenue.

Firms that didn’t have an e-commerce presence prior to the pandemic had to turn to e-commerce to keep generating cash flow while their physical locations were closed. It’s the shop down the street that's saying, “How can I get into curbside pickup?” or “How can I expand my distribution channel even though my brick-and-mortar store remains closed?” The answer is e-commerce, and with more companies turning to online services comes greater need for industrial warehousing and logistics properties.

This move to online retailing has been a long-term trend that is now being hastened by the pandemic. Because this trend has been in play for some time, industrial property in the market is richly priced, leaving investors to look to alternative strategies including strategic logistics plays. One example is a focus on ‘last-mile’ logistics. Firms are looking at well-positioned, obsolete retail properties near densely populated areas and targeting them for transition into delivery distribution centers as a means of gaining exposure to logistics demand.

We also see strength in the multi-family sector.

Everybody needs a place to live and we still see a need for greater supply of workforce housing in the US. Before the outbreak we were seeing this play out as rent prices were going up on the coasts, in the tech hubs, and in finance centers like New York and San Francisco.

What's interesting now is that demand is perhaps changing, and multi-family property is seen as attractive.

The pandemic may have people thinking twice about paying to be in a high-rise building with amenities such as gyms that have been shut down for months, and may yet see further disruption. The millennial generation – who currently live, work, eat, and do everything at home 24/7 – may be saying, “I want a little bit more space.”

So while demand for multi-family will continue, there may be more interest in property with a slightly larger foorprint in urban cores.

This trend also plays out on the single-family side. As people look for homes with more space or outside areas, or even at the greater health risk of living in a multi-family property, they might realize that the urban core isn’t for them. Couple this with a lot of remote working success stories and rising employment during the pandemic, and you may start seeing more and more people opt for single-family suburban homes.

Preqin:  At the other end of the scale, which sectors are going to be the last to recover from the pandemic?

Dietzel: Hospitality and retail are going to lag.

For hospitality, it was literally like a light-switch turning off. The moment that travel bans were enacted and a worldwide pandemic declared, you saw demand disappear and occupancy fall into the single digits.

As a result of the pandemic, domestic travel spending in the US is expected to decline by almost $520bn, which represents a significant economic loss. Nine times that of post-September 11, in fact. And as you look to some of the earnings reports that have come out, many in the industry don’t expect activity to rebound to 2019 levels until 2023.

That said, one thing to pay attention to is how different types of hospitality are performing. The economy hotel segment seems to be a little more insulated than the leisure segment. Hotels that cater to essential industries – construction, laborers, and medical support for example – are less disrupted than those hospitality assets more exposed to tourism or business travel.

We’ve spoken about how retail has been battling the rise of e-commerce for quite some time, and this pandemic has pressed fast-forward on our transition into a more tech-reliant future.

In short, mall owners are getting mauled. US mall owners have seen roughly one-quarter of expected April rent payments, with an estimated $7.4bn in April rent that hasn’t been paid. This will lead to a ‘flight to safety’ as retail landlords look for tenants with an e-commerce presence and strong balance sheet. So there will definitely be a continued renaissance for retail catering to new consumer preferences in terms of who’s buying and where they prefer to shop.

One key development in both the retail and hospitality space – and office, too – will be the increased focus on cleanliness and hygiene. As these sectors start to recover there will be pressure on these businesses to meet heightened cleanliness standards, or even increase the amount of contactless experiences.

Preqin:  How has the office market fared during the pandemic, and what’s next for the space?

Dietzel: The office sector has been pretty insulated. There are a lot of long-term leases in the market and a lot of office tenants aren’t dependent on those industries that have been hit particularly hard like retail and leisure. A lot of firms have been able to adapt to the social distancing environment and are operating with an efficient, mobile workforce and paying their rent.

What’s next for the office sector is the return to work.

Companies and landlords have a lot of questions to answer before ‘normal’ can resume. How safe do people feel going back to the office? How do you make an elevator bank allow for social distancing? A lot of protocols will need to be rethought in the short to medium term – mainly around cleanliness and hygiene – to ensure workers feel safe to return to their office.

The longer-term impact will be centered around the relationship of working in the office and working from home. And most people will probably want a mix.

There’s no disputing that workers need to be able to work from anywhere and that the technology exists to allow for that. But the office of the future will continue to drive culture, to drive brand, and be the hub of collaboration where people can build their teams.

The office assets that are best placed to be a success in the future will be those that have embraced technology. Systems that allow tenants as well as landlords to monitor the use of space and get more information about their property will be best placed to adapt to any changing demands.

Preqin:  Do you see the real estate market recovering in the second half of 2020?

Dietzel: For real estate to recover we need more policy responses and support for the labor market. The stock market has had a positive period and people seem hopeful of a ‘V-shaped’ recovery, but we’re certainly not out of this crisis.

The Federal Reserve has continued to provide a backstop, and its Main Street Lending Program – which purchases loans issued to small and mid-sized businesses by banks – is coming online at a critical point when economic recovery really is dependent on fiscal policy.

A sustained, true recovery will only be able to occur when consumer confidence is back.  Consumers are going to remain the key engine of economic growth and crucial to the recovery. So the health of the overall real estate market, and the ability for investors to feel confident in the industry, is dependent on consumer confidence.

We can be cautiously optimistic, but I don't think the second half is going to rebalance the markets. I do believe that there will be a flight to safety benefiting core asset investment strategies and properties whose tenants boast strong balance sheets. Investors still feel comfortable transacting this kind of real estate investment – even if their cash flow projections are off in the short term, the assets value will recover in later years.


This article was originally published in Preqin.  Download the Preqin Quarterly Update: Real Estate Q2 2020.

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