Is Now a Good Time to Invest in Commercial Property?
Commercial real estate investors typically play a long game, looking years ahead rather than making short-term decisions. Then 2020 happened. Wholesale predictions about markets and property sectors were upended, requiring investors to make decisions in an entirely new context.
“More than a year after the pandemic started, we realize that things turned out better than we initially anticipated," said Lindsay Dunn, head of Real Estate Banking for City National Bank. “The quick rollout of the vaccine and reopening of the economy resulted in more transaction activity than expected in 2021."
Experienced investors understand that every market has its risks and rewards, even in extraordinary times like these.
“While some property sectors have felt pain from the pandemic, overall commercial real estate has been generally resilient," said Michael Kazemzadeh, regional manager of City National's real estate group. “There are some headwinds to watch as the economy transitions after the 2020 shutdown, to be sure."
Here's a look at this year's market hazards and opportunities.
Revised Economic Forecasting
Economists continue to revisit and revise their forecasts for a post-pandemic commercial real estate market.
The Mortgage Bankers Association's economists Mike Fratantoni and Joel Kan anticipate the economic recovery to continue in 2021. In their April 22, 2021 Economic Forecast, they predicted a GDP increase of 8.4 percent, 7.3 percent and 4.7 percent during the second-through-fourth quarters of 2021.
While commercial and multifamily mortgage loan originations declined year-over-year in the first quarter of 2021, according to the Mortgage Bankers Association's (MBA) Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations, the 14% decline was smaller than the year-over-year decreases seen at the height of the economic shutdown, said Jamie Woodwell, MBA's vice president of commercial real estate research, in the survey report.
"Industrial and multifamily properties continue to attract the greatest interest, and retail and hotels saw the largest declines," Woodwell said, in published comments. “As the economic recovery and re-opening speeds up, investors and lenders should have greater clarity into which pandemic-led changes are temporary, and which are more permanent."
The industrial and multifamily property sectors are the current darlings of investors, said Dunn, while the office, retail and hospitality sectors continue to feel the lingering impact of the pandemic.
While the distress of higher vacancy rates and unpaid rents was felt in most property sectors during the initial period of the coronavirus shutdown, the short- and long-term impact of the pandemic has varied by region and by property sector.
Investors continue to have confidence in the industrial sector, said Kazemzadeh, especially the activity in developing big box warehouses of 500,000 or more square feet.
“The industrial sector is performing well at all levels in part because of additional ecommerce-related demand from the pandemic," he said.
Industrial properties are attracting investors throughout the U.S., including the Inland Empire in California, coastal port markets and other key distribution hubs in the U.S., Kazemzadeh said.
“There's an abundance of capital, especially institutional grade capital, that needs safety and the preservation of wealth," Kazemzadeh said. “Real estate, especially within the industrial sector, currently offers that opportunity."
A combination of government stimulus, rent agreements with landlords and the uneven economic recovery meant that many multifamily investors, particularly in Class A buildings, saw minimal disruption due to the pandemic.
“A year ago, we were extremely concerned about rent collection, but the majority of our clients were able to navigate through the issue of collections and were down only minimally," said Kazemzadeh.
Some high-end coastal markets are seeing more pressure on occupancy and concessions, said Kazemzadeh, but migration patterns mean that more multifamily investors are turning to the Inland Empire in California and to secondary markets throughout the Southwest, like Las Vegas and Phoenix.
“We were seeing multifamily rent concessions as high as three months in some of the urban core locations such as Los Angeles and New York," said Dunn. “Now concessions are in the one-month range."
The flight to the suburbs that started during the pandemic impacted commercial real estate in urban centers, but the movement back to cities is already beginning to occur, said Dunn.
“We're starting to see companies announce dates when they expect a full return of their employees to their offices, but realistically we anticipate hybrid work models to become more prevalent," said Dunn. “Office leases tend to last for three to 15 years, so this will be a more drawn-out process to see the long-term impact on offices. We're seeing supply increasing in the sublet market, which could indicate increased supply overall in a few years."
Leasing activity seems to indicate a flight to quality is taking place, with more interest in Class A buildings where landlords have made investments in air filtration and no-touch entrances, said Dunn.
“Our clients in the brokerage community seem bullish on a faster-than-expected return to offices," said Kazemzadeh. “They're referencing the previous unexpected return to high-rise offices a few years after 9/11 and see the post-pandemic period playing out under a similar scenario."
Parts of the retail sector have had to juggle short-term issues — such as limited rent collection from closed shops — along with long-term headwinds that were already creating headaches for some property owners before the pandemic.
“Grocery-anchored, needs-based retail did very well during the pandemic," said Dunn. “It checked off the box as a resilient part of the retail sector."
Prior to the pandemic, some retail investors were having success with experiential retail, bringing people to town centers and malls for events and entertainment as well as shopping.
“Now we're starting to see people wanting to get out again, so this may be a boost to those retail sites as they reopen," said Dunn.
However, Dunn noted, vacancy rates are high in many retail sites because of tenants that didn't make it through the economic shutdown.
“Investors are reluctant to invest in retail right now even though there may be opportunities because this sector is under pressure," said Kazemzadeh.
Senior housing was under pressure at the height of the pandemic because of the additional needs to ensure the health of residents , but most people feel the worst is behind them, said Kazemzadeh.
“Most existing and potential renters are vaccinated now, so to the majority of investors feel more comfortable about senior housing compared to 6-9 months ago," he said.
The primary driver of investor interest in senior housing is demographics.
“Looking forward over the next five years, there will be another wave of pent-up “Baby Boomer" demand for senior housing," said Kazemzadeh. “Many investors feel there will be opportunities in this sector because of that demand."
Demand is also increasing for single-family homes and townhomes built specifically for renters rather than buyers, said Kazemzadeh.
“Purpose-built rental properties are especially attractive in areas with high in-migration where new residents aren't ready to buy or can't afford to buy yet," he said.
The self-storage sector is doing very well, said Dunn, with rents up and vacancies down.
Kazemzadeh said the long-term fundamentals for self-storage are good as long as the markets are not overbuilt.
“These deals usually take from three to five years to stabilize," said Kazemzadeh. “Experienced investors know that self-storage is a long- term investment that needs to be supported by sound supply fundamentals and barriers to entry."
The rise of ecommerce has led to a resurgence in demand for land for truck storage rather than for development, said Kazemzadeh.
“Since the Great Recession, commercial banks have been moving away from financing land because of the higher risk and long timeline for development" he said. “Now, we are seeing some of these transactions are supported by Amazon and other companies leasing land for storage of their delivery trucks, which offers a more direct and lower risk opportunity for investors.
Long Term Outlook for CRE Investors
Depending on your tolerance for risk, there could be some commercial real estate opportunities in 2021 and beyond.
“The pandemic accelerated trends such as the hybrid work model and the rise of ecommerce, both of which we'll likely continue to see increase," said Dunn.
Those shifts, along with high levels of migration because of the ability of more people to work remotely and the desire for many people to live closer to their families, may demand new strategies for commercial real estate investors. For example, more multifamily development is occurring in secondary cities and suburban markets than in large coastal markets.
The fundamentals that influence commercial real estate — including supply, demand and demographics — point to continued opportunities for careful investors with the help of experienced wealth planners.
In these turbulent times, City National encourages you to review your investment portfolio with your advisor. Contact our portfolio managers today to ask questions about how we can help.
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