Real Estate's Pandemic Pause

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Commercial real estate was poised to have a blockbuster year in 2020, but that was “2020 B.C.” (before COVID-19), before many companies sent employees home to work remotely, and before a life-upending pandemic reshaped the demand for and use of commercial spaces. In the absence of a vaccine, employers and building owners have been grappling with how employees and tenants can safely return to offices and contemplating the value of dormant buildings.

Every sector of the economy was affected by COVID-19, but commercial real estate’s office, retail, and investment sectors bore the brunt of the shutdown of nonessential businesses. Bryan Atherton, CCIM, SIOR, senior adviser at Coldwell Banker Commercial NRT in Danbury, Conn., had deals in bidding wars at the start of the coronavirus outbreak, he says, but they all fell apart abruptly.

COVID-19 has caused tenants to request shorter-term leases, rent reductions, and other types of forbearance. Buyers relinquishing an asset or selling a building as part of a 1031 exchange, says Atherton, are often finding the sale in jeopardy. “There is lack of deal flow,” he says.

Making matters worse, the demand for office space is unlikely to rise in any meaningful way for the foreseeable future, reports Lawrence Yun, chief economist for the National Association of REALTORS®. Aside from the shift to remote work, which will be permanent for many workers, new office construction spending was running at a $72 billion annualized level in the months before the pandemic, which far exceeds the $45 billion average over the past 20 years, Yun says.

But where transactions are happening, commercial pros are finding success using virtual tools to move them through the process. “It takes much longer to get something sold, partly because companies have travel restrictions,” says Patricia J. Loveall, SIOR, executive vice president at Kidder Mathews in Seattle, who specializes in warehouse space. “We have to find different ways to show properties through virtual tours.”

Rather than fly to Atlanta in early June to help a client find office space, Jim J. Damiani, CCIM, SIOR, executive managing director at Newmark in Minneapolis, and his team collaborated with a local broker and created a 20-minute video using Google Earth to “fly” to buildings and Matterport technology to view the space and amenities. Having narrowed the search to two properties, only then did the client take a same-day round-trip flight to Atlanta. “Our clients spent three hours instead of two days,” Damiani says. “I think that’s going to be the future and save us and our clients valuable time.” He predicts that face-to-face meetings with long-term clients could take place annually rather than six times a year, if business can otherwise be conducted via teleconference.

Another challenge is getting other companies to do due diligence, Loveall says. The process for getting service contractors into buildings has become more cumbersome. A process that used to take 30 days has slowed to 60 days.<>In addition, some would-be sellers are waiting for the economy to rebound, so fewer properties are available to investors—there may be 10 to 12 in a market that had 50 before the pandemic. “People don’t know what the impact [of COVID] will be on values, so they’ve hit the pause button,” says Loveall.

Tenants who are renewing their space find themselves at an advantage. That’s because the trends working in their favor are likely to continue for many months: Effective rents in the office sector are expected to fall 10.4% this year, and vacancies are forecast to hit a record 19.9% next year, according to a Moody’s Analytics study. Damiani notes that tenants with less than 12 months left on their lease have gained significant bargaining power when seeking flexibility for leases with all possible rights: termination, contraction, expansion, or renewal.

Industrial Supply Chain Logistics

The pandemic fueled a surge in online grocery delivery and further accelerated the migration from brick-and-mortar retail to e-commerce. A recent report from JLL predicts that as much as another 1 billion square feet of industrial real estate product may be needed by 2025 to meet the demand for fulfillment and distribution facilities. “The real winner since COVID-19 hit has been industrial supply chain logistics,” agrees Loveall of Kidder Mathews. “That piece of business is still incredibly active. Any company that has an e-commerce strategy, any company in the food distribution or in the freezer cooler business, is thriving.”

Although many Seattle-area office and retail tenants, including Starbucks, have asked for rent relief, rents have held steady for the warehouse sector, due to a scarcity of inventory and an overall vacancy rate of 6.5% and less than 1% in some submarkets, according to Loveall.

“Companies like Home Depot, Lowe’s, Amazon, Walmart, with an e-commerce strategy, have to continue with their plan to deliver warehouses for last-mile delivery in spite of the pandemic,” says Loveall. “They are playing for the long term because they know, whether it is 18 months or three years, businesses will come back, but in the meantime, they are thriving and need to get goods to customers.”

Return to Normal?

While Amazon’s e-commerce is going full throttle, its office lease commitments to house developers and support staff are a huge expenditure and drag when buildings are empty and reopening may necessitate social distancing, staggered work schedules, and lower capacity.

As firms realign their real estate needs, experts say, it’s hard to envision a return to the way things were. In August, retailer REI sold its new Seattle headquarters, citing a desire to decentralize and encourage remote working. The social-sharing site, Pinterest, announced it would pay $89.5 million to terminate a large office lease in San Francisco.

Many clients begin by envisioning a more flexible workplace, where designated areas, seating, and conferencing will use a fraction of their previous footprint.

COVID-19 has presented an epic opportunity to reprogram, even liberate, the workplace, says David Schwarz, a partner at Hush, a design agency with a focus on commercial architecture and corporate workplaces whose clientele includes Facebook, Instagram, Google, and The Related Companies. “COVID has unlocked us from archaic paradigms of what it means to work, to be a worker, and what those spaces that used to house all that activity must do,” says Schwarz.

When 20% to 30% of a company’s workforce will not be on campus on a given day, many clients can consider a more flexible workplace, where designated areas, seating, and conferencing will use a fraction of their previous footprint. Schwarz is helping them rethink their strategy by designing workplaces offering destination-worthy experiences: talent onboarding, training, cultural events, and all-hands meetings featuring interactive exercises. “If most functional work could be done off-campus,” says Schwarz, “we have an amazing opportunity to redesign the workplace to facilitate uniquely interpersonal experiences that are untenable at home.”

But Damiani recalls lessons from some companies, like Yahoo, that experimented with remote work and ultimately called workers back to the office because collaboration was hurt. He cautions against permanent work-from-home plans, saying, “You still need your collaboration, your culture, your mentorship.” Instead, his team counters, “Try a spec suite. It’s fully furnished, and you can do a shorter-term lease. We call them ‘collaboration stations.’ ”

Office design will change; Damiani predicts back-to-back workstations, more touch-free offices, and infrared cleaning technology replacing pre-pandemic amenities such as nap pods or golf simulators.

Atherton has observed that businesses are seeking new locations with fewer building tenants or single-tenant spaces, so there is less coming-and-going around the property. Clients “want to control their destiny; they want to control air quality, and all things they can do with the building,” he says.

Because seasoned practitioners understand that commercial real estate is a lagging economic indicator, a full assessment of the impact will be clear only after existing leases, contracts, and government support programs expire, alongside a broad reduction of COVID-19 cases once a vaccine is available.

“When the virus is behind us,” says Atherton, “that’s when we will see what the real damage has been.” In the meantime, tenants, owners, real estate pros, and affiliated industries are tasked with adapting buildings and businesses in the most appropriate ways possible to life during—and after—COVID-19.