Commercial Real Estate’s Perfect Storm

The COVID-19 crisis has been the perfect storm for commercial real estate. While the economy is showing signs of life as most of the country reopens, the shock to the commercial real estate market was unprecedented. Various property types have reacted differently to the crisis. Offices and apartments have been very resilient with rent collection running around normal levels. Industrial real estate will continue to benefit from e-commerce as well as the near shoring of supply chains. The real pain in the market has been felt in retail and hospitality.

Regarding retail, the pandemic pressed fast-forward on some trends that were already present. Suburban malls have been struggling for some time due to consumer preferences for online shopping. The pandemic is essentially finishing what Amazon started and there have been several bankruptcies filed by retailers such as JC Penny and J.Crew. Retail is coming back slowly — according to Simon Property Group, a mall and outlet real estate investment trust (REIT), most of its locations are open with traffic running at about 50 percent of normal rates.

Hospitality was one of the first property-types to be hit hard as travel ground to a halt this spring. The good news is that hospitality can come back quickly, as there is not a slow and expensive process to re-tenant a hotel like it would be for an office building or an apartment.

Commercial real estate came into this pandemic in a strong position. Despite the long boom in the asset class, there was not over-supply on a nationwide basis prior to the crisis. New supply peaked in 2018 and was starting to decline due to tighter lending standards and a rise in construction costs due to a labor shortage. New supply will be limited going forward due to uncertainty around expected returns on new projects and the path of employment.

Forced working from home (WFH) caused by the pandemic has put a question mark around the future demand for office space. The mass experiment of working remotely has proven to be effective and embraced by many employees and their employers. Our view is that this change should not meaningfully impact future demand for office space. As a percentage of expenses, occupancy is generally 2-3 percent of expenses for knowledge-worker industries. While the demand for various types of office space might change in the near-term, we don't think there will be permanent demand distraction. At present, the type of office space that is in demand are creative spaces that don't require an elevator to access and have operational windows. The trend of less space per worker of the recent past could change as workers need to observe social distancing.

This crisis in commercial real estate will unfold over the next year and there is still a fair amount of uncertainty. We are positive for the long-term on commercial real estate. Our long-term outlook for interest rates is that they are going to remain low for the foreseeable future. This environment has created a challenge for generating income on behalf of clients and commercial real estate is a good way to generate income in a low-interest rate environment.

For the week, the stock market as measured by the S&P 500 was slightly lower. Economic data was mixed this week and renewed tensions with China created some weakness the stock market. Second quarter earnings season is underway and 30.5 percent of the S&P 500's market cap have reported second quarter results. Earnings have exceeded estimates by 13.7 percent in aggregate, with 79 percent of the reported companies beating their lowered projections (sourced by FactSet).

Week in Review and Our Takeaways:

• Commercial real estate has suffered the perfect storm with the COVID crisis, and the situation is still unfolding. However, most property types have been resilient, and we continue to like the asset class over the long-term.

Disclosure

The views expressed represent the opinion of Ferguson Wellman. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Statements of future expectations, estimates, projections and other forward-looking statements are based on available information and Ferguson Wellman’s views as of the time of these statements. Past performance may not be indicative of future results. Ferguson Wellman, Octavia Group and West Bearing do not provide tax, legal, insurance or medical advice. This material has been prepared for general educational purposes only and not as a substitute for qualified counsel who can determine how this information applies to you. We believe the information provided is from reliable sources but should not be assumed accurate or complete.

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