While we’ve repeatedly struggled with pestilence—including the Black Death of 1348, the cholera epidemic of the 1820s, and the emergence of AIDS in the 1980s—history offers no precise parallel to what we’re experiencing now.¹ Even in 2003, when SARS was identified, the global movement of people, raw materials, and products didn’t match the velocity and volume we’ve grown accustomed to seeing in more recent years.² The interdependent web of transport networks, shuttling humans and their wares worldwide from one commercial hub to the next, has helped spread COVID-19 much farther and faster than it might have only a decade or two ago.
History offers no precise parallel to what we’re experiencing now.
Working remotely, we’re collaborating with our colleagues, our tenants, and our investors to slow the spread of the disease, as we also continue to carry out our fiduciary duties in managing commercial real estate portfolios.
We’re also paying close attention to capital markets to monitor new deal flow (none), completed transactions (few), failed transactions (several), pricing discovery (too early), and debt financings (paused). While most segments of the market will suffer some degree of near-term disruption, some property types aren’t as well positioned as others. Real estate linked to the hospitality and service segments, including hotels and retail centers, might be the most immediately vulnerable, although grocery-anchored retail complexes appear more insulated. Longer term, what’s likely to be normal in 2021 and beyond probably won’t reflect business as usual in 2019. We see the COVID-19 experience as a possible driver of at least three structural shifts in the U.S. commercial real estate market.
1 A revaluation of just-in-time supply chains
U.S.-based multinational corporations may reassess their supply chains, which could result in a reversion to manufacturing more critical products and components domestically. Companies are likely to revisit existing business continuity plans, too, particularly mission-critical back-office functions that have migrated overseas. Many executive teams may also elect to buffer their inventories, or double down on redundant capabilities. While a long-standing trend toward just-in-time delivery has helped reduce warehousing costs, it’s also left less margin for error along a far-flung global supply chain. The coronavirus pandemic has made the risks clearer: A disruption in a corporation’s supply chain can quickly lead to a disruption in its business as well.
If onshoring and more redundant operations take hold, industrial demand in certain U.S. markets could see a big boost. Manufacturers might be inclined to favor less expensive locales with more affordable labor. Inland markets, such as those near Chicago, Dallas, and Phoenix, for example, might outperform established coastal markets, such as those in northern New Jersey or Southern California’s Inland Empire. A relative shift in emphasis from coastal markets toward the middle of the country would likely represent a net positive for the U.S. industrial property segment as a whole, particularly big-box and modern warehouse complexes in established midwestern, southwestern, and southeastern logistics hubs with access to railways, interstate highways, and commercial air transportation.
2 An accelerating flight to e-commerce
While the migration to e-commerce from brick-and-mortar stores has been a long-standing trend, the recent conditions caused by the coronavirus pandemic may prove difficult or impossible for relatively weaker retailers to weather. Almost overnight, online shopping has become less of a convenience and more of a necessity for many of us, accelerating the growth of e-commerce’s share of the overall retail market. Many traditional retail properties may shutter and be repurposed; certain grocery-anchored shopping centers and experiential retail centers may hold up relatively well, but they’ll be forced to adapt. Grocery stores might become distribution hubs or be retrofitted to accommodate more direct delivery and curbside pickup. Again, this points to a net positive for industrial segments, both the big-box, modern warehouses and the last-mile, or last-touch, fulfillment centers near densely populated areas.
3 A reassessment of flexible work arrangements and density considerations
If history’s largest work-from-home experiment ultimately reveals that employees can be just as productive without leaving their homes, many employers might be more inclined to accommodate flexible arrangements that don’t require their staffers to commute into the office each day. Under such a scenario, we’d expect an increase in the use of business centers at apartment complexes and other multifamily properties, also creating new demand for unit types that have second bedrooms or dens that can serve as home offices.
More flexible work arrangements could also reduce corporate office space requirements and, by extension, demand for downtown office properties. A potentially offsetting factor, the coronavirus crisis has drawn attention to health risks inherent in open and shared workspaces, which may cause some companies to revert to traditional enclosed office settings, which would actually increase per capita office space requirements, all else being equal. Moreover, certain benefits of in-person camaraderie just can’t be replicated remotely, and many firms will likely maintain traditional offices to maximize employee engagement and perpetuate the corporate culture.
Perhaps the more relevant question is, will population density drive big-city life and work beyond the pale? New York’s ongoing struggle to slow the spread of COVID-19 underscores the pitfalls of population density risk like no other event in modern memory. Many firms may think twice before maintaining a large presence in megacity centers; we may see more corporate headquarters migrate toward suburbia in the years ahead. Lingering public health concerns and changing cultural preferences may also drive residential tenants to less dense multifamily properties, favoring the suburban over the downtown, with increased demand for low- and mid-rise buildings over high-rise skyscrapers.
While some segments are better positioned than others, we expect to see major structural shifts in the way people perceive, use, and invest in virtually all property types.
Nimbleness has never been more important for real estate investors
While there’s so much we don’t know, we have to assume the implications for the commercial real estate industry will be substantial. While some segments are better positioned than others for the moment, we expect to see major structural shifts in the way people perceive, use, and invest in virtually all property types, with countless microshifts along the way. Real estate managers with narrow mandates and legacy portfolios might not be able to transact quickly enough for new and changing circumstances. As a result, strategies with more flexibility could be better positioned to take advantage of the structural shifts we see on the horizon.
1 The Black Death and the Transformation of the West, David Herlihy, 1997. 2 who.int/ith/diseases/sars/en/, 2020.
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