Profimex’s 2021 Outlook For Real Estate
We thought 2020 would be a relatively calm year with continued moderate growth, low unemployment, and a thriving real estate market
So we thought…
Then, in March 2020, the novel corona virus broke onto the scene and into our lives and tore up the script. The global pandemic has had a profound affect on our daily lives, the global economy, and of course the real estate sector as well. In the U.S., at the height of the crisis we saw a sharp rise in the unemployment rate to more than 14%, entry into a recession, and a dramatic decline by nearly every economic metric. A similar picture has been observed in many countries throughout Europe and the world.
Along with the crippling economic effects, many governments implemented unprecedented aid programs to stimulate the economy and help citizens cope with the complex realities of extended quarantines, mass closures, and the de-facto disabling of major components – even entire sectors – of economic activity. In the U.S., the combined value of the economic assistance programs is estimated between 12-13% of GDP – more than twice that of the 2008 global financial crisis. Central Banks around the world have lowered interest rates to record lows, including the U.S. Federal Reserve, which cut interest rates to near zero, to increase the supply of money and liquidity in the market.
Due to the special nature of this crisis, which was driven by health concerns and not poor economic indicators, the impact on real estate is not uniform. Some sectors, such as Industrial and logistics, benefited greatly; while others, such as, hospitality and retail, suffered tremendously. With that, we have also seen the crisis accelerate a few trends that were set in motion prior to the pandemic. The continued rise of e-commerce, remote work, and the re-rise of suburbs are examples of trends accelerated by the pandemic that are expected to have a long-term impact on real estate economics long after the pandemic ends.
Now that vaccines are being distributed around the world and the opening of the economy seems closer than ever, the central question for 2021 arises: how much will the “new normal” be similar to the “normal” we knew prior to the pandemic? In this brief review, we will discuss the trends and forecasts for the coming year in the major investment areas in which we operate in the U.S. and Europe.
The COVID-19 virus, whose first known infection in the U.S. was detected in March of this year, severely damaged the U.S. economy and the longest continuous period of economic growth in U.S. history was quickly replaced by the sharpest drop in GDP in U.S. history. General and local lockdowns, as well as the closure of substantial parts of economic activity, caused a 24% decrease in consumption in the second quarter of 2020 and approximately a 33% decrease in GDP as annualized. It will likely take until 2022 to return to the GDP levels seen in 2019. The impact of the crisis initially led to a loss of 22.4 million jobs within 5 weeks and an unemployment rate above 13% in May. With a partial reopening of the economy and a period of adjustment to the new situation, the unemployment rate dropped to 6.7% by the end of November.
To help mitigate the economic effects and prevent a long recession the federal government responded by providing an unprecedented stimulus package with immediate assistance of over $2 trillion in direct incentives to both individual citizens and businesses. In addition, the Federal Reserve announced its intentions to leave interest rates at near zero for the foreseeable future, which will provide attractive financing for business and real estate transactions.
With the onset of the COVID-19 vaccine approval process, euphoria began to seep into the capital markets as the Dow Jones Industrial increased by 11.8% in November – the single largest monthly increase since 1987. At the same time, with the end of the pandemic in site, there are many questions about the long-term implications for the economy, particularly given the high levels of U.S. debt, which for the first time since World War II exceed the annual GDP.
From initial indications of various REIT funds and real estate transactions made throughout the year, it appears that the real estate recovery is expected to vary considerably depending on the industry, location, and property type.
Driven by economic stimulus, historicaly low interest rates, the need for housing and a lack of housing supply, the multifamily sector weathered 2020 and the pandemic better than most. Despite a disparity in the economic effects of the pandemic, government stimulus along with increased unemployment benefits enabled tenants across social classes to continue paying rent. Data from the National Multi-family Housing Council, which aggregates information from more than 11 million rental units across the country, shows that the rental collection rate between April and November 2020 averaged 94.9% compared to 96.3% for the same period in 2019.
With the expectation that interest rates remain low and the need for housing remains; the multifamily sector expects a steady recovery in market fundamentals and investment activity in the first half of 2021, with a near full recovery by the end of 2021. CBRE expects multifamily transaction volume to increase to approximately $148 billion, which is below the 2019 record volume of $191 billion but a 33% increase above the $111 billion projected for 2020.
For the most part, the pandemic is accelerating demographic and geographic multifamily trends that were already in motion; however, even slight shifts or accelerations can have a significant effect. Prior to the pandemic, a few major trends existed harmoniously, despite competing for a similar demographic. Millennials, those born between 1981 and 1996, now comprise the largest segment of the U.S. population and the most significant tenant population, and, therefore, continue to be the key driver of these trends.
Burgeoning Sunbelt – The geographic relocation to communities in the “sunbelt” is perhaps the most unchanged and fundamentally secure of the trends, which has only intensified because of the pandemic. Markets that offer a good combination of relative housing affordability and economic diversity with less exposure to industries affected by COVID-19 continue to outperform. Both urban and suburban submarkets in the southwest and southeast regions, such as Dallas, Atlanta, Charlotte, and Jacksonville, to name a few, are likely to continue to outperform the market and provide interesting investment opportunities in the short and long-term.
Strengthening of the Suburbs is another trend that began prior to the pandemic. Catering to millennials with the live-work-play balance in mind, developers built multifamily complexes in suburbs that offered some of the benefits of city-living – chic and trendy amenities such as pools and fitness centers, with a short drive to restaurants, entertainment, and, most importantly, strong employment opportunity. This trend is expected to continue, but the quarantines and the need to work from home put a crucial emphasis on the quality and spacing of residential properties, and therefore the future of this trend will be driven more by amenity packages that account for home office space, outdoor space, and healthy and well-spaced amenities.
At the same time, there has been a trend of young people and students between the age of 18 and 29 returning to live with their parents at the highest rate since the Great Depression.
Respite to Major Cities – Prior to the pandemic, the multifamily and office sector, alike, benefited from a two-decade-long urban renaissance, which was transformative for cities both large and small across the United States. Urban markets, particularly gateway cities such as New York and San Francisco, have been hardest hit by the pandemic. Big-city-living, considered one of the most appealing trends immediately prior to the pandemic, has lost its momentum. Experts believe that while these cities might struggle for a few years, this COVID- induced pause in their appeal is not permanent, thereby provide long-term upside potential. In the end of the day, large cities provide economic, social, and cultural opportunity that cannot be found elsewhere.
The office sector experienced a deep shock in 2020. Disrupted labor markets, a sharp rise in the unemployment rate, the need to socially distance, and the ability to work from home, led to offices remaining closed for extended periods of the pandemic. At the same time, the long-term nature of office leases helped mitigate the immediate financial impact and helped landlords get through 2020 safely.
Opinions about the recovery and future performance of this sector vary substantially, but fundamentally address the same question – is the work-from-home trend here to stay?
The demand for office space will largely depend on the balance between an employer’s future need for additional physical office space to provide for a safe and productive work environment for the employees; measured against the effect of moving to a “hybrid” work environment, where employees both work from home and the office.
The optimist believes that offices are more than just physical space; rather, they are necessary for establishing company culture, organizational creativity and innovation, training employees, and have a positive effect on employee morale and productivity.
Interestingly, the largest tech firms, such as Facebook and Google, are exploring permanent work-from-home options for employees, while simultaneously increasing their office space in several major markets. It is this trend – a mix of work-from-home and from the office – that will dictate the future of the office sector.
We believe that offices are here to stay, and it is far too early to mourn the death of the office sector. At the same time, even marginal changes in the way employers approach work-from-home may have a significant effect on certain locations and certain assets.
Two sub-categories that will potentially provide for attractive investment opportunities, are suburban office and life science and medical office. The sub-urban office sector has been the largest absorber of office demand in the past ten years and the demographic shift to the suburbs, accelerated by the pandemic, may lead to more firms relocating to cost-efficient non-Central Business District (CBD) locations.
Life science and medical office, on the other hand, is supported by an aging baby-boomer population combined with increased spending on healthcare. The undersupply of medical office properties, even considering the increased development activity over the past few years, makes this an attractive investment target. In addition, the spotlight given to this field in the current crisis and the increased budgets allocated to areas of medical research, along with the existing shortage of such assets, makes this an attractive area of investment.
For the past 5 years, industrial and logistics has been the darling of the real estate world, consistently outperforming expectations in both relative and absolute terms. Logistics entered 2020 with a near historic high national occupancy rate of 95.4%, and occupancy rates near the largest consumer markets (such as Los Angeles, New York, Chicago, etc.) were closer to 98%. The growth of logistics has been driven by multiple catalysts including e-commerce, speed-to-consumer supply chains, and last-mile delivery.
The pandemic increased demand for logistics and warehouse storage wherever it was available, due, in part, to a dramatic $150 billion increase in online spending in 2020. Looking forward, we expect e-commerce demand to continue to grow. A CBRE study found that every $1 billion increase in online sales consumes 1.25 million square feet of new logistics and storage space. In 2021, peak demand is expected to reach 250 million square feet. While there is record breaking new supply coming to market, it is still outpaced by the historically high demand.
In addition, the pandemic caused many companies to realize that the supply chain is the lifeblood of their revenue stream. Therefore, we expect more companies to fine-tune their supply chain strategies, maintain higher levels of inventory, and require more storage on all levels of the supply chain.
A surge of supply in the real estate market in early 2021 is expected to outpace demand in the short term, bringing rental growth to a temporary pause and adjusting the vacancy rate to a healthier 5%; however, with lower anticipated supply and intensifying demand drivers, market rental growth is poised to strengthen, led by last-mile delivery and cold-storage.
During the last year, the hospitality sector has been one of the hardest hit sectors due to the dramatic drop in travel and vacationing. In the second quarter, as lockdowns peaked, revenue and occupancy dropped to levels not seen since the 2008 financial crisis. As vaccines become available to the public in early 2021, we expect travel to begin to normalize, and by early 2022, we expect a surge in travel that will push well into 2024. With that said, there is uncertainty about the pace of business travel considering the widespread adoption of Zoom meetings and remote business activity.
Recovery for the hospitality real estate sector, however, is a bit more complicated. Many owners have accrued significant levels of debt, and a slow ramp-up of vacationing might not be sufficient to cover their debt service. The drop in hotel property transactions was largely due to large bid-ask spreads, limited debt available for hospitality-related real estate, and continued economic uncertainty. Owners looking to sell assets to reduce leverage were trading at 15 to 40 percent discounts from pre-pandemic values, depending on the level of distress. This trend will likely continue to expand as pandemic related pain deepens. On the other end, this presents interesting investment opportunities for those with healthy balance sheets access to financing, and the ability to manage through the uncertainty currently hovering over the sector.
Retail and Shopping Centers
Prior to the pandemic, retail was in steady decline and many industry experts believed that the era of traditional big-box shopping centers and one-size-fits-all retailers was coming to an end. The increase in online shopping created an excess supply of retail space leading to a fall in property values in certain areas across the U.S. COVID-19 has only exacerbated this, as the retail sector was hit hard with record bankruptcies.
On the more optimistic side, many retail experts also believe that well located brick-and-mortar retail will be beneficial for companies looking to build a more robust customer experience and deepen customer engagement. Additionally, the increase in online sales in 2020 was in-part due to necessity and many experts believe that this number will decrease slightly in favor of in-person shopping.
The rate of recovery remains a threat to the sector as well. Experiential and entertainment tenants such as food and beverage, amusements, and one-of-a-kind activities, which was viewed as the future of retail prior to the pandemic, is likely to have a delayed recovery due to the health concerns of congregating in enclosed spaces; however, this tenant mix is likely to recover over the next few years. On the other hand, retail centers anchored by regional supermarkets will make a quicker recovery.
Although the retail footprint will continue to contract in 2021, what remains will be stronger, more interesting, more convenient, and more experiential. Retail properties will largely depend on the quality of the property, access to the property, and the tenants that anchor them. Additionally, leasing and transaction volume will likely grow in 2021, driven by the fall in prices and rental rates during 2020.
Lastly, in the long run we expect see adaptive reuse and conversions of Class B and C shopping malls and retail centers into logistics centers and multifamily developments; however, this requires extensive capital, sophisticated rezoning, and is frequently challenged by the surrounding communities, as such it remains in the long-term periphery.
Like in the U.S., the novel coronavirus presented a challenging year in Europe. Surging infection rates and imposed lockdowns dragged the European economy into a recession, impacting businesses and individual lives. European countries also introduced a wide range of economic aid programs for individuals and businesses, including the European Union’s €2.2 trillion pandemic recovery fund for those most affected by the crisis.
Investors have appreciated the various stimulus measures implemented by European countries individually and collectively. Nevertheless, countries were able to cope with the pandemic and new environment with varying degrees. Investors, looking for low-risk investments largely chose Germany, proving itself as Europe’s safe-haven for containing the coronavirus better than other countries and keeping the economy largely open. As a result, German real estate transactions accounted for 34% of Europe’s total, up from 28% last year. The UK and French market-share came in second and third with 27% and 11%, respectively.
Considering the continuation of negative interest rates and increased enthusiasm about access to vaccines in 2021, European real estate markets will continue to attract individual and institutional investors alike. The positive developments towards the end of the year give us confidence that Europe will remain an attractive location for real estate investments.
Summary & Final Thoughts
With best wishes for the New Year & Keep safe,
The Profimex Team
CBRE U.S. Outlook 2021
Knight Frank wealth report 2020
Pwc: 2021 emerging trends in real estate – US and Canada
Pwc: 2021 emerging trends in real estate – Europe
Savills Article: https://www.savills.co.uk/insight-and-opinion/savills-news/307711/savills–germany-s-share-of-european-real-estate-investment-increases-as-prime-office-and-logistics-yields-in-europe-harden
U.S Department of Commerce – U.S. Census Bureau
U.S Department of Labor – Bureau of Labor Statistic