Major League Baseball’s iconic Hall of Fame catcher, Yogi Berra, famously said this about a
restaurant awhile back but the pandemic has created inconsistencies in the real estate market
that makes the joke relevant in this context as well. While we certainly don’t want to diminish
the tragic loss of life and economic hardship caused by Covid-19, this post will focus on the real
estate implications of the pandemic. This giant forced experiment has upset real estate
fundamentals as we previously understood them. Here’s where I think real estate fundamentals
go from here. As much as we love partnering with you on your real estate transactions we also
would like to have an exchange of ideas so please let us know what you think as well.
To quote Yogi one more time: It is tough to make predictions, especially about the future.
One can argue that residential real estate will move seamlessly back to “business as usual” once
the pandemic recedes. Overall, the economy should bounce back quickly when normalcy is
restored. Because asset prices are a function of money supply, with the central banks being
accommodating, real estate will stabilize along with the rest of the economy. Employees
working from home and retail weakness were factors that everyone was very aware of well
before the pandemic so all this past year has done is accelerate these trends. So maybe the
answer is that simple and aside
One can argue that residential real estate will move seamlessly back to “business as usual” once
the pandemic recedes. Overall, the economy should bounce back quickly when normalcy is
restored. Because asset prices are a function of money supply, with the central banks being
accommodating, real estate will stabilize along with the rest of the economy. Employees
working from home and retail weakness were factors that everyone was very aware of well
before the pandemic so all this past year has done is accelerate these trends. So maybe the
answer is that simple and aside from a funny cartoon and the trivia at the end of this blog we
can stop our analysis right there.
The problem is we all know recovery is going to be a lot more complicated than that.
Even in “normal times” it is easy to forget that macro factors drive real estate markets. We
often get caught up in the specific transaction, whatever it may be, and we don’t recognize that
the takeout for our deals is driven by macro factors that are changing in a variety of ways. The
uncertainty of the pandemic has created many more variables potentially impacting the real
estate market for many years to come.
Work-from-home levels post pandemic will impact office, retail, residential and every other area
of the economy. An estimated 18% of US workers will likely work from home every day in the
post-pandemic era, more than double the 7% who did beforehand, according to a director of
the Transportation Laboratory at the University of Illinois at Chicago. This could very well be a
conservative estimate and if you then include those workers who use some hybrid model the
impact on all of these sectors cannot be overstated. Just to take one non real estate example,
think about the potential impact to municipal finance as public transportation ridership
decreases by these kind of numbers. This is the kind of change not discussed in mass media
right now. Factors such as these will slow investment in many sectors until we get more clarity
on how and where we will work going forward.
Given that real estate is often a game of leverage, changes in interest rates can have huge
implications. The 10 year treasury has already moved from 50 bps in early August to 1.10 %
today so rates have been moving up. We continue to be in a very favorable interest rate
environment even with this recent move up in rates, but that could change quickly in these
uncertain times. In March, when Covid spread rapidly, financing dried up and so did the real
estate markets that were fueled by it. If interest rates rise significantly, a similar slowdown in
real estate could occur.
All fair questions for sure. But, I do believe that the basic demand for better housing options will
continue even when this pandemic is far behind us.
There is plenty of negative data to go around to make a case for challenging commercial
markets, for many years to come. One survey said that 43% of all tenants are looking to reduce
their office space needs going forward. Office vacancies in Manhattan jumped to a twenty first
century record. A partner at a global law firm told me that they plan on reducing their office
space by about 25-33% as lawyers are working productively from home. I am sure we can all
add our own stories to the negative commercial office space case, but there are some positives
as well. First of all, we are all social creatures by nature. Management wants collaboration and
brainstorming to take place. Less experienced employees need access to mentors. There are
many reasons that an office place is needed for companies to operate at peak productivity.
Further, many companies are talking about increasing the square footage per person to go from
125 to 175 for social distancing purposes, which could offset some of the workstation
reductions.
Retail is also suffering . A commercial real estate broker representing a tenant who owns a chain
of coffee shops told me that he negotiated a lease for his client whereby he pays 40% of the
rent until sales reach pre pandemic levels. On the other hand, supermarkets and banks were
paying full rent throughout the pandemic. Hospitality is also having its issues. One can argue
that even after leisure travel returns to pre pandemic levels, business travel will diminish as a
zoom call is almost as productive and much less costly and more efficient. There is certainly a lot
to think about in the commercial sector.
If you believed in that adage before the pandemic, it is even more accurate today. The
pandemic has had very different impacts on real estate depending on location. Some areas have
suffered more severely from Covid than others. Urban has, generally speaking, suffered more
than suburban or rural real estate. If you are involved in a foreclosure state, you were relying on
a process that shutdown. One multifamily deal had an occupancy decrease from over 90% to
70% because the tourist industry in that city has been hit so hard. Location matters now more
than ever in real estate, in ways we never would have imagined just one year ago.
When I worked on Wall Street, I hated when firms would put out research without any
conclusions, so here it is: In residential the enduring desire to live in a new or improved single
family house will drive that market higher. It might not be in a continued straight line, but the
pandemic has only reinforced this inclination. Residential will continue to thrive. Commercial
offices will be in for a challenging few years, but ultimately office demand will bounce back.
Trivia — Just for the fun of it.
Here is some real estate trivia:
Thanks so much for reading this — we would be happy to discuss any of this in more detail if you
have any questions or thoughts.
Brandon Dunn is the Chief Capital Markets Officer at Roc360. Brandon began in fixed income sales and trading roles at institutions such as JP Morgan, Deutsche Bank, Smith Barney and LF Rothschild. He later became co-head of trading groups and Managing Director and Head of Structured Product Marketing at UBS. At Roc360, Brandon is responsible for all capital markets related activity and investor relations. He supports these efforts by leading the origination team and being involved with due diligence processes.
