The State of the Market 2021

state of the market blog image
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.
Workspace
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.
Interest Rates
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.
Residential
In a nutshell, single family residential is hotter than ever. Covid has encouraged people to move from urban apartments to suburban homes. People want more space for an office, kitchen, home gym, and, frankly, to remain a safe distance from others. US home prices jumped in October by the most in more than six years. The pandemic has added to a perfect combination of factors that are driving home prices in just one direction. Of course, we all know that markets don’t just move in one direction forever, so, the question becomes, what will slow this rally in residential home prices and what is the timing? Will housing affordability finally be thwarted by an increase in interest rates? Is everyone going to move to Montana to build a house on 20 acres because workers no longer need to be near an urban office? Is a house that just sold for a price way above where it traded two years ago, because of Covid flight, simply go back down in value when fears subside?
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.
Commercial
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.
All Real Estate is Local
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.
Yogi Berra predictions
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:
  1. What is the largest private real estate development project in American history?
  2.  What was the nickname of the Empire State Building when it was opened in 1931?
  3. In what country do homeowners paint their front door red when they pay off their
    mortgage?
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.
About the author
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.

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