Key takeaways

1. Retail and hospitality properties are getting hit hard now and will take long to recover
2. Industrial properties are a clear beneficiary from the crisis, as consumer and corporate behaviors change
3. Multifamily and office properties are faring well – for now – but likely face headwinds in the future

The COVID-19 crisis is sending a number of mixed signals across the five key commercial property types. The crisis has accelerated some trends and nearly halted others.

Burning

Retail (RT)

On one end of the spectrum sit retail properties. While not every retail property is the same, retail properties as a whole are in a world of hurt right now. When the American consumer started to quarantine, they stopped going to stores (except where they could buy groceries), eating out, and buying stuff. This halt is visualized by the freefall of the advance retail sales time series below. The rapid change in consumer behavior put a major liquidity squeeze on many retailers, who were forced to make difficult decisions – seek emergency funding, furloughs, layoffs, and potential insolvency. Two major themes that are apparent across many retail properties are:

Deleveraging

The current crisis has accelerated the speed of many anticipated bankruptcies, deleveraging the retail sectors’ collective balance sheet.

Decreasing

The current crisis has also expedited store closures, decreasing the physical footprint of the sector’s large retail chains and department stores.
Both of these “deleveraging” and “decreasing” trends have been underway for years, and were expected to continue, but this crisis is turning a steady pace into a massive wave. So long as the virus is on consumers’ minds, there is a real challenge posed for “experiential” retail.

The recent drop in advanced retail sales and food services is the largest drop ever seen.
(Source: https://fred.stlouisfed.org/series/RRSFS)

Hospitality & Lodging (LO)

Hospitality and lodging was hit very hard, too. If sleeping in a bed that was used by a stranger shortly before sounds unappealing before the pandemic, it now sounds like a potential life risk when fears of the virus began to spread. If the drop off in consumer demand wasn’t enough, travel bans and lockdowns have made travel (business and leisure) all but impossible. Flagged and unflagged hotel properties saw occupancy rates dropped off a cliff, falling below 30% in major and minor cities.

While hospitality has traditionally been a boom and bust property type, and many expect it to continue to be, there is concern that revenue per available room (RevPAR) will likely take years to recover to recent peaks. While this bust is much more severe, there are pockets of light in an otherwise dim picture – long term rentals, economy, and extended stay properties are performing well through the crisis and will likely be the budget-friendly option available when the American consumer emerges from their quarantines and are looking for a change of scenery (and something more real than a new virtual Zoom background). While many hotel operators will not survive this crisis and will be forced to sell or shut shop, some of the larger hotel operators with stronger balance sheets to weather the storm, have expressed an appetite for acquisitions.

Earning

Industrial (IN)

If retail and hospitality are on one end of the spectrum, industrial properties are on the other end. Industrial properties look to be largely benefiting from this crisis. Last-mile distribution and fulfillment centers, which were already hot coming into 2020, are getting additional fuel for their flames as more people stay in and shift their shopping to online channels. Also with interrupted supply chains and troubled trade negotiations, there is a real case to be made for moving away (at least partially) from just-in-time inventory management, as well as on-shoring production – two additional trends that may increase the demand for industrial space. Other industrial property sub-types, including refrigerated storage and data centers, are also performing well, as demand for their use remains high during the quarantine measures and they require very few people to maintain / use.

Churning

While retail and hospitality are clearly in a lot of pain right now and industrial appears to be benefiting, the cases of multifamily and office are not so clear.

Office (OF)

While performance across office properties has remained strong – April office rent collections reported by REITs were generally around or above 90% – this is likely buoyed a bit by government stimulus (i.e., Paycheck Protection Program). Many corporate tenants are not going to make it out of the crisis and will have to shut down. And those that do survive will have to consider what they will want to do with their office space. The future of office properties has been called into question by many. Companies that were able to adapt to remote work will likely keep remote work to some degree in the future, even when quarantines are over and a vaccine or cure are available. Greater flexibility for employees and cost savings for employers look like promising incentives for both employees and employers.

While there will be a natural decrease in demand for office space as many firms shutter for good, we are still social creatures and many jobs will benefit from a degree of collaboration in person. Also, there is an element of peer pressure that is difficult to measure now, while everybody is working from home. A shift away from open office plans with trade-floor style seating will give way to more square footage per person – so while fewer employees will likely be in the office at any given time, many companies will still require more space for those who are in the office. And with fewer workers in the office at any given time, and a more disparate employee base due to the flexibility of remote work, many employers might choose to relocate their headquarters to warmer, cheaper, or more tax-friendly locations.

Multifamily (MF)

More prevalent remote work policies will also serve as a tailwind for millennials’ continued push towards warmer weather (South and West) and lower cost of living locations. While crises in the past have demonstrated the resiliency of multifamily housing – especially more affordable workforce housing – this crisis appears to be different because of the disproportionate impact that the employees of service industries have been feeling. So unlike past recessions, where Class B and Class C multifamily property performed well, during this crisis, it appears as though the Class A properties are in better condition as the tenants tend to be higher paid and in jobs that were able to adjust more readily to the quarantines.

The future of multifamily has also come into question, as positive rent growth expectations have been hampered by a more gradual recovery with high unemployment. Shared tenant amenities, once a source of rent growth justification, are likely less desirable in a post-COVID world. Rather, residents will likely prefer more space for their remote working set up. Additionally, depending on how long it takes to find a vaccine or cure, there could be a decrease in overall resident appetite for multifamily living and a greater desire for a single-family home with a yard and more space.