The collective eagerness to finally put an end to the rollercoaster year of 2020 is palpable. With seemingly more exciting events (both downs and ups) than one year usually contains, the year 2020 will not be forgotten for a long time. Major events in nearly all aspects of life – medical, social, political, technological, and economic – affected all of us at the individual and group level. News coverage of these events were constantly vying for readers’ attention. It was the year when the world seemed to suddenly stop. And then restart – though not without significant friction – with jerks and jolts along the way.
For US commercial property markets, 2020 will certainly be memorable. It was the year when many existing trends were accelerated and new trends emerged. At first, these changes were thought to be temporary, like the pandemic that accentuated them. However, as time passed but the pandemic remained, many began to think that some of these pandemic-related changes in speed and direction to trends may stick around much longer than initially expected.
For a quarterly complete recap of 2020, check out Hindsight 2020: A look back at the past year
While we believe that 2021 will be a much more stable year than 2020, we do think that there are many major areas of change worth paying close attention to and have highlighted the top three below. Many of these areas of change are not novel, but we believe are likely candidates to capture the theme for 2021. These areas of change are broad, but have major implications for commercial property markets, owners, operators, and service providers.
Here are the major changes we are watching in 2021…
Fund frenzy
The hunt for yield and continued rise of massive non-bank players will help buoy commercial property values and financing, even as banks become more cautious.
Even though benchmark yields have increased over the last nine months, they remain well below pre-pandemic levels and are historically low. With few expectations for a rate increase in the near term and continued support from the central bank to stabilize financial markets in case of continued pandemic-related disruption, the risk-appetite that once left the market when the pandemic initially hit, has largely returned.
Coming into 2020, the main commercial property financing sources were expecting to see largely a continuation of 2019. However, that didn’t quite go as planned. By the second quarter of 2020, the institutional capital sources began to have very different outlooks for the year. Private label CMBS issuance halted, banks shifted focus to PPP loans and dealing with criticized or non-performing credits, REITs explored big strategic moves in terms of refinancing if they could or combinations / exits, and funds generally shifted focus to distressed opportunities and hands on asset management. With the exception of the government sponsored enterprises (GSEs), which barely took a breather on the residential / multifamily side of the house, the pandemic slowed down nearly all other capital sources.
Excess capital, a low yield environment, and increased expectations for inflation will drive commercial property debt and equity financing in 2021. While many bank lenders will be focused on risk mitigation and reduction within their existing commercial property loan portfolios, the other major capital sources will be jumping into the new year with both feet. Non-bank competition, which has picked up significantly in late 2020, will continue through 2021, as these capital allocators try to fill commercial property target allocations.
While the GSEs will continue to dominate in any multifamily financing that fits within their mission, the real action to watch will be in the non-bank space (REITs, funds, insurers). These institutional players have billions in dry powder that needs to be put to work and performing commercial property is an attractive asset class both in relative and absolute terms. As these non-bank capital sources finance commercial property through large portfolio transactions and one-off transactions, they will fill the financing gap created by bank lenders pulling back. This non-bank financing activity will also help increase price discovery across commercial property markets; however, not all property types stand to benefit.
The key differentiator between property type performance can be boiled down to valuation basics – certainty and timing of property cash flows (revenues and NOIs). Already we can see that the property types that have had the most disruption in 2020 cash flows have underperformed (hospitality, retail), while those which exhibited more certainty and less interruption outperformed (industrial, and niche property types such as life science and self-storage). We can expect to see this continue in the new year.
Changed climate
Call for greater focus on ESG from regulators and capital sources will catalyze discussions about incorporating across commercial property markets – beyond building certifications
Considering sustainability and social impact of an investment in addition to the traditional return and associated risks, is not a new concept. However, the recent push for being able to better measure and monitor three of key factors of sustainability and social impact – environmental, social, and governance (ESG) factors – is gaining more widespread traction in the US than ever before.
While calls in the past by individuals, select firms, or advocacy groups for greater attention to these three ESG factors have been heard, but didn’t really catch on as they had in other parts of the world. Whether it was reporting carbon emissions or management / board diversity, these issues didn’t seem to be all that relevant for US firms to report. However, this appears to be changing.
What makes this time different is that the calls for change are not coming from a few individuals and advocacy groups, but rather from many of the major sources of capital and key regulators and the political climate is just right for a large-scale adoption.
What does this mean for US commercial property markets? Big changes – but not immediately. Each of the three factors (environmental, social, governance) need to be better defined for commercial property market participants. 2021 will likely be a year of key discussion and decision making in terms of planning what to measure, how to measure it, and where to report it. While this doesn’t sound exciting, this has real potential to have a lasting impact on the industry – with real financial consequences. If capital providers in the future have to measure and report and manage their ESG factor exposure, it will be critical for each property to be able to do the same.
Historically, most of the overlap between ESG and commercial property has been at the property level – e.g., “green” certifications, specialty financing for environmentally-friendly upgrades, percentage of units reserved for affordable housing. However, with greater push and adoption of ESG by capital providers, it is conceivable that the scope of these factors will go beyond what is within the four walls of a building – and will seek to capture the broader impact that the property plays in the local and broader community and environment.
Diverging demographics
Differences in consumption habits and location preferences between older and younger Americans will continue to diverge and dictate the winners and losers in the pandemic recovery
Many of the major changes that emerged from the pandemic were behavioral and affected where and how we earn and spend money. In doing so, these changes reshaped much of the thinking about the demand for commercial property. The accelerated rise of online shopping, wide adoption of remote work, and large-scale relocation away from cities are three of these major trends that received ample coverage during the pandemic. These changes have been key contributors to the recent performance deltas across property types and will continue to do so through the recovery.
Despite the vast majority (70%) of US wealth being held by Boomers and the Silent Generation (people 56 or older, the largest generation working and earning in the labor force is the Millennial generation (people 39 or younger). During the pandemic, the generational differences in consumption and work were less pronounced, as many of the pandemic responses taken by individuals and governments were applied universally and irrespective of generation. For example, lockdowns and quarantine rules generally differed by state, and many workplace rules differed by industry (e.g., essential vs non-essential) or company. However, as the increased availability of the vaccine helps to fuel the gradual transition away from an open-shut-repeat economy in the new year, the generational differences based on preferences will become much more pronounced.
Generational changes tend to be gradual, however, because COVID-19 is more dangerous for older adults than it is for younger, the post-pandemic recovery will largely be shaped by the increasingly more prominent Millennials and Gen Z’ers. And it is their preferences in both how they earn and spend their money that will help explain a lot of the recent shifts in demand for different commercial property types.
They will want the option to work remotely, but not miss out on having an office entirely. They will do most of their shopping online (through Amazon Prime), but will be certain to browse cool stores in person – especially for big ticket items. While many did learn to make food from home during the pandemic, they still appreciate restaurants for more than just the Instagram-worthy cocktails and décor. And while many will consider moving out of the city and buying a house, the convenience of city living will likely push more to consider relocating from the major gateway cities to smaller cities, rather than picking up a commute of greater than 60 minutes. And while they won’t get to do too much traveling for work in 2021, they will be finding great deals on Airbnb and using up credit card and loyalty points for all of their friends’ pandemic-delayed weddings (which will have an unsurprising lack of older family members).
Key Property Themes for 2021 and Beyond
