As the COVID-19 pandemic continues into 2021, there is still much uncertainty as to the longer-term impact on real estate markets. While the impact has been widespread, certain sectors and markets have been harder hit than others due to shelter-at-home policies, economic disruptions and ensuing job losses.
The COVID-19 pandemic has not only exacerbated trends that were already in place (such as the growth of e-commerce) but has turned existing trends on their head (office densification, for example.) It’s also created newer trends (such as working from home, increased demand for suburban residential) — the extent and duration of which are still unknown.
Versus the global financial crisis, the COVID-induced recession is expected to be more short-lived with less impact to property values as a whole. Real estate fundamentals were much stronger going into this recession. Many property owners, conscious that it was late in the cycle, had reduced leverage and had assumed a more defensive positioning. Additionally, with the exception of a couple of overbuilt pockets on the multifamily side, supply for the most part was not an issue. The lending market was also in a stronger position this time around. We have only started to emerge from the shutdowns and shelter-at-home policies that brought the transaction market to an abrupt halt in March. Overall, according to Real Capital Analytics, transaction volumes declined 57 percent year-over-year as of September and current deal volumes remain well below pre-COVID levels. Firm closures and job losses have resulted in lost revenue and incomes for tenants, impeding their ability to pay rent. Value-add and development projects stalled and leasing activity collapsed. While the lifting of some of these restrictions helped alleviate the damage to some extent, increasing infection rates are resulting in localized lockdowns, and putting further pressure on property owners, particularly in the retail and lodging sectors.
In terms of those sectors, both retail and lodging have felt the most immediate impact and suffered the biggest declines. The outlook for both sectors remains challenging over the near term. Other property types, such as industrial and apartments, have been more resilient. Valuations for the most part have held up, particularly for industrial. Apartments have seen some rent pressure and concessions have become the norm in some urban areas as landlords battle to attract renters. The big question is office and to what extent office workers will continue to work from home. Long-term leases have supported office valuations; however, the outlook is less certain as lease roll-off increases throughout 2021 and beyond. Will the need for greater space due to COVID requirements help offset the loss of remote workers? Interestingly, niche sectors such as life sciences, data centers, cold storage and self-storage have been relatively strong performers, while medical office, senior living and student housing have recovered to some extent after an initial pull-back. Outside retail and lodging, there is little evidence yet of a widespread “COVID discount” due to limited transaction volume. As such, fund managers are adjusting valuations as they see fit and on a case-by-case basis. Conversely, there is even some talk of a “COVID premium” for industrial assets.
Overall, the impact to private real estate as a whole has not been as bad as initially expected, with the exception of some sectors such as retail and lodging, which have been disproportionately affected. However, despite vaccines providing hope for an end to the pandemic as well as government stimulus/intervention, much uncertainty remains as to its duration and the shape of the recovery. Softening fundamentals are starting to impact property pricing.
Looking ahead we expect:
Other observations to consider in 2021:
Notably, there was $4.5B in investment queues across 14 of the 22 funds, 70 percent of which was concentrated across four funds (Principal US Property Account $955.5M, Morgan Stanley Prime $892, PGIM PRISA $643.3M and CBRE $635M). Some funds have reported an uptick in interest in the last few months.
The COVID-19 pandemic has wreaked havoc across the world with lives lost, economies stalled and livelihoods destroyed. The effect of the virus has been far-reaching but disproportionate in its impact. The impact across societies, industries and markets has been mixed. Real estate is no exception.
The disparities in performance across different sectors and markets highlight the need for diversification within the real estate allocation.
As mentioned, many core funds have large allocations to office properties and gateway cities. In a market where transaction volume has stalled, it will be difficult for many core funds to alter their sector and geographic allocations in the near term. While we do not know the longer-term impact on properties and markets, it may be worthwhile considering reallocating capital or increasing exposure to the multifamily and industrial sectors, look toward more growth-oriented markets and/or to non-traditional property types such as medical office, senior living, etc.
Segal Marco Advisors provides consulting advice on asset allocation, investment strategy, manager searches, performance measurement and related issues. The information and opinions herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Segal Marco Advisors’ R2 Blog and the data and analysis herein is intended for general education only and not as investment advice. It is not intended for use as a basis for investment decisions, nor should it be construed as advice designed to meet the needs of any particular investor. Please contact Segal Marco Advisors or another qualified investment professional for advice regarding the evaluation of any specific information, opinion, advice, or other content. Of course, on all matters involving legal interpretations and regulatory issues, investors should consult legal counsel.
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