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Thursday, June 11, 2020

Four Commercial Real Estate Trends to Watch Post-COVID


The American work model may be changing indefinitely. We’re all wondering how a shift to a permanent work-from-home culture could potentially affect commercial property managers, owners and developers.

Right now, there are more questions than answers. During this ongoing uncertainty, we are following (and analyzing) key trends to see how they may impact commercial real estate portfolios.


Setting the Stage

During the last several decades, we have seen a tremendous investment in mass urbanization, with demand for multi-use properties and transit-adjacent developments increasing. High-density housing inside urban cores has been growing steadily.

However, COVID-19 and the resulting impacts on lifestyle may forever reshape the commercial real estate market. Forbes reports that this pandemic will "reframe future values, priorities, perceptions of risk, choices, and, ultimately, behaviors."

A recent article in The Week shares the potential ramifications of social distancing, self-quarantine and shelter-in-place orders and says, “The economic effects of the COVID-19 pandemic for urban areas … seem likely to resemble the Great Depression more than the Great Recession where urban migration is concerned. As cities shut down for social distancing, service jobs will disappear, like industry jobs did in the 1930s, and office jobs will go remote. Both shifts incentivize leaving the city and its high costs of living, tight quarters, and distance from family members, especially those in vulnerable demographics.”

USA Today quotes Lawrence Yun, chief economist at the National Association of Realtors, as saying, “people will be much more cautious about living in high-density areas with so many people nearby."

The New York Times reports that, “The pandemic has been particularly devastating to America’s biggest cities … And it comes as the country’s major urban centers were already losing their appeal for many Americans, as skyrocketing rents and changes in the labor market have pushed the country’s youngest adults to suburbs and smaller cities often far from the coasts.”

With the recent civil unrest, many urban cores have also become locales for protests. Forbes senior contributor Jack Kelly says, “It's highly likely that people will start moving out of the big cities …Companies will consider relocating their office buildings into the suburbs. It will be seen as too dangerous to remain.”

The same article also notes that “about 5% of New York City's population, representing about 420,000 people, already moved out of Manhattan during the Covid-19 pandemic.”


Four Trends to Watch

Here are key trends we are following closely.

1: More people will relocate to rural or suburban areas

The effects of recent events may cause a mass exodus of the workforce from urban centers.

According to Redfin, as of March 23, the seven-day average year-over-year change in pageviews was up 115% for homes in rural areas and 88% for homes in smaller towns. Pageviews for homes in urban metro areas with populations of 1 million or more were down 10% over the same period.

In April, a Harris Poll of more than 2000 adults in the U.S. found that almost 40% of those living in urban areas would consider moving “out of populated areas and toward rural areas,” versus 29% of overall respondents. And 43% of urban residents said they'd recently looked at real estate websites for homes or apartments to rent or buy, versus 26% of suburban and 21% of rural residents.

Effects are already being seen. The San Francisco Business Times mentioned recent data that showed apartment rents in Bay Area tech hubs dropped by as much as 15.9% in May. And KQED expects that rents will continue to soften in the Bay Area, and new housing construction will slow.

In fact, in our research, a decrease in urban demand is the only trend agreed upon by all sources. It appears there is no question that many Americans will leave large metropolitan areas. The percentages of that exodus are yet to be determined.

Some sources predict a delay in the impact, as “urban flight is often only an option for wealthier households with remote employment options,” according to business media brand Fast Company. Axios points out that people are less inclined to move during a recession, which could mean that we’ll be dealing with the aftereffects of the pandemic for a very long time.


2: Office leases will not be renewed, or tenants will vacate spaces early

With a labor force fleeing urban areas, businesses will be impacted. Continued remote work could mean fewer office space leases, and demand for commercial real estate will lessen.

Additionally, many companies are now allowing employees to work from home indefinitely, says Forbes, with giants like Twitter, Facebook, Apple and Google leading the way.

Many law firms are readying themselves for increased commercial lease matters, such as forbearance, deferral, lease extensions and terminations.

Litigation is already pending. For example, the San Francisco Business Times reported that Simon Property Group, the largest mall operator in the country, filed a lawsuit against Gap, Inc. for failure to pay rent on its leased properties.

Whether it is because companies do not survive the crisis, or because they have to redefine the role of the physical office or retail center, space will become less critical. Companies, even those that did not have strong work-from-home cultures, will begin to de-invest in office space. The desire for corporate campuses and business parks may dwindle.

Multi-use developments that relied on shared space will see a decline in new tenants. CNBC quotes the head of property research at Singapore’s DBS Bank as saying, “companies could even look at longer-term flexible working arrangements, spurring concerns of a smaller real estate footprint ahead.”

We also have to think of the ramifications this may cause, as many businesses are dependent on a bustling midday crowd. Companies like Specialty’s Bakery, which concentrated operations in business centers and focused on serving and catering office meals, recently closed permanently, according to the Mercury News. The closure of retail or office space will greatly impact neighbors and could potentially cause a domino effect.


3: Developers will shift focus

As demand for transit-adjacent housing and mixed-used facilities in urban cores declines, developers will look to refocus their efforts.

Residential developers will need to shift to larger individual dwelling units — a change from the current trend of smaller living quarters with larger, shared common areas. Common amenities will not have their previous draw.

Luxury properties in urban settings will become less desirable and see a shift to a buyer’s market. However, luxury properties in more rural areas will increase, as the affluent population will start to look into investing in a large, more remote second or third home for an escape. This gives more opportunity for residential investment in these markets.

From Seattle to Philadelphia, news reports are filled with stories of commercial developers pulling out of projects and redesigning their strategy. They may shift to a different workplace model or change industry segments entirely.

The San Francisco Business Times highlighted one major developer, FivePoint, as it pivots on plans for a mixed-use housing development in Candlestick Point, instead shifting to building healthcare facilities.

Nareit reports that grocery-anchored retail is holding value in this climate. This may cause a shift toward investment in “essential business.”


4: Investors will continue to invest

We know from historic recessions and events that investment may slow. But there is always a trajectory toward growth. Investors may shift to tier-two or tier-three markets. There is a high chance money will just flow in different directions, and we will see new, warm trends, post-COVID-19.

We may see an increase in development of suburban hubs that offer a balance of restaurants, retail and entertainment, while allowing for more physical distancing. Close suburbs that offer vibrancy might be the next logical investment opportunity.

Overall, there are many more questions than answers. But, we believe these trends will shape the value and location of investments in coming years, whether it be tax or investment strategy, work-from-home planning or positioning your business for faster analytics and reporting. (One way Armanino is enabling clients to think through these trends is through analytics dashboards like our COVID Recovery Tracker.)

As we look to future impacts, we do our best to anticipate the changes. We plan, prepare and engage resources. However, as political scientist Robert Muggah says in a recent article in Foreign Policy, this situation “is also providing an opportunity for urban planners and entrepreneurs to build back better." You need to also look for growth opportunities, such as government policies that can help your business. Be involved with calculated optimism and stay active in shaping the future of your company.

We’ll continue to follow these trends and monitor their impact on commercial real estate owners, developers and property managers.

Armanino assists real estate investors, owners, developers and property managers in capacities ranging from audit, tax and consulting to advertising. Reach out to learn more about how we can help you develop individualized strategies for your organization. And for the latest regulatory updates and information on keeping your business running through disruption, visit our COVID-19 Resource Center.

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