Commercial Real Estate Turns a Corner to Recovery

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The end of the slowdown in deals for commercial real estate appears to be near. While initial shock over the global impact of Covid-19 sparked dire predictions about a repeat of the 2008 financial meltdown, commercial real estate performed better than expected, according to James Costello, senior vice president of Real Capital Analytics.

Costello presented his forecast during the July 15 webinar “What’s Next: Trends Driving Commercial Real Estate Markets,” sponsored by the Counselors of Real Estate.

The global drop in sales of income-producing properties, which was down 24% year-over-year in the first quarter of 2021, should be the last big quarterly drop in sales for the foreseeable future, said Costello.

“Every property sector, even industrial, was down at least a little year-over-year because fewer deals have been made over the last 12 months,” said Costello.

Sales volume was down 37% in the industrial sector when comparing the first quarter of 2021 to the first quarter of 2020, primarily because the property sector had an exceptional first quarter of 2020. Volume in the multifamily sector declined just 7%, while hotel volume declined 19% and office volume declined 34% year-over-year.

“Now, investors now are hungry for yield and there’s plenty of liquid capital available, so investors are chasing deals,” said Costello.

Unlike the previous financial crisis, Costello said that more lenders are available and willing to work with investors, particularly if they are investing in apartments or industrial properties.

“Prices held up globally this time around and there’s minimal distressed activity,” Costello said. “There’s lots more equity and less debt than we saw during the financial crisis.”

Government support meant that lenders were more willing to help property owners, which in turn led to fewer distressed properties, said Costello.

“Even if banks toughen up on borrowers, which isn’t likely, there’s lots of liquid capital ready to buy any resulting distressed property at a discount,” said Robert White, founder and president of Real Capital Analytics. “But those buyers would probably be disappointed by the lack of a deep discount.”

Multifamily strength

Construction investment is increasing, particularly for apartments, according to Costello.

“There’s debt available and prices are good,” he said.

Total construction investment in the multifamily sector was $144.6 billion from June 2020 through June 2021, far ahead of other property sectors. Construction investment in the industrial sector was $58.9 billion during that same period.

“We’re seeing development in scattered markets and secondary markets, but what they’re building is a little different than in the past,” said White. “There are more garden apartments getting built in secondary markets that have less regulation and less NIMBYism.”

Flight from cities not universal or permanent

Sales volume fell faster (by 40% when comparing the last 12 months with the previous 12 months) in the six largest metro areas compared to secondary cities (where sales volume fell by 35%) and tertiary markets (where volume dropped 26%).

Remote work led some people to leave cities, but Costello believes the notion of a permanent flight from cities is overblown.

“Activity in the office sector has shifted to suburban and secondary markets, but we were seeing that shift from high cost, high tax markets to lower cost, lower tax markets before Covid,” said White.

The location of the workforce, whether in an office, remote or hybrid, has yet to be determined and will require months and possibly years to analyze, particularly when it comes to the impact on cities, says Costello.

“We were already due to see millennials move to the suburbs now that they’re starting to have kids,” Costello said. “The Gen Z workers temporarily went to live with their parents, but they’re already rebounding into cities.”

While the long-term impact of the pandemic on offices, in particular, remains to be seen, the general outlook for commercial real estate is optimistic. 

“We thought prices would collapse but that hasn’t been born out,” said Costello. “Now we’re through the worst of it.”

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