Each year the Counselors of Real Estate® (CRE), an international consortium of commercial property experts, develops a “Top Ten" report including issues that will have the biggest impact on real estate in the coming year. In the most recent list, the group unsurprisingly expects the COVID-19 pandemic to have an outsized influence on real estate, both in ways known and yet unknown.
“Real estate lags the economy," says Michel Couillard, 2020 global chair of the CRE. “We expect to see a ripple effect from COVID-19 for years."
While the CRE report doesn't attempt to make predictions about the aftermath of COVID-19, it points out that the pandemic and a preference for social distancing could both increase and decrease real estate demands. Social distancing could drive a reduction in density and therefore increase demand for larger residences and suburban locations. On the other hand, because of the preference for remote work, home shopping and home entertainment, demand may decline for office and retail space.
Pandemic-related Issues of Concern
The top issues cited by the CRE are related to the pandemic: economic renewal and capital markets risk.
“Economic renewal can be both a crisis and an opportunity for real estate investors," says Couillard. “We're anticipating a W-shaped recovery with a slow rebound and a decade-long constrained economy. Investors need to be prepared for the 2020s to be a period of weak GDP in the U.S. of about 1.5% to 1.6% annual growth."
Since March, capital markets have experienced volatility. In addition, Couillard points out the last four months demonstrated how quickly debt and equity capital liquidity can stop flowing when risks and returns become difficult to evaluate. While private equity capital is available, fund managers are being cautious, waiting to see how the economy recovers and how various property sectors fare.
“Liquidity is sluggish but it's still available," says Couillard. “We'll likely see more interest in investing in multifamily and industrial real estate in 2021 and beyond, but there's still concern about loan defaults and late payments even as liquidity is returning to the market."
Existing Issues Will Continue to Resonate
The remaining issues impacting real estate markets existed before the COVID-19 crisis. Many of these trends have been exacerbated by the pandemic and economic shutdown.
- Public and private indebtedness. Federal debt has topped $26 trillion and state government debt is $1.2 trillion, both of which are drains on savings and investment activity. “Commercial real estate is often funded by local, state or federal government support, so this may have a direct impact on CRE investing," says Couillard. “The cost of capital may rise as the huge federal debt impacts the federal balance sheet."
- Affordable housing. The lack of supply of affordable housing was one of the biggest issues facing real estate before the pandemic and is anticipated to grow as unemployment batters household incomes. The shortage of an estimated 7.2 million homes for households earning less than 30% of area median income not only hurts those households, but it also pushes up rents for market-rate apartments and drives up costs for multifamily development.
- Flow of people. Reduced immigration and migration within the U.S. due to government policies, a slower economy, and COVID-19 hurts demand for all types of commercial real estate including multifamily residences.
- Space utilization. The CRE anticipates more medium-density, mixed-use communities with walkability and integration of uses to replace older models of building. Mixing residential, office, retail and public spaces will provide connectedness for communities without compromising the need for physical distancing imposed by the pandemic. Multifamily development will by necessity be part of these types of communities.
- Technology and workflow. Smarter and safer buildings will rely on technology to mitigate risks, says Couillard. Things like contactless doors and elevators, air and water quality monitoring, and health screenings will become mandatory and expected by tenants.
- Infrastructure. The U.S. is rated D+ for infrastructure by the American Society of Civil Engineers. Underfunding infrastructure improvements can lead to failing infrastructure, which then impacts real estate values and development prospects.
- Environmental, social and governance (ESG). Addressing ESG issues is a critical component of the long-term value of real estate investments, says Couillard. Before the pandemic brought renewed attention to ESG issues, investors and other stakeholders had begun tracking ESG performance and initiatives, influenced by new ESG investment alternatives and the growing number of ESG-focused millennial investors.
Over the next decade, as investors evaluate their options, considering all the trends and potential outcomes from the COVID-19 pandemic may help guide long-term value. Even with real estate demands uncertain, investors can continue to take advantage of strategic opportunities in the meantime.