Preparing for a New Normal in Commercial Real Estate
The coronavirus pandemic has accelerated social and economic changes that were underway before the outbreak, while also leading consumers, workers and employers to adopt new preferences and behaviors. Collectively, these changes will require that commercial real estate firms adopt new approaches to design, customer relations and business operations to be successful in the future. Christopher Lee, founder and CEO of CEL & Associates, offered his predictions for how the outbreak will reshape demand for commercial real estate in the U.S. and outlined steps that firms can take to remain competitive during a recent NAIOP webinar.
Lee observed that the commercial real estate market is currently about halfway through a downturn. Although the Federal Reserve’s intervention in credit markets and fiscal stimulus measures have mitigated some of the outbreak’s effects on the economy, “all of that is going to burn off fairly soon unless another economic stimulus comes forward.” Substantial economic uncertainty and fears about the coronavirus have paralyzed decision-making in most markets. Buyers are concerned about the pandemic’s effects on building revenues and expenses as well as potential liabilities from infections, and some may no longer be able to secure favorable financing for an acquisition. Sellers are uncertain whether they should sell now or wait out the pandemic, and are unsure whether they will have good options for investing the proceeds of a sale.
The pandemic is impairing economic growth and contributing to higher levels of unemployment. In turn, these trends will reduce demand for most types of real estate. Although Lee observes that the industrial sector has performed well during the outbreak, he expects that declining rents in other sectors will result in an aggregate decline in commercial real property values of 7-10% during the current downturn. However, Lee is optimistic about commercial real estate’s role in an economic recovery. “We’ve gone through these crises before […] and during and after every one of these crises, the real estate industry has always emerged as one of the pivotal drivers of financial and economic revival.”
Effects Will Vary by Sector
Lee anticipates long-term shifts in business operations and consumer preferences that will lead to changes in demand for each sector of commercial real estate. He expects that the digitization of office functions will reduce space demand from tenants, with 40-55% of work that was formerly performed within offices to be performed remotely by 2025. He also expects a 20-25% reduction in per capita retail square footage in the U.S., with up to 50% of retail space being repurposed over the next decade. Remaining retail centers will need to be reconfigured to facilitate curbside pickup and to support delivery services.
Multifamily building owners can respond to the increased tendency for residents to remain at home for work and entertainment by providing them with enhanced connectivity and by augmenting common areas with sensors, smart walls and voice assistants. In the future, tenants may also come to expect onsite emergency equipment and quarterly “health certifications” for onsite personnel and common areas. Multifamily developers should consider updating designs to include areas for delivery services within buildings and drop-off zones in parking lots.
Lee predicts that factors such as government stockpiling of medical supplies; onshoring of pharmaceutical and medical device supply chains; and growth in e-commerce will contribute to demand for industrial real estate. However, tenants will also likely expect owners of industrial buildings to equip them with improved air ventilation systems, antimicrobial technologies and motion detectors that can replace frequent touch points.
How Firms Can Remain Competitive
Lee advises that real estate firms develop a post-pandemic strategic plan that will allow their businesses to thrive in these new contexts. “You cannot be reactive […] You really need to make sure that you are not doing things differently. You need to do different things.” The firms that will recover most rapidly are those that proactively adopt a more decentralized and agile organizational structure and embrace communications, remote work and compliance technologies that support this structure.
Lee identified specific steps that firms can take to improve their resiliency against future crises. He suggests growing recurring income from sources such as property management until they fully cover overhead expenses. Healthy balance sheets and a large “rainy day” fund are also important priorities. Firms can improve their ability to respond to rapidly changing circumstances by creating contingency plans and outsourcing non-core business functions to independent contractors. Investments in research, analytics and client engagement can help a firm identify emerging trends and adapt operations to meet client expectations.
Lee also said he expects that the current crisis will accelerate a wave of retirements in the real estate industry. In this context, it is important that firms emphasize on talent management. Recruiting and retaining high potential employees and emerging young talent will be vital to a firm’s future success. “If you don’t take care of your emerging young talent, then there won’t be a future for your company.”
Content and strategies shared on NAIOP blog posts are intended to provide information and insights to industry practitioners and do not constitute advice or recommendations. NAIOP and its blog authors disclaim any liability for actions taken as a result of these blog posts.
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As NAIOP Research Director, Shawn Moura manages the NAIOP Research Foundation research committee and day-to-day operations of the Foundation’s research projects.
