By Michael G. McGuinness
While there has been some gradual improvement in commercial real estate deal activity from earlier this year, nearly half of the national industry leaders and professionals taking part in NAIOP’s recent “September Coronavirus Impacts Survey: Deals Continue but Challenges Persist” believe the pandemic will significantly affect their business operations for at least another 12 months. As reported in the Oct. 2 blog post by NAIOP Research Foundation Research Director Shawn Moura, Ph.D., some also cited other factors that may affect demand, including the elections, wildfires and social unrest. Additionally, proponents of ongoing development projects have recently noted more complications than in prior months, and more building owners are offering tenants a broader range of rent relief arrangements and increasing building safety precautions.
As expected, industrial properties continue to attract more investors and lenders than other property types, with an uptick in acquisitions of existing buildings and buildings under construction. Office and multifamily are also seeing more building acquisitions and slight increases in new development activity. Deal activity for industrial, office and multifamily properties has improved substantially since April, when nearly half of respondents reported no industrial deals and two-thirds reported no office or multifamily activity. About 80 percent reported no deal activity in the retail sector. It was reported that “the debt markets appear to be open for business with the agencies (Freddie Mac and Fannie Mae) continuing to propel the multifamily space, and insurance companies looking to get more capital out in 2020, as many are well behind their stated goal after a slow second quarter. Interest rates are expected to remain low, presenting some excellent buying opportunities for investors.”
Overall, rent collection rates for retail properties remain much lower than for other property types, with less than a quarter of respondents reporting that more than 90 percent of their retail tenants had paid their rent on time and in full. Conversely, more than 90 percent of industrial owners report on-time collection rates of 90 percent or more. Office rent collections experienced a minor setback, while multifamily rent collections remained strong. Survey data suggest that building owners and managers are fielding more requests for rent relief from non-industrial tenants. Office properties experienced the sharpest increase in rent relief requests, going from 25.4 percent in August to 37.7 percent in September, and more owners are offering longer-term rent relief options. Delaying rent payments and amortizing them over the remainder of the lease remains the most common form of rent assistance, followed by extending the lease term. Owners are trying to maintain occupancy rates in a softening rental market.
The pandemic clearly remains a major concern for current building projects and operations, causing ongoing complications, lost revenues and lost time. Delays in permitting and entitlements remain widespread, reported by 72 percent of respondents, and almost half still reported a decline in leasing activity compared with before the pandemic. Although delays due to on-site social distancing have lessened, a record-high 42 percent reported supply shortages. Reported delays due to worker absenteeism or shortages were 32 percent, versus 34.7 percent in April.
Enhanced safety for tenants is the new norm through increased cleaning, communicating hygiene and safety guidelines to tenants, distributing hand sanitizer and disinfectants and closing common areas. Other measures include closing properties for additional cleaning when an occupant reports testing positive for COVID-19, banning visitors who are not tenants and, to a lesser degree, screening visitors for symptoms (more common in high-rises in central business districts).
Companies now expecting to bring in new hires over the next three months is 23.2 percent, the highest level since April, and two-thirds of respondents plan to maintain current staff levels. The survey solicited comments about future industry conditions, but only a small minority answered, with mostly negative comments. Two comments to ponder: 1) “Still many people out of work and that will filter down to spending habits pretty quickly. I think it gets worse before it gets better. Real estate is a lagging industry and I think we will see declines in value” and 2) “As a lender, it seems that the market will only get worse. More and more borrowers are reporting that tenants are downsizing and requesting to break leases, sublet or give back space in office and retail properties. The effects of this can only get worse as new properties are delivered to market and companies realize that their employees are just as effective working from home.”
Released on Oct. 2, a NAIOP Research Foundation report — Mid-Year Economic Impacts of COVID-19 on Commercial Real Estate Development Industry, by Stephen S. Fuller, Ph.D. — evaluates how the pandemic and the deep contraction in the second quarter of 2020 has impacted the building industry as of midyear. Fuller reports declines in expenditures and value across most building types. Key findings:
- Overall, construction employment proved somewhat resilient and declined at half the rate of total unemployment in the U.S. However, nonresidential building construction unemployment increased to 6.2 percent in July 2020, from 5.5 percent in June.
- As of midyear 2020, commercial nonresidential building construction accounted for $514.1 billion, or 37.9 percent, of the year’s projected $1.355 trillion of spending for all types of construction. This is a decline of 2.1 percent from midyear 2019.
- Construction expenditures and building activity for office, industrial (excluding warehouse) and retail buildings declined from June 2019 to June 2020. Only warehouses showed a modest improvement. Total spending dropped dramatically (-23.4 percent) from midyear 2019 to midyear 2020. Overall construction activity dropped 11 percent in the same period.
- The midyear 2020 value of nonresidential construction put in place was down 23.2 percent from midyear 2019. It is estimated that the value of nonresidential construction put in place for all of 2020 will decline by 18.1 percent from 2019.
- Real estate development is a proven, significant contributor to U.S. GDP. The recovery of private-sector nonresidential building construction could assist an accelerated national economic recovery in 2020 and 2021, as it did after the Great Recession. Government’s failure to re-establish a positive business environment in support of the real estate development industry will constrain its recovery and reduce its potential for stimulating broad-based economic growth.
- S. GDP could return to pre-pandemic levels in mid-2022 if forecasts for growth are realized, with full employment achieved possibly by the end of 2023.
The future of the economy depends on the course of COVID-19, including the development and distribution of an effective vaccine. Vaccinations would significantly reduce the health threat to the general population, which would increase personal mobility and commercial exchange. These conditions could be achieved during the second half of 2021, making 2022 a “near-normal” year. Still, the consequences of the pandemic — such as national debt load, shifting consumer preferences, delayed or reduced business investment — will impact the nation’s future economic performance. The projected post-pandemic GDP trajectory will most likely track below its pre-pandemic level throughout the coming decade.
Michael McGuinness is CEO of NAIOP New Jersey and has led the commercial real estate development association since 1997. NAIOP represents developers, owners, asset managers and investors of commercial, industrial and mixed-use properties, with 830 members in New Jersey and over 19,000 members throughout North America.