When will the real estate market recover? Not very quickly, according to many commercial real estate experts surveyed and interviewed for a recent report from the Real Estate Center at DePaul University. As noted in this Bisnow real estate story, more than 60% of survey respondents are either concerned or trending toward concerned about the market’s direction.
COVID-19 Commercial Real Estate Outlook
The Third Annual Mid-Year Perspectives on Chicago Real Estate Markets report also showed that less than one-third are either optimistic or moving toward optimistic. “COVID-19 has dealt every market across the country a set of challenges and circumstances no one could have anticipated,” said Charles Wurtzebach, the Douglas and Cynthia Crocker endowed director of the Real Estate Center at DePaul University. “Yet people want to be optimistic; they are tired of COVID and want it to be over.”
Among the biggest concerned noted in the survey are:
- the unknown duration and intensity of the pandemic
- the financial crunch on state and local governments
- rising unemployment and
- the uncertainty about the timing of a vaccine
Given these factors, survey participants pointed to a slow “Nike swoosh” recovery versus a rapid “V” recovery. This is due to the stable Midwestern mode of Chicago, which typically sees moderate-growth for commercial real estate versus the stronger extremes seen in coastal markets.
While many survey participants addressed the concerns with today’s marketplace, Brian Forde, Partner, O’Keefe Lyons & Hynes, LLC chose to highlight some of the glass half full and big picture aspects of the current situation.
“Real estate developers and brokers are as creative a group of professionals as you can imagine,” Forde says. “They adapt, they innovate, they don’t sit still. Given everything that has happened, there will be difficulties, but in response to those challenges, there will also be creative adaptation. Difficult challenges tend to bring out the best in real estate professionals.”
Cook County Tax Increases: The ongoing market threat
Chief among the market threats is the Cook County tax situation, which is different than any of the other 101 counties in Illinois. Before the pandemic, the Assessor showed his hand in Evanston in terms of how valuations and the valuation process would change. It was viewed as a precursor of what is to come. Looming large on the horizon are the valuations for downtown properties, which won’t be completed until 2021.
Forde believes Cook County property taxes will continue to be a real threat to property investors and business owners. “As long as Cook County uses a classification system where commercial and industrial real estate is assessed at 2-1/2 times that of residential properties, property taxes will always be a challenge, and it always will be so long as the system currently in place persists,” Forde says. “That will be further exacerbated when coupled with the inability of taxing officials to manage the sheer volume of valuing 1.8 million parcels. There is just no one size fits all solution.”
For more, see the DePaul University Mid-Year report.
The surge in consumer goods shopping during the pandemic is having a significant impact on Chicago industrial expansion at mid-year 2020, according to a Q2 2020 Chicago Industrial Report from Avison Young.
Amazon leads the pack in the ecommerce space race, adding more than 2.4 msf in the first six months of 2020 and on track to add another 4.3 msf by year end. This will bring Amazon’s total Chicago industrial space commitment to 15 msf. Amazon is just part of the story, however, as consumers gravitate to buying goods online from a variety of businesses.
A recently released NAIOP survey shows continued optimism about the industrial real estate sector, along with improving rent collection and development activity since April. This was the third survey of the organization’s U.S. members since the onset of the COVID-19 pandemic.
The June survey results also provide insights into rent collection and rent relief, which are top of mind for investors in these challenging times. The good news is that 69% to 74% of respondents reported on-time, full payments by 90% or more of their industrial and office tenants in June. (Note that the survey also covered multifamily and retail properties).
Tenant requests for relief declined across all asset types from April to June, with industrial and office real estate showing similar results –moving down from approximately 50% in April to about 38% in June.
Industrial Real Estate Development Outlook Improves
The survey also notes that the impact on current development projects continues to soften,
with fewer reports of leasing declines, delays in financing or government restrictions impacting construction. While 66.1% of NAIOP survey respondents note delays in permitting or entitlements due to COVID-19, the percentage
of respondents reporting a decline in leasing dropped from 57.2% in May to 49.4% in June; reports of delays in financing also dropped from 23.3% to 16.1% in June.
The industrial sector remains the strongest of all sectors, including multifamily, office and retail. The percentage of respondents noting new industrial development more than doubled since April, to 43.3% from 18.5%.The survey tracks sentiment from investors, lenders, developers, among other CRE practitioners.
COVID-19 Issues Mount for Retailers
How will retail store closures fare due to COVID-19? When Americans emerge from their homes, it may be to a completely new normal, particularly in the retail shopping sector. According to GlobeSt, Gap announced that, despite several tough choices, some retail store closures are likely in the months ahead.
Aside from not paying rent for North American stores in April, a $115 million savings, Gap also:
- Furloughed workers
- Suspended stock repurchases and dividends
- Cut executive pay
- Reduced capital expenditures by $300 million
- Tapped its entire $500 million revolving credit
100,000 Retail Store Closures by 2025
Also, a recent client note from UBS projects as many as 100,000 retail store closures by 2025. This is a dramatic increase from the 9,548 stores that shuttered in 2019 (according to Coresight). That’s partially because consumers have already shifted the vast majority of their buying to online platforms, and they will need some time before they feel safe and comfortable visiting crowded shopping venues again.
Some Retail Stores Emerge as Winners
The potential good news is that 91% percent of consumers say they plan to visit restaurants, movie theaters, gyms, salons, stores and banks as stay-at-home orders are lifted, with about 32% reporting that they plan to shop more after the pandemic ends, according to a recent survey by Momentfeed. Big winners will include big box retail stores such as Target, Costco and Walmart, which are already seeing a boost in sales during the pandemic.
The Momentfeed survey also showed that 28% of consumers plan to continue increasing their online shopping. As online shopping continues to impact bricks-and-mortar retail stores, the supply chain will have to shift to keep up with more deliveries to more locations than it had previously. This may result in a higher demand for warehouse space as retailers work to keep inventory close to their customers and available for quick delivery.
As COVID-19 deals a harsh blow to many industries, there are also some, such as the online grocery sector, that are seeing a silver lining. The acceleration of ecommerce during the pandemic has been a boon to online grocery shopping, as well as sales of apparel, and electronics.
According to the recent Adobe Digital Economy Index (DEI), which tracks the state of ecommerce, online shopping has become the main source of commerce during the pandemic. Consumer brands have shifted strategies to focus on giving consumers quick and easy delivery of products, including those in the apparel and electronics segments. Click here for more.
The index found that online shopping and store pickup orders surged more than 200% year-over-year in April as consumers looked to gather goods while limiting exposure to the pandemic.
Also, the index showed that ecommerce sales jumped nearly 50% between early March, when state shutdowns occurred, and the end of April. Among the gains were in curbside pickup and e-grocery. Daily online grocery sales increased by a whopping 110%, with electronic sales jumping 58%. Instacart, an online grocery delivery service, saw its first profit and sales of $700 million worth of groceries in the first two week so April, according to The Information. This shows the power of online grocery shopping and the industrial sector’s ability to meet consumer needs during the pandemic.
April 7, 2020
There are some positive signs as the commercial real estate industry works to navigate the COVID-19 pandemic. Many believe industrial real estate can weather the storm. Here are a few recent examples:
While the U.S. supply chain has been put to the challenge in recent weeks, there are long-term signs of the resiliency of logistics real estate. According to a Prologis report, continued e-commerce adoption, diversified manufacturing locations and other factors point to a positive long term view.
Among the key indicators are: rising inventory levels, continued adoption of e-commerce (particularly in this online grocery shopping frenzy), and the diversification of manufacturing locations.
Amazon Still Leads Industrial Real Estate Activity
Fully leased Amazon facilities continue to attract investors, as noted in this GlobeSt. story. Industrial Logistics Properties Trust closed on the final property of its $680 million joint venture with an Asian institutional investor by acquiring an Amazon leased warehouse in Ruskin, FL. The 12 properties total 9.2 msf across nine states.
Industrial Investment Returns Should Outperform
Tenant demand for new industrial space hasn’t slowed significantly in the wake of the coronavirus, according to Pensions & Investments. The market could see pressure on returns, but the sector is expected to continue to outperform other investment options. Warehouses earned 13.4% returns in 2019 and were the only sector with double digit returns, according to the NCREIF Property Index. While new warehouse construction and increasing rents may cause a short-term lag, the long-term outlook is positive.
Industrial Real Estate Shifts to Boost Response to COVID-19
The industrial real estate sector is taking center stage in the response to the coronavirus pandemic. While some businesses have stalled or stopped during the pandemic, there are many essential services still at work and expanding production in the warehousing, distribution and light manufacturing sectors.
From online grocery delivery to medical supply manufacturing and distribution, there are businesses making hand sanitizers and other goods to help the COVID-19 response.
“This is an unprecedented time when companies are being asked to respond rapidly — or reposition themselves just to survive,” said Karl Heitman, founder and president of Heitman Architects. “We are seeing companies looking to increase production or shift to making hospital masks and industrial grade hand sanitizers to fill the incredible demand from the healthcare industry and support their own operations and workforce.”
Many newly constructed industrial buildings, designed to satisfy incredible demand for space in markets across the country, may provide much needed options for companies that are responding to changing market needs.
Heitman highlighted one newly constructed Class A fulfillment center his firm designed in Tampa that is being repositioned by ownership to support the medical needs of that 3 million population metro. The 178,000-square-foot Tampa Fulfillment Center was designed to serve the needs of ecommerce and last-mile warehouse tenants as well as traditional warehouse and distribution users.
Given its flexible and efficient design, the facility can be repositioned to accommodate a single medical response effort or be configured for several businesses that support the medical community .
“This facility was designed with ultimate flexibility,” says Gerard J. Keating, SIOR, CCIM, CEO of Keating Resources, the building’s ownership. “While no one could have anticipated the complexities of the world we’re experiencing today, that flexibility may prove to be extremely opportunistic as companies scramble to meet their immediate needs or look to reposition a business that might otherwise languish due to the current economic conditions.”
Heitman recently reached out to Keating and other clients to brainstorm ways to adapt facilities to meet current needs and help keep operations flowing. “During these challenging times, businesses need to be able to shift and turn to meet market demand,” Heitman says. “The companies that will survive and prosper moving forward will do so through hard work and a willingness to adapt to market conditions.”
For example, food ingredient companies could be well positioned to support the demand for industrial grade hand sanitizers. A plastics packaging company could expand into packaging for medical kits.
Industrial Real Estate Transforms During Times of Challenge
This wave of industrial activity is the beginning of a transformation that will likely change the way logistics, warehousing, and construction operate after the pandemic, Heitman says. “When designed properly, many of today’s modern distribution facilities can be repositioned to serve multiple purposes. Instead of distributing automotive parts or food ingredients, they can be quickly tailored to store and distribute medical equipment and supplies.”
A Look at Building Design and Construction
A building’s design and construction play a key role in its adaptability. The size of the bay, capacity and availability of power, parking configuration for ingress and egress, and the configuration of interior office and industrial workspace are among the features to consider.
Where is commercial real estate investment headed toward mid-year? The 2020 RCM LightBox Investor Sentiment Report points to a potential surge of activity, followed by a pause ahead of the U.S. election. Report participants noted the intersection of strong market fundamentals, ample investor capital, the potential for increasing headwinds generated by a slowing economy, and other factors driving activity.
“I think in the first half of the year, capital will rush to put money to work ahead of the election and before the Fed changes its mind on interest rates,” says K.C. Conway, MAI, CRE, CCIM Chief Economist and Director of Research & Corporate Engagement, Alabama Center of Real Estate (ACRE).“The wind is at your back for the first six months.”
The report, which incorporated views from investors, brokers, lenders and economists, noted that nearly 70 percent of participants believe investment activity levels in 2020 will be the same or higher than in 2019. Almost 80 percent believe sale prices in 2020 will be the same or higher than in 2019.
“We’ve reached a point in this current cycle, where optimism and discipline continue to prevail and drive investment activity, but not necessarily for everyone,” says Tina Lichens, COO, RCM LightBox. “Investors expressing a more cautionary tone aren’t completely pulling back but instead are adapting their investment profile and looking at different markets and risk profiles.”
Phoenix Leads for Multifamily
The hottest sectors continue to be multifamily and industrial, which have each had significant investment levels in recent years. Among the strongest U.S. multifamily markets are Phoenix and Orlando, (with Austin close behind), where there continue to be strong opportunities for rent growth.
“Phoenix may be the hottest multifamily market in the country,” adds Brian McAuliffe, President, CBRE | Capital Markets. “It is the market that on various levels is outperforming almost any other across the country. Investment and development activity is strong there; rent growth is occurring at a rate of approximately 8 percent annually.”
In markets like Phoenix there has been strong cap rate compression. Two years ago, multifamily assets in Phoenix were trading at an approximate 5% cap rate, moving to a 4% cap rate today. Comparatively, in Austin, cap rates over the last two years have remained at about 4.5%, according to the report.
See the 2020 RCM LightBox Investor Sentiment Report for details on:
- How investors, developers and lenders are shifting strategies
- What landlords are looking for to better evaluate tenant stability
- The top threats to CRE investment
Chicago Developers Branch Out, Diversify
Sterling Bay, Magellan, CA Ventures, and other real estate developers and investors have been big names in Chicago for decades. But now, as property taxes are increasing, they’re finding that it’s harder to finance new buildings locally, according to a recent Chicago Tribune article on commercial real estate development. So they’re branching out into other cities in the Midwest and across the country.
Among the growth markets cited are Denver, L.A., Nashville, Austin and Atlanta.
These Chicago real estate developers have reimagined entire neighborhoods including the Fulton Market District, Lincoln Yards, and Lakeshore East. While they still see great potential in the city, these developers feel a growing uncertainty over increasing property taxes, city and state pension obligations, and policy changes like affordable housing requirements and TIF reform. This has led to a sharp decline in investment sales from $12 billion in 2018 to $3.9 billion in the first three quarters of 2019, and a harder environment for financing developments.
Chicago Real Estate Developers Expand Markets
Because of this more difficult financing, Chicago real estate developers are looking farther afield for the next big neighborhood. Miami’s Wynwood District, Dallas’s Deep Elum, Milwaukee, Minneapolis, and Los Angeles have all been on the radars of Chicago companies looking to diversify. Many of Chicago’s recently transformed former industrial neighborhoods could be just as profitably replicated in other cities, the developers say, and sometimes at a lower price.
Some real estate developers are hoping that structural changes at the state and local level will resolve the escalation of property taxes and pension obligations. But with capital still flowing in to the city, the slowdown in investment and development might be an inevitable part of the commercial real estate cycle.
Multifamily investment remains strong across the United States according to Yardi Matrix’s Multifamily National Report. The research, through November 2019, showing the sixth consecutive year with at least 250,000 units absorbed. The 320,000 multifamily units absorbed in 2019 rented for an average of 3.1% more year-over-year, showing the continuing strong demand for apartments as job growth continues,
The Southwest and West are leading the way for multifamily investment fundamentals, with many metro areas exhibiting nearly double the national average of multifamily rent growth. Apartment units in Phoenix are renting for 7.5% more than last year, while Las Vegas and Sacramento are up 6.0% and 5.3% respectively. Southeastern cities are also showing strong performances with Raleigh and Charlotte both experiencing 4.6% rent growth and Nashville growing by 4.5%. Midwestern cities, including Indianapolis, the Twin Cities, and Kansas City are also performing above the national average.
Multifamily Investment: Rents Stable
Both multifamily rent growth and absorption are down slightly from the previous quarter, and rents are down an average of $3 from the previous quarter. However, with some seasonal changes impacting multifamily markets, this is a typical pattern for multifamily and shouldn’t adversely impact multifamily investment. The Pacific Northwest seems to be affected the most by these seasonal changes. Yardi experts expect rents to grow again in 2020.
In the longer term, multifamily rents have grown nearly $100 on average over the last two years, from $1,375 in November 2017 to $1,473 in November 2019. These numbers could continue to grow depending on what level and quality of new product is delivered throughout 2020.
Markets leading the way for year-over-year rent growth include:
- Las Vegas
- Inland Empire
For more on multifamily investment, check out this Commercial Property Executive article.