COVID-19 upended the commercial real estate sector in many ways. It accelerated trends that benefitted a few sectors while negatively impacting others. In this post, I’ll give you a quick snapshot of how the major property sectors are performing as we begin to see the light at the end of the tunnel. But first, lets start with general macroeconomic conditions in the U.S.
Unemployment Rate: The unemployment rate fell to 6%. However, total employment is about 8MM jobs below pre-pandemic levels. Job gains have surpassed expectations. The primary driver of this growth comes from the retail and hospitality industries that are able to operate with fewer restrictions. Increased vaccinations and improved confidence about the safety of reentering these establishments is also fueling the growth.
Consumer Confidence: Up. Consumers are more confident in the future as the “light at the end of the tunnel” appears bright. Stimulus checks have arrived, asset prices are at all-time highs, unemployment keeps falling, the savings rate is way up; so people are feeling confident about the future. I expect a bit of a roaring 20’s starting this summer.
Asset Class Performance
Let’s start with retail as it was one of the most impacted sectors. As I mentioned in my post (Impact of COVID-19 on CRE) retail values, occupancy, and other metrics took a dive in 2020. However, brick and mortar retail has proven to be quite resilient—much more resilient than the headlines of the past 12 months would have you believe. Retail pricing has remained flat so far in 2021. It remains well below pre-pandemic levels. Malls are down 20% and strip centers are down 13% since the pandemic. Nominal cap rates for malls are at 6.8% and cap rates for strip centers are about 6.4%. Note that mall and strip center cap rates are currently the highest of all the major property types in the U.S.
As one of the sectors that benefitted most from the COVID-19 pandemic, industrial real estate values have soared. As commerce shifted online during the lockdowns, demand for industrial property increased. Since the pandemic, industrial properties have increased about 14%. Nominal cap rates for industrial are about 4.2%.
As you might expect, office properties are trading at a significant discount. With all the uncertainty about whether companies will downsize or eliminate their office footprint due to the relative success of the work-from-home movement, office properties have lost value. Properties are down 9% compared to pre-pandemic levels. Nominal cap rates for office are about 5.4%.
As you can imagine, the pandemic crushed hospitality. Early in the pandemic, pricing was down over 25%. Now, pricing is down over 10% over the past year. Nominal cap rates for hospitality are under 2%. This number is tricky to evaluate because it is based on current NOI numbers that are down significantly. On the bright side, hospitality PSF revenues are expected to increase about 25%–much faster than any other sector.
However, lodging designed to accommodate travelers on day trips have done well. Due to the pent up demand for travel and entertainment, and the fact that people are generally staying within the country, domestic destinations like Florida, Hilton Head, and anywhere near a national park are doing quite well. Good luck trying to book a hotel or resort near a national park in the next year or two! It’s getting tougher and tougher.
Multifamily has also performed relatively well since the onset of the pandemic. Capital is flowing away from retail, hospitality and office, and into industrial and multifamily. There have been challenges due to deferred rents, increased delinquencies, and the moratorium on evictions. Class A assets in urban areas have struggled most, as the benefits of living in the city have largely gone away during the pandemic. Nominal cap rates for multifamily are at about 4.2%. Prices on multifamily properties has decreased 4% since the onset of the pandemic; however, prices have increased about 1% so far this year.
I don’t generally write about housing, but I’m somewhat involved in a single family home development project involving the construction of several hundred homes, so I’m keeping a close eye on this sector. Due to the tight supply of housing, new home sales have come up short of expectations. Mortgage rates increased slightly, but remain well below historical standards and continue to support increased home prices. According to NAR, U.S. home prices are up 15% over last year.
One interesting sector that is blowing up is the single family rental market. Build-to-rent construction, which is a relatively new concept, is exploding across the country. This is in large part due to the institutional capital flowing into the space coupled with the demand for said product.
This increase in demand is fueled by three factors: historically low interest rates, changing demographics (the Millennial cohort is having babies and cannot raise families from small urban apartments, and the WFH environment has people desiring more space. The benefits of living in an urban environment (entertainment, ball games, great indoor dining) are no longer present. Many forecasters are predicting that the home ownership rates will continue to climb. From 2006 to 2015, home ownership rates declined from almost 70% to about 63%. Since 2016, home ownership rates have steadily increased to almost 66% and are projected to continue to slowly increase.