The Covid-19 pandemic has presented the real estate sector with a swath of unprecedented challenges and rapid developments. What do these imminent difficulties portend for the market going forward? The unexpected theme that has emerged while interviewing the industry professionals is the surprising resilience of the property market in general, leading to confidence in the industries abilities to adapt to rapid changes that have been brought forward by this recession.
Faced with a disastrous medical crisis of unknown proportions, the economy experienced a considerable loss in output and jobs as most of the country hastily shut down to prevent the further spread of the virus. However, defying the initial expectation of extended economic downturn and a slow recovery, the economy began to quickly recover and the official recession lasted only 2 months – shortest on record. The economic output has already surpassed pre-covid levels and the labor markets are expected to rapidly recover by the end of Q1 2021.
Even due to the V shaped recovery of the economy it would be remiss to state that the real estate segment escaped unscathed. Nearly all property sectors were forced to make rapid changed. Retailers were affected the most, and were forced to make some drastic changed to their business models scaling up their home delivery and curbside pickup options and overhauling their supply chains to meet changing consumer appetite. The key factor in the property markets during these trying times was flexibility, if the segment was fast to adapt to the consumer demand, it was able to rapidly recover to pre-pandemic levels.
Working from home was the emerging trend that has initiated major changes in the property market over the past year. Many people have left the burgeoning metropolitan areas for quiet suburban life which resulted in urban office vacancies and shortage of work space in the suburbs. Now that growth is forecasted to be the highest in decades, will the suburban migration persist during this prosperous period leaving many urban assets obsolete and needing to be repurposed?
When the biggest pandemic of the century interrupted life as we know it in spring 2020, people were forced to find new ways to do just about everything: how to work, how to shop, how to socialize and how to educate their children. Our lives changed almost overnight. Working from home was a relatively rare occurrence in the pre pandemic life but soared during the initial lockdown period. Having experienced the flexibility and convenience of working remotely, it's unlikely that employees will be eager to relinquish these benefits. As the economy slowly reopens, many still choose to work from the comfort of their home.
Housing affordability worsened during the pandemic as the rise in both home prices and rents exasperated due to the migration induced by the increasing remote working and inadequate supply for new development. The pandemic also awoke the largest generation in U.S. history – 72 million millennials, working age 25- 40 yeas old began a family and started looking for their nest in 2019. The bottleneck for raw materials caused by the logistical backlog constrained adequate supply of new homes and the Fed’s willingness to keep interests rate low, therefore borrowing more affordable, has caused the steepest increase in single family home prices since the Great Recession.
The dramatic escalation in the amount of people working remotely looks to become permanent for the sizeable share of the workforce. Freed from the burden of daily commute, employees are more inclined to relocate to suburban areas which had profound impact on metro area property markets. This migrating might lead to the most consequential change in the property market dynamics in the coming years. Residential adaptations are going much further than just a home-based workspace. Changes in how people shop have produced significant impacts on the retail sector. Homes also have become the educational facility, gym and entertainment center. All of these producing enormous impacts on the urban property market.
Office buildings had long been at the foundation of commercial real estate portfolios for many real estate investment companies. Urban offices more than often had multiple lease agreements with tenants of highest quality which secured predictable cash flows for many years to come. These cash flows made it easier for the investors to ascertain the underlying value of the property. Because offices in lucrative business hubs usually have higher share of occupants most amendable to remote working, these districts are likely to experience greater vacancies. This is evident in the steepest drop in sales transactions of any sector relative to pre-pandemic volumes. Institutional investors are primarily on the sidelines and are looking to decrease their exposure to office assets.
The abating appetite of institutions for office assets has caused a real predicament for the sectors and its investors. Offices are still the largest sector in the NCREIF Property Index and CBD office – Central Business District the single largest subsector measured by asset class. Prominent institutional investors were primarily attracted to this sector because of long-term stability as well as large size individual assets. CBD offices rank second to only superregional malls in terms of asset size by market value. Due to the drastic change in the lifestyle of tenants most offices are becoming functionally obsolete, this will bring forth the opportunity for development of new products.
A renewed emphasis on the work and life balance and the importance of convenience and productivity in how people manage their time will require physical changes to properties to better align with how people will use the space in the future. The pandemic demonstrated the capability of the real estate sectors to rapidly adopt to the fast-evolving space demands. As world recovers from the pandemic and we revert to our normal life, the “new norm” will emerge which will bring forth novel ways of working, shopping, and living. These changes in how people live will require for physical properties to adopt rapidly to the incessantly evolving use cases and changes in demand.