How Will COVID-19 Affect Commercial Real Estate?
As the coronavirus spreads globally, many industries are adjusting to the impact. Among those that are adapting is commercial real estate.
Commercial real estate is a significant asset class, with an estimated value of over $12 trillion in the U.S. It includes apartment buildings, shopping malls, offices, and hotels.
Vacancies
Commercial real estate properties remain crucial for many businesses and are often a significant investment. When these spaces become vacant, they can create exposures, including building deterioration, utility breakdown risks, coverage limitations, and wasted expenses.
As COVID-19 spreads and the economic outlook becomes more uncertain, property owners may repurpose their assets to accommodate new business operations. For example, a retail business that has transitioned to online sales may wish to repurpose its storefront as a warehouse or distribution center.
Repurposing buildings for new uses can reduce the likelihood of vacancy and ensure that space is utilized. It also reduces the cost of maintaining and operating the facility.
However, real estate leaders must understand that the response to COVID-19 will only be a one-size-fits-all solution for some commercial tenants and assets. Instead, they will need to be able to make fact-based decisions on local epidemiological and economic scenarios, what is happening around their portfolios, and the impact of the pandemic on individual tenants.
Deterioration
The COVID-19 pandemic has taken a unique toll on many sectors, including commercial real estate. The virus is forcing people to change how they work, where they travel, and where they socialize – all of which work against the current demand for and use of many commercial properties.
For this reason, real estate leaders must take steps now to ensure their buildings and the spaces within them remain helpful to their end users and remain viable. This includes ensuring that their cash management practices align with the current market environment and focusing on efficiency and digitization for better tenant and customer experiences.
For landlords, this means adjusting the spaces they offer and securing clauses that give tenants the flexibility to extend their leases or sublease them to other businesses in the future. This will help them survive the inevitable changes that will come with the COVID-19 pandemic and ensure that they offer their end users the best possible product.
Increased Risks
The COVID-19 pandemic was an unprecedented shock for commercial real estate. Unlike other economic downturns or pandemics, trade activities and occupiers’ businesses were shut down (see figure 1).
The shock was immediate and broad-based, with different property sectors experiencing more dramatic stress than others. This has contributed to declining market fundamentals, including weakening demand, softening rents, and rising vacancy rates.
Vacancies are a significant risk for any commercial property owner or operator, as they can limit income capabilities and lead to wasted expenses such as mortgage payments and utility bills. These exposures can be mitigated by ensuring that properties are fully utilized and maintained.
However, the severity of vacancies also depends on the type of commercial property and its location. Office, retail, and hotel properties will likely experience the most severe vacancies from COVID-19-related social distancing and stay-at-home orders.
Inflation
Commercial real estate has long been considered a haven during inflationary periods. However, how inflation will affect the sector remains to be seen.
Inflation is a standard driver of property price appreciation and rental rate increases. This can be good for commercial real estate owners as they will benefit from increased demand.
Inflation is an important factor that may slow down commercial property development. This could impact the chances of a commercial real estate property owner selling at a profit.
As a result, commercial real estate investors must ensure that they aren’t relying solely on the inflationary effects of COVID-19. Instead, it is essential to consider the value of each asset class and CRE sector in addition to inflation.
