by Brad Houle, CFA
Executive Vice President
We are beginning to see the end of the pandemic as U.S. vaccine distribution begins this week. In addition, our research partner, Evercore ISI Research, is projecting that 100 million people will be vaccinated by end of the first quarter. Along with these victories comes predictions for the unfolding outcome for post-pandemic commercial real estate. The big debate centers around the persistence of the “work from home” trend permanently impacting demand for office space. Additionally, with the recent shift in preference from urban core to the suburbs for office and residential space, will this cause permanent changes in demand?
Work from home, or remote work, has been around for decades and the pandemic forced a great experiment in its effectiveness. Questions remain whether remote work will be persistent enough to permanently negatively impact demand for office space. In high-cost areas there have been many anecdotes surrounding companies decreasing office space and declaring that employees can work remotely even after COVID restrictions are lifted. Data from PricewaterhouseCooper’s June U.S. Remote Work Survey suggests that many workers find some benefit from working from home and would like to do it part-time in the future. For knowledge professions, the percentage of expenses that go toward occupancy is only 2 percent to 3 percent whereby the largest expenditure is for employee compensation costs. Knowledge work, like software development, accounting, and law, is largely collaborative work and people most effectively collaborate in-person. Despite the widespread adoption of collaboration technology such as Slack, Zoom and Microsoft Teams, the communication that is facilitated by meeting in-person is often the driver of workplace culture and effective collaboration.
Another trend that has gotten attention in the media is the shift in preferences from cities to the suburbs and, in some cases, rural areas. There are rising apartment vacancies in gateway cities like New York and San Francisco. The tradeoff of limited space and high cost for urban amenities no longer works when those amenities are largely closed, increasing the demand for the additional space and the quiet appeal of rural life. In addition to residential housing, there has been a movement of companies from central business districts to the suburbs to take advantage of the greater space and the preference for low rise offices that do not require an elevator.
Following the pandemic, the trends that make urban living attractive to millennials as well as many retirees will still be in place. Walkable communities will remain in demand due to the health benefits and convenience of being able to accomplish many of life's errands on foot while avoiding urban area traffic continues to worsen. However, the counter argument to this is that millennials will finally leave their parent's basements and will want to own homes and start families in the suburbs. In addition to buying homes, many millennials are also venturing out of their parents’ home to rent apartments which will also impact the demand for multifamily housing.
One measurement of the health of commercial real estate is rent collections. Immediately following the quarantine lockdowns, rent collections dropped for several different property types. Most affected were retailers and hotels which saw their rent collections drop to as low as 30 percent of rent due. Rent collections for retailers has rebounded to 80 percent but hotels are still struggling at less than 30 percent collections. For other property types like offices and apartments, rent collections have recovered to greater than 90 percent, which is a normal level nationwide.
However, rent collections do not tell the whole story of the health of commercial real estate. The other metric that we watch is when leases expire and the property is re-leased, also known as a “rent roll.” There will clearly be a downward bias to the rent that can be charged on various property types depending on the supply demand dynamics of different markets. However, we do not think that there will be enough negative adjustment in rent to impact property owners’ ability to service debt or materially impact property values.
Week in Review and Our Takeaways from the Week:
Vaccine rollout coupled with dovish comments from the Federal Reserve on Wednesday drove the stock market, as measured by the S&P 500 higher, by nearly 1 percent
Interest rates moved slightly higher with the 10-year U.S. Treasury ending the week at .94 percent
The Federal Reserve pledged to keep aggressively supporting the economy until we are back to pre-pandemic levels of employment
The commercial real estate market is starting to heal from the pandemic as evidenced by rent collections
Changes in demand due to remote work and urban versus suburban will play out in the near future