Even after the pandemic goes away, commercial real estate may stay in trouble

Commercial real estate and STO
Commercial real estate may be in trouble after COVID-19

In recent years, commercial real estate operators, brokers, and landlords collectively made several hundreds of billions of dollars a year as the economy zipped along.

Now, the pandemic-fueled global crisis is getting them clobbered. Worse still, it can change their business forever.

Let’s state the obvious, it’s difficult to collect rent from just about anybody right now. According to the National Multifamily Housing Council, by April 5 just 69 percent of U.S. households had paid their rent, compared to the 81 percent that had paid by March 5 and the 82 percent that paid by the same time last year.

The figures would almost certainly look worse by May 5, despite both the laid-off and furloughed workers’ soaring numbers.

The situation on the commercial side is starting to look as serious. Besides the countless small retail and restaurant companies that may be forced to permanently vacate their commercial spaces because they can’t afford them for long, an increasing number of corporate giants are also starting to prove unwilling or unable to pay their rent.

For example, WeWork has avoided paying rent at several U.S. locations when attempting to renegotiate contracts, the WSJ reports, even though the co-working business continues to charge their own tenants.

Staples, Subway and Mattress Firm have avoided paying rent as a way for strong-arming building owners to minimize rent, push lease modifications and other measures intended to mitigate the losses they suffer as a result of the coronavirus.

Changes Ahead

The question is what happens next. Although some might look to bully their way into distressed properties, the commercial real estate market is very likely never to look the same.

For one thing, though small retailers and restaurants are melting away, beefing up at the moment are their online rivals. Amazon is gaining market share by the day in spite of no lack of poor PR. Actually, it sailed into trillion-dollar territory again this week.

The online streetwear marketplace StockX is booming, too. Its CEO, Scott Cutler, said at the time that they have always been a marketplace of scarcity, but now that people can’t physically go into a real retail spot, they’re going to StockX. The landscape can change especially rapidly in markets such as San Francisco, Chicago, Boston and New York, where there’s not only a proliferation of independent shops and restaurants, but also start-up workers and other white collar workers that are now home-based.

Consider Cadence’s founder and CEO, Nelson Chu, a New York seed-stage, 17-person securitization platform startup. Cadence signed a lease last month, after recently landing $4 million in funding, with a landlord who decided to start charging the outfit only when he is ready to move into his new digs in the uptown area.

For Cadence, it’s a nice deal, who doesn’t have to think about paying for square footage he can’t use. However, Chu mentions that being forced to work remotely has awakened him to the possibility of integrating more remote work into the processes of startups.

Chu believes one always questions whether remote work will have an impact on the continuity of business, but found her business has not missed a beat now that they are compelled to do it. There could be something to be said about having less office space and allowing people who travel from outside the state not to be in the office every day. It’s easy to imagine that using tools like Slack, Google Sheets, and Zoom, other founders and management teams that have not already joined the trend of telecommuting are coming to the same conclusion.

Handling business

Real estate firms are aware of this.

Remote work is something that property pros are learning a lot about right now, according to Colin Yasukochi, research and analysis director at the giant commercial real estate company CBRE. People are pressured to do it right now and some of the workers will stay that way. The issue of how many is unclear, and for how long. Obviously this year wasn’t the phenomenon that CBRE or others were anticipating in the real estate sector. A report published last November by CBRE on the “outlook” sounded understandably rosy. Barring any unforeseen risks, it was thought at the time, resilient economic activity, strong real estate fundamentals, low interest rates and the relative attractiveness of real estate as an asset class suggested that 2020 would be a very good year for commercial property.

Of course, that unforeseen risk has prompted shutdowns in the ensuing months that have resulted in layoffs across almost every sector of the economy. It has also made it highly likely that even when people are allowed to re-occupy commercial spaces, they will be less enthusiastic about dense workspaces, because of the very nature of it being a viral contagion.

If they think they can get their job done outside the workplace, that is doubly so.

This might well potentially contribute to reduced demand for office space. This may also mean the same amount of space with reconfigured office configurations β€” or maybe even more so. None, including real estate agents, knows yet.

Mark George, a broker based in San Jose, Calif., with Cresa, a commercial real estate firm, is currently working from home, sharing an office with his partner, who is working for the first time remotely, too. It’s nice to be home with their kids, George believes, but being housebound makes it more difficult to get a pulse on changes in business, especially in his business.

Brokers are, he noted, a little lonely, since touring activity has dried up, as they are unable to show properties. In every municipality the City Hall is closed, so you can’t pull permits. The industry really is being shut down. According to George, deals were possibly signed if they were at the finish line before the coronavirus really took hold in the U.S. but the deals which have been close and not quite there – not so much. Any contract that he has seen was put on ice. George’s Cresa colleague in San Francisco, Brandon Leitner, shares the impression that things aren’t moving quickly. However, Leitner expects the company β€” which manages customers as big as Twitter to Series A and even seed-stage businesses β€” to see a surge of activity once the city’s new stay-in-place ban is lifted and brokers may start showing properties.

Specifically, citing the CBRE, Leitner expects the demand to fall by at least 10 percent and potentially 20-30 percent from where San Francisco’s commercial space has cost in recent years, which was $88 per square foot. Driving the expected drop is the 2 million square feet that will come into the city’s market as soon as possible β€” space that businesses want to get off their books.

That’s a lot, particularly given that there are already roughly 3.2 million square feet of commercial space available, according to Yasukochi from CBRE, who adds that a significant amount has come onto the market in the last six months alone.

What will happen?

That’s not ideal for tenants, who are hesitant to put a new money amount on the market right now, Leitner knows.

He offers to hold on to and retain new tenants by being realistic and likely making as many concessions as they can. Naturally, they can only do so much. They usually have debt to deal with, which means that if there is a prolonged downturn or less employees come to the workplace, they can depend on their mutual relationship with the lender to see themselves through.

George, the broker based in San Jose, claims that borrowers would be willing to help keep their own investments running. The Federal Reserve will also provide banks with the right to delay mortgage payments, making it easier for property owners to defer rent charges.

Even so, it remains to be seen if the commercial real estate market comes back all the way after COVID-19.

Yasukochi noted rightfully that this pandemic is something we’ve never been through before. He says economists at CBRE estimate that the next two quarters will be very tough. At the same time, he says, the four-quarter market might see a substantial upturn.

It really depends on whether demand is coming back, and whether expansion plans are being put on hold, or permanently shelved. For now, he remains hopeful about a return to business as normal, particularly within his San Francisco home market.

He reminded that in the Bay Area, it feels like things go wrong very fast, but usually, they always come back quickly. Industry players definitely count on that.