The economy seemed poised for a correction. It had been ten years since the last downturn and any catalyst would send us down again. This time it was a pandemic that started the collapse. Now with the highest unemployment rate ever recorded and with ongoing Covid-19 concerns, we are seeing the collapse in the form of mass bankruptcies and the largest government intervention of Fed money creating the largest debt bubble ever. The fact is that the taxpayers will be stuck with the bill.
What happens next is anyone’s guess but having been through the last economic collapse in 2008, I was confident in knowing how to navigate the uncertainty that landlords and tenants were facing. Escrows were canceled, lease negotiations abruptly came to an end, and the phone stopped ringing with new business while only ringing from panicked people with problems. However, some of us were able to get buildings back into escrow and leases signed, even during the lockdown.
The plan to solve the economy’s problems involved enormous amounts of government money, seemingly helicoptered in. This event kept many workers flush with the cash to continue paying their obligations and keep spending to keep the economy functioning. However, it is logical to assume that the government cannot continue to expand the money supply or “print to infinity” as that is simply unsustainable.
The events leading up to the Covid-19 economic collapse and its aftermath will leave permanent changes to the commercial real estate market. In our area of of specialty, Retail, Office and Industrial properties, we saw the following signs and indicators:
Retail : In actuality, the “retail apocalypse” was already underway before Covid-19. Amazon and other e-commerce websites were past the tipping point of dominating brick-and-mortar retail stores. I post Covid-19, we will continue to see more store closings and bankruptcies. We are already witness to many large retailers filing for bankruptcy protection, such as J.Crew (May 4), Neiman Marcus (May 7), JCPenney (May 15), Aldo (May 7), Tuesday Morning (May 27), Pier 1 (Feb 17), and Hertz (May 22), GNC (June 24) just to name a few. Now with 24 Hour Fitness and many large chain restaurants filing for bankruptcy, we are likely to see a huge increase in vacancies and permanent loss of jobs. In some cases, entire retail centers could go vacant as the last standing retailers that rely on the traffic generated by other tenants disappear. Supply will outpace demand, which will force rents downward. The ripple effects to large mall landlords and publicly traded REITS are difficult to imagine.
I predict that the next wave in the economy will see consolidations within the banking industry, which means shuttering many (or most?) branch locations. The result would be more unemployment and a surplus of vacant, non-performing space.
What comes next is anyone’s guess but macro trends indicate we had too much retail space and a lack of medical and residential space. It is conceivable that malls could convert empty anchor space to medical use on one side and residential on the other to practically guarantee a customer base for the existing retailers. This strategy would be very capital-intensive but would put many back to work ultimately modernizing retail and possibly increasing income returns for investors.
Office : The largest tenants impacted in the last collapse were in the mortgage industry and this time around, the largest tenant is WeWork. This company has yet to turn a profit, having picked up huge chunks of expensive office space at the top of the market. Their business platform is a membership program for the use of their office space as a place to work, collaborate and drink free beer. These “members” always seem to appear to be loitering around the building and looking like they are “playing office”. It would not be a huge stretch to imagine membership taking a hit if the job market continues to shrink. As I understand, many WeWork offices are already shuttering. The office building where Lee & Associates Newport Beach is located recently signed a lease with WeWork, and the amount of building improvements that the building owner made to accommodate WeWork as a tenant was staggering. Now, if WeWork goes bust, then all of the improvements made went to complete waste.
Another interesting outcome of Covid-19 is the prevalence of working from home. From this phenomenon, companies like Zoom came to center stage with people having business Zoom meetings as well as social Zoom parties. (I still can’t seem to get my mike to work reliably).
Companies have figured out that they do not need the amount of office space they have and that a certain number, if not all of their employees, can actually work from home. This is sure to have a negative effect on office space, as companies with lease renewals will look to downsize. On the other hand, tenants that require office space for their employees may look to increase the office footprint to accommodate social distancing requirements. This seems unlikely to justify the added expense, but something worth considering.
My bet is that we will see a massive increase in office vacancies that will take years to absorb, rents will fall, building expenses will increase and I expect many over-leveraged office building owners will go bankrupt.
Industrial: Industrial real estate seems to be the least affected. The industry has been under attack as existing buildings are demolished and replaced with housing, hotels and other “higher and better” uses. In the future, we may see an increased demand for manufacturing as Covid-19 exposed our vulnerabilities with medical supplies manufactured in other countries. Square foot values could actually increase as our nation de-globalizes and moves to on-shore manufacturing.
In Orange County, we still have a solid foundation, as most ownership of investment type industrial has been held for generations with little to no debt. These owners can lower rents, give concessions and otherwise readily adapt to current market conditions.
Although we saw some tenants asking for half rents or deferred rents during the lockdown, most industrial users were busy working through the shutdown and are likely to fully recover.
Asking rental rates seem to have gotten ahead of themselves, as they appear to be on the high side. However, the inventory of buildings for sale and for lease is the tightest I have seen in my 21 years in the industry. I do not see a wave of new building construction coming to the market anytime soon, so the industrial market should continue to remain stable.
In closing, it goes without saying that we have experienced an unprecidented event that has been compared to the Spanish Flu, which resulted in an economy that has been compared to the Great Depression. Even though the industrial market appears to be a healthy standout, it is hard to imagine that the entire commercial real estate market will continue as we know it. The massive amount of government stimulus has inflated asset classes to new levels that look illogical and unsustainable. As common knowledge dictates, what goes up must come down. The trillions of dollars in government stimulus must be paid back, so it seems inevitable that taxes will go up and I suspect real estate owners will be a major target. At this point, interest rates are low, banks are still lending, and there is still plenty of demand in the market, so if you have ever considered selling, now is the time to call me and talk about what your options look like. Good sense tells you that an established agent who understands the market, anticipates these trends, and has a tried-and-true strategy is worth their weight in gold. By theway, I recommend buying some gold.
The above commentary is merely an opinion and should not be construed as investment advice.