The Orange Report – 2020 Q2
Commercial real estate is an industry that thrives on change, but 2020 has been a wild ride that has left many wondering, “Where do we go from here?” Real estate visionary, Sam Zell, said it best when he said, “Real estate isn’t just about buildings as inanimate objects. It often reflects the pulse of the nation.” As it stands today, the pulse of our nation lacks a clear path for stakeholders to follow and has created a very unique and challenging environment that even Zell, an industry thought leader who is always two steps ahead, is hesitant to advise jumping into for now. So where DO we go from here? Should real estate professionals and investors just all go on a long vaca…err… stay-cation?
‘The bid-ask gap’ – Valuing commercial real estate during a crisis
From an investment standpoint, the current ‘wait and see’ attitude from buyers and investors has caused a major dip in activity in the second quarter. According to data provided by CoStar, second quarter investment sale transactions were down 48% nationally over Q2 2019. Moreover, pricing and cap rates have stayed relatively stagnant, indicating sellers are sticking to their valuations despite a major drop in demand. The sharp and sudden decline in sales volume likely points to significant pent-up demand in the future.
Buyers who are closing deals today are generally looking for one of two things: essential businesses that remain strong, or the ability to purchase an asset at a discount. However, most landlords are reluctant to bring their property to the market under the current conditions. It’s possible that some will be forced to the market in distressed sales, but foreclosures have yet to bubble to the surface and probably won’t for some time. The direction of the market will largely depend on a number of factors including the prospect for additional federal relief, and the duration of the pandemic.
Preserving a stable tenant mix in existing holdings is essential to keeping balanced portfolios and freeing up capital to pursue opportunities as impacts of the COVID crisis begin to subside. Even in normal times, open lines of communication between landlord and tenants may be one of the most important aspects to maintaining healthy investments and business relationships. Each business has a unique set of circumstances to deal with stemming from the pandemic, and they need to be addressed and understood accordingly. In addition to tracking empirical data like sales volume, it is important to explore innovative measures to prepare for the future as the virus isn’t likely to disappear in the short term.
In worst case scenarios, some businesses may be too far underwater to make it to the other side of the pandemic. In those cases, it is very helpful for landlords to know who their struggling tenants are before it’s too late. If there is something that can be done to breathe life into a struggling business, it is far better to act now then to wait until the damage has been done to keep a property afloat.
In addition to regular communication with tenants, it’s important to consider new ideas that could give them a competitive advantage. For restaurants, that could mean adding designated pick-up and carry-out parking, expanding patios into parking lots or sidewalks, or providing vacant space for storage for excess chairs and tables. For fitness users, that might require offering outdoor common areas to allow for social distancing during classes.
Landlords are in a unique position to observe how similar tenants are addressing the same issues and share knowledge of best practices. Foresight, research, and collaboration are needed to find reasonable solutions to keep customers safe and to keep businesses open.
Where are opportunities emerging?
It’s still too early to make predictions on how long the pandemic will last, but it is not too early to begin identifying new opportunities on the horizon. Some retailers have actually seen an uptick in sales growth due to the pandemic – paint stores, auto parts, and grocery stores for example. These are “safe havens” for investors looking for stabilized assets, particularly in the short-term.
Long-term market disruption is inevitable. It is still unclear if additional federal assistance or other forms of support will help retailers to survive the impact of a prolonged battle with the virus. The most successful retailers, landlords and investors are not waiting for the problem to fix itself; they are aggressively adapting to make their businesses stronger.
If you have not already done so, roll up your sleeves and start repositioning your business, examining your investment criteria, and looking for ways to create value. You will be happy you did.