A Difficult Forecast for Commercial Real Estate

Winter 2020/2021 Issue
By: Trey Barrineau
Attendees at the NAIOP Research Foundation’s National Research Directors Meeting said office tenants may be seeking shorter-term leases for the foreseeable future. Getty Images

The COVID-19 pandemic and its impacts were major topics during the NAIOP Research Foundation’s National Research Directors Meeting in September.

The NAIOP Research Foundation held its National Research Directors Meeting in September ahead of CRE.Converge Virtual 2020. The meeting, which was conducted via Zoom because of the ongoing COVID-19 pandemic, brought together NAIOP’s Distinguished Fellows and research directors from national real estate brokerage, data and investment firms for a virtual discussion of current trends in office and industrial development, as well as the effects of the pandemic on the commercial real estate industry.

Office Markets: Current Conditions

Shawn Moura, Ph.D., NAIOP’s director of research, opened by asking the panelists their thoughts on general conditions for office development in the near future. The consensus point of view was that investors continue to be reluctant.


For example, Jim Costello, senior vice president of Real Capital Analytics, noted that construction financing dried up in the second quarter of 2020 as the pandemic gripped North America.

“If you don’t give developers financing, they’re not going to build,” he said. “The largest, most aggressive types of lenders in the past have been the investor-driven lenders, the debt funds. Not anymore.”

John Affleck, vice president of market analytics with the CoStar Group, said his company’s research bears that out.

“Our data shows it’s really dropped off a lot for national or institutional buyers,” he said. “It’s hard to get on an airplane and visit an asset these days. But the local players and individuals have been relatively more active.”

Mark Stapp, executive director of real estate programs at Arizona State University’s W.P. Carey School of Business, said predictions for commercial real estate are difficult right now.

“It’s really hard to look beyond 30 days, let alone two quarters or a year from now,” he said.

Stapp added that the strength of the economy in the months ahead could depend on future government stimulus packages, as well as what happens when individual states end their prohibitions on evictions.

Dean Violagis, vice president of research with CoStar, noted that rents are softening in major markets.

“It’s not a landlord’s market, it’s a tenant’s market,” he said. “It’s also in the concessions. From what I hear, landlords are offering very aggressive concessions to lure tenants to buildings, depending on the city. Washington, D.C., the Bay Area, New York, these markets are very different than they were six or seven months ago.”

Violagis also said that an enormous amount of sublease space is being released, which could hurt a number of major cities.

The pandemic is affecting different property types in different ways based on geography and asset types. For example, Stapp said the industrial market is doing very well in his hometown of Phoenix, and the office market hasn’t fallen off significantly from the first of the year.

“We’ve yet to see the full effects of what started six to eight months ago,” he said.

Next, Moura asked attendees to share what they’re hearing with regard to occupancy and leasing. Most predict shorter leases and fewer people in the office because of COVID-19.

“People are not ready to renew their leases for 10 years,” Violagis said. “They’re more on a shorter time period. People are not committing to long-term leases until we get out of this mess we’re in. From a landlord’s perspective, with a shorter lease, at least you have the rent for a year or two instead of a vacancy, and that’s troubling.”

Raymond Wong, vice president of data solutions with the Altus Group, said that’s happening now in Toronto, where leasing activity fell 50% year over year in the first six months of 2020.

“We’re already starting to see shorter-term leases, or less of the seven- or 10-year leases,” he said “Unless their leases are expiring tomorrow, they’re not going to do anything.”

Wong said Altus was going to adjust its forecast upward for square footage per employee before COVID-19, but the pandemic forced an immediate change into the market.

“There will be more space per employee, but the footprint of the office will shrink,” he said. “It will be more of a hybrid. With the growth in teleworking, not everyone will be in the office together at once, so you don’t need that space to accommodate everyone.”

Bill Argeropoulos, principal and practice leader for research with Avison Young’s Canadian operations, said he sees working from home becoming a complement to, rather than a replacement for, the office. However, that could shift once workers feel safe in their old workspaces.

“Despite the easing of some government restrictions and a commendable effort by landlords and employers to provide safe and healthy work environments, the return to the office has been slower than initially thought,” he said. “There is a growing awareness and acceptance of the idea of more ‘flexible’ or ‘fluid’ workplaces, and longer-term remote work plans will ultimately result in a more distributed workforce going forward. However, there is also staunch support for the physical office remaining a key component in the increasingly hybrid workplace.”

Anthio Yuen, director of research and strategy with GWL Realty Advisors, noted that there will be a higher focus on employee flexibility, wellness, and health and safety looking beyond COVID-19. Greater use of technology will be key in this regard, whether monitoring air quality and HVAC systems, or adoption of proptech to optimize employee densities and collaboration.

Lexi Russell, director of research and analysis with CBRE, reminded the group that structural limitations are also in place.

“If you can only have 20% to 50% capacity now, that’s where you’re going to be for the foreseeable future instead of measuring demand in new square feet per person,” she said. “It also depends on what industry you’re in, what type of building you’re in, and how many people can work remotely.”

The panelists offered their thoughts on whether more offices might move from central business districts (CBDs) to the suburbs in the wake of the pandemic. For example, in major cities like New York that rely heavily on public transportation, attitudes toward returning to CBD offices appear to be more cautious.

“It depends on the geography,” Violagis said. “It’s possible that a satellite office for a subset of workers may be an ideal scenario for some companies, depending on their situation and depending on where they are.”

Argeropoulos said he’s seeing that dynamic play out in the Toronto area, where Avison Young has three offices — one downtown and two in the suburbs.

“For me, the hub-and-spoke model and/or the ability to work from home part-time minimizes the time to and from the urban core, the cost of parking (if you drive) and eliminates the risk of transmission by taking transit, for now,” he said.

Affleck said CoStar’s data shows that the negative net absorption for office and the increase in sublease space is more pronounced in CBDs, but it’s an issue in suburban markets as well.

According to Affleck, CoStar’s multifamily data shows rent divergence between CBDs and suburban markets, as well as strong evidence of people moving out of downtown areas, though he said he’ll need to wait for government statistics to confirm that.

Russell noted that it’s not just about urban vs. suburban, it’s also about primary vs. secondary markets.

“Think San Francisco vs. Oakland,” she said. “Where can you have your family and your downtown? The demographic change is going to show a shift toward larger ‘suburban’ markets where the infrastructure is still there.”

Affleck said the geographic areas seeing the strongest demand and rent growth in multifamily are affordable, regional markets.

“Richmond, Virginia, along with Sacramento and the Inland Empire in California, offer significant discounts to D.C. and San Francisco,” he said. “With labor increasingly democratized or at least freed from location because of telework, a lot of firms may begin to look to those secondary markets as a home for offices.”

Industrial Markets: Current Conditions

Panelists agreed that the strong performance of industrial during the COVID-19 pandemic, when e-commerce soared amid stay-at-home orders, should continue for the foreseeable future.

“In Canada, overall investment activity is down 20%, but industrial investment is up 24%,” Wong said. “It’s a very safe bet.”

However, not all industrial properties will thrive. For example, Wong noted that small-bay operators are seeking rent deferments at a much higher rate than other industrial properties.

“We’re seeing deferment rates of around 10% to 15% for these operators, compared to 5% to 7% for other operators,” he said. “It will be interesting if we get a second wave of COVID. Some of the small-bay users serve the restaurant and hospitality industries, and as we know, they’re taking a hit right now.”

Industrial performance

Industrial’s strong performance during the COVID-19 pandemic has been a bright spot for the commercial real estate industry in 2020. Getty Images

Amazon continues to take on an enormous amount of warehouse and distribution space. The e-commerce giant has added more than 58 million square feet in 2020, and a lot more is on the way. During an earnings call in July, CFO Brian Olsavsky said the company wants to increase the square footage in its fulfillment network by 50% before the end of 2020 to keep up with demand driven by the pandemic.

However, panelists pointed out that the operators fueling the expansion of distribution space are more diverse than most people realize.

“It’s not all Amazon,” said James Breeze, global head of industrial and logistics research with CBRE. “While Amazon is dominating 2020, if you take out all the Amazon deals, industrial transactions are still up. Just 1% or so, but they’re still up. The reason for this is the continued strength of the third-party logistics (3PL) industry. 3PLs have accounted for 30% of transactions this year, the most for any occupier type.”

Breeze said that in the short term, a big driver for expansion is the need for higher inventory levels and increased safety stock.

“Demand from inventory control is not coming from retailers so much,” he said. “It’s coming from wholesalers and outsourced 3PLs. They need to keep more product on shore to keep retailers happy. If they don’t, the supplier will lose shelf space or the 3PL could lose the contract. These kinds of companies will require more space and could be a major demand driver in the next 12 to 24 months because of this.”

Chris Caton, senior vice president of global strategy and analytics with Prologis, said he’s seeing that as well.

“We’ve seen other multichannel retail fulfillers growing, too,” he said. “In addition, 3PLs are active as they can quickly spool up. They offer expertise, real estate and the labor for logistics operations. We’ve seen some essential industries such as food, beverage and health care companies taking space.”

Looking ahead, panelists said automation and robotics in distribution facilities should continue to grow, as will cold storage. Conversions of obsolete retail buildings into last-mile facilities should also accelerate.

Because the pandemic exposed vulnerabilities in global supply chains, panelists discussed the future of nearshoring and reshoring to ensure that critical supplies are always available in North America during a crisis. They indicated that it could be years before a permanent change takes place.

“It takes time and money to completely revamp supply chains, but our desire for decreased reliance on China will support that trend,” said Amanda Ortiz, national director of industrial research with Colliers. “There’s a lot of benefits to reshoring. Offshore costs are rising. We could respond to needs so much faster. We could also reduce unemployment and create jobs, which are all good things for the industrial sector.”

Despite that, Caton said it might not be a crucial part of business plans for most major logistics operators.

“A lot of the response to the China trade deal was to go to other Asian locations and potentially Mexico,” he said. “We’ve seen that along the northern border of Mexico, but the trend is just beginning. It’s expensive to manufacture in the United States. If nearshoring is a trend, it will be concentrated in small markets. In those locations, that’s not really a real estate strategy, that’s a financing strategy.”

Conversion of empty retail spaces into distribution facilities has been a hot topic in the commercial real estate industry in recent years. However, Caton said he takes the other side of the retail-conversion conversation.

“I think it could be big for certain categories for retail, but it won’t be big for our business,” he said. “I have a hard time seeing this get past 10 million square feet a year in retail conversions. The sites are not suitable for logistics. Many are too small. Also, there are a lot of people at the table to negotiate. The value differential between retail and logistics is too wide. In the end, it gets down to economics, it gets down to legal, and it gets down to municipalities, which are often worried about traffic and noise associated with these facilities.”

Rethinking Retail

Panelists were asked what types of retail are going to survive and thrive, and whether ground-floor retail will remain attractive.

Panelists agreed that the types of brick-and-mortar stores that stayed above water during the pandemic — grocery-anchored retail, open-air centers and power centers — should continue to see strong business.

“They’re a value proposition for the shopper who is on a budget, especially as we’re exiting a recession,” said James Cook, Americas director of retail research for JLL. “Target, Walmart, Aldi, TJ Maxx, anything like that has a good outlook.”


The retail sector was hit hard by the COVID-19 pandemic. Class B and C malls in particular could face a gloomy future. Getty Images

Malls, however, continue to face a difficult business climate. Decimated by the rise of e-commerce, they’ve struggled even more during COVID-19 lockdown orders. As anchor stores vanish, mall owners are searching for new ways to drive foot traffic. While food, beverage and entertainment helped prior to the pandemic, those are on hold right now across the country because of COVID-19.

“It’s really the malls we’re most worried about, particularly the B and C malls in major metros,” Cook said. “But I’m pretty positive that a B or C mall in a relatively small town that’s nowhere near a bigger city, even if it’s a declining mall, even if it loses the JC Penney, they could make it if it’s the only place to go shop.”

Cook said gyms will struggle as well, noting that most are saying memberships are down 50% to 70% from the previous year.

“It’s going to be a tough two years for gyms,” he said. “People aren’t going to feel safe, even though they’re rolling out these great safety and hygiene procedures. It’s going to take a long time for them to recover. It’s going to be a long haul.”

Cook said movie theaters could survive if they take social distancing and hygiene seriously.

“Movies only have to sell about 30% of seats in order to break even,” he said. “That’s why they have blockbusters on some screens and niche films on others. If you can space people out and have a big enough multiplex, you can break even.”

Finally, Cook said he doesn’t think that recent news about major mall property owners like Simon Property Group and Brookfield Property Partners buying out some of their distressed retail tenants such as JC Penney will become a widespread strategy.

“I think it was an opportunity to handle an occupancy issue and get out ahead of it and buy something,” he said. “Ultimately those purchases made economic sense for them, but I don’t see a lot of shopping center owners buying a bunch of retailers.”

Trey Barrineau is the managing editor of publications for NAIOP.