The Year of the Rebound
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The Year of the Rebound
At the mid-point of 2021, newly appointed Green Street Director of Research Cedrik Lachance offers his views on where the commercial real estate markets are headed, from a public and private market perspective, and in the United States and Europe. 2021 has rightfully earned the moniker “Year of the Rebound.” But as any sports fan knows, the key to benefitting from a rebound is knowing which way the ball (or puck) is likely to go.
Commercial real estate prices have posted solid gains so far in 2021, up about 8% through July as measured by Green Street’s Commercial Property Price Index®. How do fundamentals look going into the second half of the year?
It looks very good, but with one cloud of doubt. First, from a pure GDP perspective, this is a year of rebound and many of us who analyze commercial real estate have increased our GDP forecasts and our expectations for 2021 and in some cases, 2022 as well. Since we received news of the vaccine in November 2020, estimates have been going up and of course share prices have been going up tremendously as well.
For fundamentals in the private real estate market, what you are seeing for all sectors we cover is about a 300-basis-point rebound in occupancy, which should swing back above 90% across the commercial real estate landscape. From a market rent perspective, we are going to be back to where we were in 2019 probably by the end of this year or early next year. Fundamentally, we have moved past Covid, but with the final timing of a full recovery still not entirely certain.
The pandemic meant very different things to different commercial real estate sectors, and it appears that is also true for the recovery from the pandemic. Which sectors does Green Street think are in the strongest position now?
There are sectors that have hardly suffered, and some that have in fact benefitted to some extent, from the Covid era. Manufactured homes and industrial are two sectors that have the best combination of market rent growth and occupancy gain expectations over the next five years. From a cash flow perspective, there is a significant rebound in sectors that were more affected by Covid, including senior housing and lodging. We expect very attractive sustainable growth for a few years in sectors such as apartments, single-family rental, and student housing. In fact, several other sectors should experience net operating income (NOI) growth in the four to five percent range for the next couple of years. This is a good era for real estate fundamentals, and we see that continuing.
What about the office sector, which is one of those more affected by Covid than others? Do we know what the ultimate impact of working from home will be?
This has been the big question almost since the start of Covid. It is interesting to see the back and forth recently between employers and employees. You have employers saying: “You better come back to the office!” And you have employees in some sectors saying: “I'm not going back to the office, and if you insist, I will just go work somewhere else.” This push-pull is very interesting.
To us, work from home is really the defining story of the real estate world during the pandemic. Choosing where one does work has meaningful impact to not just office, but to residential, hotels, and suburban shopping centers, which will all have different fundamentals based on the decisions that people make.
The lack of clarity is likely to last for at least another year, because implementing a hybrid workplace is truly daunting from an employer's perspective. We now have a lot of experience with working from home, but we have not really done the truly hybrid model. Trying to manage workforces where you have individuals who want to be in the office five days a week and individuals who never want to see an office again will be very difficult. Companies are still trying to figure this out.
From Green Street’s perspective, we expect there will ultimately be about a 15% drop in office demand versus pre-Covid trends. It is not going to happen overnight, and you are going to see many disparities between markets and countries. Coastal markets in the U.S. should suffer a bit more from work from home, whereas in markets that are a more dynamic from an employment perspective, often in the south, you might not even notice that work from home is becoming a greater percentage of the pie. We are open-minded as to what will happen, but nonetheless cautious about the office business.
Green Street continues to enhance its cross-border collaboration and Pan-European research and data/analytics. What does the pandemic recovery look like in Europe?
One of the things we are trying to accomplish as a firm is to be even more globally minded. Being able to compare the trends we see in the United States with those in Europe helps make our research stronger. We were able to capitalize on our coverage of different geographies very early on during Covid because the challenges were taking place a lot sooner and in a more noticeable fashion in Europe than in the U.S.
From a thematic perspective, work from home is a good example. We are even more open-minded about the office business in Europe, because in some places, working from home may not be embraced as much as in the U.S. and the market is healthier to start with. The other theme that is interesting in Europe is the growth of non-traditional property sectors in the public market. In the U.S., non-traditional sectors represent more than half of the value of the REIT industry, and that has been a fantastic way for investors to participate in the growth of these sectors. Europe is not quite at that point. Health care, self-storage, and residential sectors are not as institutionalized in Europe as they are in the U.S., and those are businesses that should flourish in the public market over time.
Are there any other trends property investors should keep their eyes on?
There are two that come to mind. The first is inflation, which is a hot topic right now. What is interesting about inflation is there are no potential inflation spikes priced into the bond market and as a result, there are none priced into the real estate market either. The REIT market is currently priced attractively versus many investment alternatives. We recently completed a study of inflation and real estate historically, and it suggests that commercial real estate is likely a very good inflation hedge. With real estate poised to appreciate if inflation remains relatively stable, and offering a hedge if inflation does spike, it effectively becomes a free option for investors. Secondly, we continue to firmly believe that the public market will remain an area of growth for real estate investors. There are very good reasons to have a portfolio that includes public and private real estate, and we think the public market should grow in a healthy fashion going forward.
What are your top focus areas in your new role as Green Street’s Director of Research?
Green Street is committed to offer unparalleled, actionable intelligence, research, data/analytics, and exclusive news in the real estate space. While our roots are in analyzing public real estate companies and we are still sometimes referred to as a “REIT shop,” Green Street does so much more now. We provide critical advice and context for private property market investors. Our expanding coverage of markets and top-quality news in the U.S. and Europe adds incredible value to give clients a full 360-degree view of the macro, sector, market, and property-level insights needed to make better investment and strategic decisions. Our proprietary data and analytics are unmatched in our industry, and Green Street’s research and data/analytics teams will continue to be focused on enhancing and expanding the depth and breadth of this intelligence.
Green Street has always had a very collaborative, integrated Research team. While we have many analysts who are specialized by sector, market, or macro and strategic topics, the bulk of what we do is the result of thought-provoking discussions and collaboration. While I am very fortunate to lead the team, in my new role I will continue to interact with Mike Kirby, the co-founder of Green Street, who has created this incredible research machine. Going forward, we will fine tune our products, be more active with our global presence, and focus on producing unique, innovative thought leadership, which is very important for us. Our Heard on the Beach and Insights reports will continue to be must-reads for the industry while we bulk up our data infrastructure and analytics offerings. In the near-term, this is a continuation of what we’ve already been doing for many years, further enhancing our efforts for the benefit of our growing, diversified mix of clients.
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