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back December 09th 2020 back

2021 Vision: The Road Ahead

This time last year no one could have imagined how 2020 would turn out. But with the contours of a once-in-a-lifetimes Black Swan event now clear, we now have a realistic sense of how 2021 might unfold.

Atlas Restaurant Group was projected to generate $85 million of business coming in 2020. Not surprisingly, the novel coronavirus ruined those plans.

But as the year winds to a close, CEO Alex Smith thinks 2021 is ripe for growth, with the recession offering restaurateurs an opportunity to secure management deals in spaces that might otherwise be unattainable.

“There are a lot of developers out there with big projects still moving forward, and they’re going to have empty space,” Smith says. “Now, landlords who have capital behind them are looking to build out spaces for restaurateurs to provide traffic into their developments.”

Currently, Smith is talking to a few developers about this very topic.

“We’re talking to people that normally would be leasing space, but are now looking to build out these spaces for a competent operator to come in and run a good concept to drive traffic to their development,” he says. Finding capital for restaurants is extremely difficult right now, Smith notes. So, developers’ willingness to work with restaurateurs can be a huge win.

Restaurants that have survived the ravages of 2020 could be excused if they have a hard time seeing the upside in the current situation. “Restaurants have been dramatically impacted, and will continue to be challenging with remote working continuing into the New Year,” says Grant Greenspan, principal of Kaufman Organization.

But if commercial real estate is going to have a successful 2021 it will require the ability to seek out unexpected advantages, such as the one Smith describes.

A NORMALIZED MARKET

As we move into the New Year there is plenty of reason to feel better about the industry’s prospects, starting with the strong likelihood that a vaccine for Covid-19 is widely expected to be available by mid-Summer. Also, certain asset classes such as multifamily, industrial and the life sciences are well-positioned to perform well. The liquidity that fled the market is starting to return and year over year transactions are expected to increase. “What gives me hope for the year ahead is that we expect the markets to normalize and for there to be more certainty in 2021,” says Al Brooks, managing director and head of commercial real estate for JPMorgan Chase.

To be sure, the recovery will be a bumpy one.

Urban Land Institute’s Real Estate Economic Forecast predicts a varied recovery that will begin in 2021 and last through 2022. “The worst fears of earlier this year have mostly eased,” says William Maher, principal at Maher Strategies. “As of now, leading real estate economists are signaling that resilience and underlying strength will likely win out over uncertainty and risk.”

Respondents forecast 3.6% GDP growth in 2021 and 3.2% GDP growth in 2022. This year will be a wash with a negative 5% growth rate, but even that is an improvement compared to the prior survey, which estimated a 6% fall in GDP for 2020. Projections about employment follow a similar trend. This year, the survey expects jobs loss to total 9 million, but—like GDP—job growth will begin in 2021 and 2022, growing by 3.5 million and 3 million jobs, according to the survey. By the end of 2022, unemployment could fall to 5.5%.

The report also predicts that real estate transactions will also rebound in 2021, totaling $400 billion in 2021 and $500 billion in 2022. Next year, the report says, price growth will remain flat but it should increase by 4% in 2022.

RETOOL, POUND THE PAVEMENT

None of this is to dismiss the ravages the pandemic has had on commercial real estate and the difficulty that is still facing the industry. To survive, companies must seek out those slivers of advantages.

Consider the dilemma facing office buildings located in central business districts, for example.

Over the past couple of decades, these buildings have thrived as tenants and employees sought out cities’ work-live-play appeal. Then came Covid-19. Most white collar employees were able to work from home and downtowns fell silent. Companies began rethinking the role the suburbs could play in their operations.

It is still unclear whether this will be a permanent shift or if companies will choose city locations again. One argument being advanced is that if CBDs and their office buildings are to survive they need to embrace this new approach to working.

“Owners and developers will need to identify how to configure a building so that it can be quickly repurposed for the different uses and types of working demanded by occupiers, evolving previously homogenous single-use buildings into mixed/multiple-use environments,” according to a report by international law firm Withersworldwide. “The aim will be to change the utility of a space within days, so a building isn’t just tied to a particular usage, or a single occupier.”

The path forward, Withersworldwide says, is for buildings to generate a return on investment by producing spaces that people want to play, socialize and even live in. If a building is diversified and occupied by many smaller occupants, the risk is spread out. If one company defaults, another one could easily step in.

Grocery stores are another example but in the reverse. As people avoided in-restaurant dining during the pandemic and stayed at home, grocery stores have been the beneficiaries.

But this momentum could be lost unless they retool for the strategic challenges ahead, according to Bain & Co. In fact, the sector could be facing several challenges in the year ahead, it argued.

“The dilutive shift to online grocery has accelerated, and omnichannel leaders are locking in shoppers to subscription services,” according to the report. “Discounters continue to build stores, lowering prices and squeezing margins. Consumers still want more convenience, more value, more environmental and social impact. Restaurants—such an easy alternative to eating in before Covid-19—will regain traction at some point.”

Without concerted strategic action, Bain modeling suggests grocery profits will only increase 1.2%—from just over $34 billion to $39 billion–between 2019 and 2030, in the absence of concerted strategic action.

The problems could start next year. If there is a vaccine, Bain thinks diners could rush back to restaurants and annual revenues could fall by 4% to 7%. In comparison, grocers posted 2.6% annual sales growth between 2014 and 2019.

In some cases, navigating 2021 will come down to just pounding the pavement looking for needed investors or tenants.

BTI Partners, a developer based in Ft. Lauderdale, FL, is still delivering new projects but with scores of retailers going out of business, it isn’t easy to find new tenants. Vice president of retail development Britney Mroczkowski, though, isn’t deterred.

“I’m still doing all of my normal marketing tasks, but I’m just making a targeted list and really looking at who’s doing well,” Mroczkowski says. “I think it comes down to who marketed themselves extremely well during quarantine and how they’ve evolved their business.”

For Mroczkowski, this means on-the-ground research.

“I’m walking around town and, if I see someone that is doing great, I’ll reach out to them,” Mroczkowski says. “It’s just being laser-focused and, keeping your eyes on what’s happening in your market.”

CHANGING TRENDS

In other instances, 2021 will require being able to react quickly to changing trends. The office sector, as one illustration, is still trying to determine how extensive and long-lasting the work from home movement will be. There have been numerous surveys that show companies are in no hurry to have their workers return to the office. One was conducted by S&P Global Market Intelligence and it concluded that pandemic-inspired workplace models will likely stay in place following the pandemic.

Namely, it found that 69% of companies have determined that 75% of their workforce can work remotely without issue. As a result, 64% of companies plan to increase remote work policies following the pandemic, compared to policies in place prior to the pandemic. In addition, 32% of companies will reduce their office footprint as a result of remote work adoption. Smaller companies are more likely to adopt these policies permanently, and companies with fewer than 1,000 employees found that 100% of the work staff could work remotely in the long term.

On the other side is Marty Burger, CEO of Silverstein Properties, who doesn’t think COVID-19 will permanently alter the office landscape.

“For the most part, most companies will see the value in having an office,” Burger says. “You can’t mentor people through a Zoom meeting, and it is difficult to raise money over the phone. You can’t collaborate as well when you’re not all in a room together.

“Net-net in the long term, we’ll need about the same amount of space,” he continues. “I think it [the office transition brought on by COVID] may benefit the newer office buildings, but I still think tenants in class B buildings will need the same amount of space.”

In fact, in some cases, it may encourage tenants to lease more space, he says.

“Spaces will change, but it’s tenant by tenant,” Burger says. “There are many tenants who had a very efficient space and may need to have more offices now because they were too efficient.”

What is certain, says Eric Cagner, executive managing director with Newmark Knight Frank, is that there will be an overall re-thinking about space. “For TAMI companies, space utilization has changed from high density space where we were 165 square feet per person to a space that is used for collaboration and culture.” As a compromise these tenants may opt for new boutique office buildings, like The Warehouse in Manhattan, as a single-user office space with increased privacy.

And of course, much will depend on Covid-19 protocols and restrictions in subsequent waves, says Time Equities founder Francis Greenburger. “These restrictions constrain economic activity and will affect whether existing tenants pay their rent, renew their leases, and expand.”

BETTER LIQUIDITY, MORE DISTRESS

CRE also stands to benefit next year from capital sources that are emerging from their bunkers.

In its recent Capital Alert, Marcus & Millichap reports that “recent conversations with institutions and investors across the lending landscape suggest dynamics are shifting quickly.”

Asian and European groups are looking to invest in open-ended US funds while banks and insurance companies are drawn to commercial mortgage loans where they can get yields of 2.5% to 3%. Investment banks, for their part, are gravitating to fixed-rate construction loans, which could help them lock in low-leverage deals.

As usual, much depends on the asset class in question.

Hotels, for example, are having difficulty finding lenders and when they do the loans are only made available at double-digit rates.

Compare that to the manufactured housing sector, where capital is plentiful.

“The appetite for manufactured housing communities from investors and debt providers has never been stronger, with no shortage of capital in the market for virtually any transaction profile from core to value-add,” says Zach Koucos, managing director at JLL Capital Markets.”

“Fannie Mae and Freddie Mac are both on track to exceed their 2019 manufactured housing community loan originations, and we’re seeing an ever growing field of capital sources interested in manufactured housing including life insurance companies, debt funds, regional banks, CMBS / conduits, bridge, and structure finance providers.”

Next year could also see some movement in the long-anticipated but yet-to-materialize distress transactions. Almost since the beginning of the pandemic, investors with dry powder have been waiting for such opportunities to hit the market. In late April, for example, Mark Foster, attorney at Snell & Wilmer, put together a couple of distressed opportunity funds for his clients.

“They thought they might be able to get some good deals,” he says. “They got a few, but then that dried up.”

The reason, generally, is that lenders and landlords have been willing to work on forbearance with their partners to keep the market afloat. It is debatable how long this spirit of cooperation can last.

Also, as Foster points out, eviction moratoriums have been another major reason for the lack of distress opportunities. “Right now, the tenant is in default, the borrower is in default, and nobody can go in and take the property back and re-tenant it or anything,” Foster says. “They’re not sure what they want to do.

Foster thinks once the moratoriums on evictions are lifted, things will start moving. “When they do stop, there are going to be a lot of chess pieces moving,” he says. “Most retail tenants, like restaurants and fitness centers, will not be able to recover. I don’t think the landlords or their lenders are going to be able to extend and do anything. All of a sudden, you’ve got a bunch of evictions and a bunch of half-vacant buildings that owners are going to have to sell. And they’re going to have to sell at a discount.”

And that, in a nutshell, will be 2021’s overarching story: more opportunities amid the ongoing pain.

 

www.globest.com