How COVID-19 can change the face of the Commercial Real Estate Market

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The commercial real estate market has been upended by the COVID-19 pandemic and the long-term impacts are still to be written. The fact is that no one knows how this will play out but many have provided their views as to which impacts are expected to be short in nature and which ones are expected to have meaningful long-term implications for commercial real estate.  Human behavior is being altered every day in the current situation. What sticks and what lingers will determine the winners and losers in CRE. The hotel and retail sectors are the two most impacted corners of the CRE market. Some of the most successful and respected investors are those who ran to opportunities that at the time seemed counterintuitive but proved highly profitable. I imagine that the current situation will likely present the same potential for meaningful gains.  

Hotels

Sitting here today, hotel owners and lenders are in serious trouble. Conventions, business travel, and personal vacations are off the table and it will likely take many months for people to be comfortable to travel and stay anywhere other than their home. However, the longer-term prognosis for hotels, I believe, is far more positive. People enjoy travel and look forward to it, whether it be a convention or leisure. Hotels provide escapes and new experiences that people seek out. Inferior hotel products may close or be converted to alternative uses but travel will come back and hotels with it. The hotel experience will likely look very different and the changes will add an additional cost burden to operations but if the hotel is well-located in a major market with consistent demand drivers, that hotel should be a viable investment that can provide potentially meaningful returns. The key for any current owner is to be able to hang on long enough to get to the other side of the current situation.

Brick and Mortar

Brick and mortar retail is a sector that has been spoken about ad nauseum and I will not bore you with things that you already know. People like to shop online and the process of shopping at most retail stores is painful, time-consuming, and inefficient. Retail was in pretty bad shape heading into the pandemic and this could be the impetus to push it over. I have to be careful here when I speak of retail in a broad sense. There are many different types of retail properties from malls to high-street to single-tenant to grocery-anchored. They are all facing different challenges. One overarching theme across all retail is that it is dependent on an economically healthy consumer with disposable income to spend.  With the unemployment rate approaching 20%, retail will likely suffer as wallets close, and discretionary purchases are postponed.  

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Retail

Digging into the specific property types, I am personally of the view that malls are dinosaurs and their death is upon us. I also said that in 2007 and look where we are now. There are around 1200 malls in the United States. Depending on who you ask, some expect 50% of them to eventually close for good and some are calling for potentially as many as 70%. There are certain malls that are trying to adjust by incorporating a substantial mix of experiential retail like American Dream in New Jersey. This is a massive property that has a majority of its space dedicated to experiences like an indoor ski mountain, indoor water park, and indoor Nickelodeon themed amusement park, among others This playbook has worked for the Mall of America in Minnesota. It will be very interesting to see what happens with the American Dream.  

Pivoting to grocery-anchored shopping centers with a nail salon, dry cleaner, liquor store, fast food restaurant, among others, these are clearly the properties that many, including me, believe will survive and do well.  While the pandemic may alter consumer behavior to be more comfortable with online food delivery, penetration of online food shopping prior to the pandemic was extremely low. This is a clear example of short-term vs. long-term implications.  In the short term, online shopping for food is booming and likely will do well as consumers avoid people.  As normalcy returns, whether in 3 months or a year, I am of the belief that the vast majority of people prefer to food shop for themselves but may see the value of having non-perishable items delivered (toilet paper, paper towels, detergent, etc.).  

The last point I want to highlight in retail is that the expectation is that 2020 will see the highest number of store closings ever recorded. So many retailers were on shaky footing in a growing and healthy economy, let alone one where people could not leave their homes. I believe that if it was not for COVID-19, something else would have brought about the demise of the names we are all reading about, including J. Crew, Stage Stores, and Neiman Marcus, among others. The survivors will likely benefit immensely from the smaller competitor set. Like hotels, the owners have to get through the other side to take advantage

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