December 14, 2020

Dispatch from the front lines; The COVID-19 investment edition

One question we hear a lot is, where are the distressed assets? And the deeper we go into the pandemic-induced recession, the stronger the call for distressed pricing from investors becomes. But nine months into the pandemic, there is very little true distressed pricing, and the gap between sellers and buyers has grown from a crack to a canyon. Seller underwriting reflects pre-pandemic fundamentals, and buyers expect returns to be adjusted for our new normal. In our December newsletter we are going to look at some of the reasons behind this disconnect in expectations and dive into what we are seeing in each of the main asset classes.

We see two different outlooks among investors. The first is that we will quickly rebound out of the recession as soon as a vaccine is widely distributed. Rents and occupancy will bounce back, and our economic recovery in general will be quick. This view is bolstered by the stock market continuing to reach all-time highs. It’s important to remember that first and foremost, we are experiencing a public health crisis. The recession we are in was not precipitated by a collapse in the financial system, and overall, the underlying fundamentals have remained solid. As a seller looking to exit their asset at the highest value possible, this is the optimistic view.

On the other hand, there is a view that even with a vaccine, the recession will not end quickly. People’s habits and trends will have been altered for the long term, which will especially impact office assets. And when we do come out of the recession, rents are going to be below pre-COVID levels. There is also a snowball of other issues that must be dealt with, which include an eviction moratorium for unpaid rent and non-performing loans. As a buyer looking to minimize risk and anticipate the reality that they will be operating the asset, this is a commonly held view.

The interesting thing is that there is data to support both points of view. And it is this opposing outlook on the world that has created a canyon between sellers and buyers. So how do we advise our clients in this uncertain market?

If you are selling a property right now, you are capitulating to being a market seller, and in this time of great uncertainty that can be a difficult process. Buyers are going to be very conservative and the property is going to be picked apart. If the seller has a choice to sell or not to sell, currently our recommendation is to hold and wait until we are coming out of the pandemic. But we recognize that some owners will need to sell during his time.

For buyers we are advising our clients to be patient and stay prepared. To use a basketball analogy, the best place to be right now is waiting for the rebound. Once a seller and buyer play the game and that transaction bounces off the rim, the seller may be more motivated to get another buyer to step up, which is a good time to push for discounts on the asking price as the second buyer.

With that in mind, each property type has its own opportunities and challenges for an investor. Below we give a high-level overview of the four major property types and how we recommend proceeding with each asset type.

Retail Investment Outlook

Arguably COVID-19’s effect on commercial real estate is most pronounced on retail properties. The daily news of what seemed to be stable companies announcing dozens of store closings including J. Crew, GNC, and Victoria’s Secret or closing altogether like Pier 1 Imports has shaken the retail market. Beyond the national department stores and the specialty stores, local businesses have been affected tremendously. Portland’s once vibrant restaurant scene has been changed forever with notable closings that include Pok Pok, Clyde Common, and Bluehour. Some operators have been able to pivot to limited seating as well as embracing delivery services to stay afloat while we wait for the vaccine. Unfortunately, this is not the norm. It means lots of vacancies that landlords must fill in a troubled marketplace.

On the other hand, one area of food service is seeing record numbers: QSR, or quick service restaurants. These establishments comprising mostly fast-food concepts (examples: Dunkin’, Wing Stop, Chick-fil-a, etc.) were already well-positioned to take advantage of the pandemic. With drive-thru service, these establishments became very attractive as customers never had to leave their cars.

Despite the news of store closings, we believe retail properties can be one of the best assets to consider acquiring in this time of uncertainty. One type of property to consider is the neighborhood retail center. These properties provide an important service to customers who live nearby. It could be the dry cleaner or nail salon. It might be the convenience store or the local bike shop. These are businesses that will always have a place in the neighborhood – especially post-vaccine.

Recommendation: Proceed cautiously. Be sure to know the market and look for strong demographics and focus on service-oriented centers that provide true value to a neighborhood. This is a contrarian play but there can be great opportunities for patient investors focused on quality real estate in irreplaceable locations despite the current struggles.

Industrial Investment Outlook – the E-Commerce Effect

The pandemic’s quarantine has pushed our economy back into the home. Retail is now happening on the kitchen counter via Amazon and other online retailers. This massive shift to online retail was already happening. It was bound to grow year over year. But COVID-19 accelerated that trend. What does that mean for industrial real estate? A lot. Especially if you are an industrial owner with huge, state-of-the-art warehouses.

The new standard for e-commerce warehouses has caused a new wave of development. This trend is important to note for owners and would-be owners of commercial real estate. The wave of new warehouse development is helping e-commerce but not traditional industrial users. Smaller companies that do light manufacturing or distribution are finding it harder to locate properties to fit their needs.

Recommendation: Industrial properties in average to good locations are going to continue to be in demand. Also, the costs to re-tenant industrial properties (tenant improvements) are much less capital-intensive than office and retail.

Office Investment Outlook

More than any other asset class, the outlook for office properties is uncertain. The pandemic has pushed those who spend their days working in office buildings to working from home. It has accelerated the adoption of new technologies as we figure out how to stay connected when we are all working remotely. With companies seeing success in this model, we anticipate a hybrid model continuing in the future, which is going to shrink a tenant’s footprint and lead to less demand in general for office space. This will result in higher concessions and lower rents.

For investors this means underwriting conservatively and understanding the depth of the leasing market. Does the building have modern amenities that will attract tenants? Is it well-located? What’s the parking like? What type of tenants will be interested in the building? These have always been important factors, but really understanding them now is crucial.

Recommendation: Office properties are generally capital-intensive projects, and with a shifting landscape and uncertain future demand we see a lot of risk. However, for buyers willing to be patient, there will be good opportunities to pick up assets at a low basis. Be patient but be ready to act quickly when the opportunity presents itself.

Multi-family Investment Outlook

The challenges with multi-family properties in our market have more to do with owning and operating than they do with underlying market fundamentals. There have been eviction and rent moratoriums and various restrictions with little guidance, making the landscape challenging for landlords to navigate. Not to mention the challenges of trying to keep the building residents safe from the threat of COVID-19.

In the face of these challenges, the underlying fundamentals remain strong, and Portland is a desirable city to live in. For those with the experience and appetite for operating in the complex and changing landscape, there are opportunities to buy and sell.

Recommendation: Multi-family remains an attractive investment in the Portland metropolitan area, but because of the constantly shifting regulatory landscape, we don’t recommend it without the knowledge or team in place to operate the asset.

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