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As part of its ongoing series of virtual conversations about business-related impacts of COVID-19, the VCU School of Business on May 6, welcomed Jeff Gronning and Brent Smith to address the topic of “COVID-19 Effects on the Real Estate Industry.”

Gronning, a 1990 graduate of the VCU School of Business, currently is chief investment officer for Columbia Property Trust and has been involved in the commercial real estate industry for his entire career. Smith is a VCU real estate professor and the CoStar Group Endowed Chair in Real Estate Analytics. He holds a Master in Business from the University of Notre Dame and holds a Ph.D. in Finance and Economic Geography from Indiana University.

VCU donors, c-suite executives, real estate leaders and VCU alumni joined the live conversation via Zoom and participated in a Q&A. These highlights have been edited and condensed for clarity.

Jeff Gronning breaks down each real estate sector
A time of challenge and opportunity:
The COVID-19 pandemic has had a major impact on global and national economy, the real estate markets and life as we know it. During my 30-year business career, I’ve counted seven different crisis periods. All have been different, all have been very impactful, and all have resulted in lasting change. But they’ve also given way to new opportunities. This pandemic will be no different.

Northeast and California hardest hit: Stay-at-home orders, the closure of non-essential business and the halting of construction projects have all dealt a serious blow to commercial real estate. In addition, our largest real estate markets, the most densely populated geographies in the country, have been particularly hard hit by the virus and remain the most tightly quarantined markets in the country. The Northeast and California include America’s gateway cities, and together represent more than half of the U.S. gross domestic product. These two regions in particular, the coastal markets. are likely to lag rest of the country in terms of reentry and ultimate recovery.

Hotel sector hit hard: Hotels were one of the first property type to feel the impacts of the pandemic. Occupancies have fallen from 70 percent to somewhere between 0 – 25 percent with many properties actually closed or ordered closed.

Retail properties suffering: Retail properties are also massively impacted. Retailers and restaurants are not generating revenues and therefore they are not paying rent. Most retail landlords in the public space are reporting collections somewhere between 25 – 50 percent of billed rent for the month of April. The month of May will likely be worse.

Online buying a trend that could hurt retail properties: The accelerating trend of online buying has picked up dramatically as a result of COVID-19 pandemic. The pandemic is reinforcing a trend that was already having a disruptive effect on the retail property sector. The determination of winners and losers across this space is going to accelerate as a result of the macro trends we are seeing.

Office landlords still collecting rent: Many cities have shut non-essential businesses and enforced shelter-in-place orders. This has had a direct impact on office building occupancies. Fortunately, office landlords have longer term leases and many commercial tenants have been able to conduct business from home. Most office portfolio managers have reported collecting 95 – 97 percent of April billings. While there is much more stability in the office sector, there are unknowns about what the month of May will look like and what the impact will be if the economy doesn’t reopen soon.

Is work from home here to stay? The COVID-19 pandemic could impact the long-term demand for office space. There are going to be fundamental shifts in trends and demand patterns. The CEO of Morgan Stanley is on record saying he sees a future with less need for office space and more people working from home.

Creating safer office spaces: Landlords can create a safe office environment for tenants, their employees and customers. They can achieve this through distancing, limiting the number of people on an elevator or requiring tenants and their guests to wear personal protective equipment. Landlords can create drop-off points for food deliveries and constantly clean and disinfect of common areas.

There are a number of things you can do to make buildings healthier. Landlords can improve air quality with purification, bipolar ionization and HVAC systems that circulate more fresh air. Tenants can impose social distancing by rotating employees through the building with groups of employees working every other day to implement six-foot distancing protocols across their space.

Properties dependent on mass transit face challenges: Until we have a vaccine or effective therapy for COVID-19, we may see changes in the type of office that employees are going to want to sit in. Do they want to be in 50-story office towers where you need to step into an elevator with 20 other people to reach your floor or would they rather be in low-rise buildings where you walk up and down steps?

What will be the impact on office buildings in cities that are dependent on mass transit, like New York where you have eight million people a day riding the subway? How comfortable will people feel being on subway? How people get to their offices is not within the control of investors and landlords. Mass transit is important to many cities and it won’t be possible for all employees to drive their cars to work. These questions will change demand patterns and will ultimately have an impact on supply and demand of office space.

Will we need more or less office space? We are actually witnessing a reversal in the trend toward densification in coworking. If workers must stay six feet apartment, office tenants may need a lot more space. It remains to be seen how long the social distancing and move away from densification will last, whether it will be permanent, and what the impact of working from home will be.

Winning properties? Industrial and life sciences: Industrials already had a lot of momentum and those trends are being reinforced by the pandemic and the resulting growth of ecommerce. Life sciences, historically a niche property type, is poised for significant growth, given the likely increase in investment for biological and healthcare research and the need to provide the facilities and properties to support that growth. Areas throughout the country, such as Cambridge, Mass., San Francisco and San Diego could be big winners coming out of this pandemic.

Multi-family assets have held up reasonably well: Most landlords are reporting collecting 95 percent of rents month over month for April thanks in part to the federal fiscal stimulus that is directing funds to individuals who use them to pay rent and address other necessities.

Distress in mortgage sector: Companies that hold and invest in residential and commercial loans have been very hard hit. Some are levered essentially 9-to-1 and, because of that, they are facing margin calls from their lenders as the value of the securities that they hold declines. There is a corresponding inability of these companies to make good on these margin calls. Their stocks have been down 60-70 percent. They have come back slightly, but there is some real distress in that sector.

Forgiveness and flexibility: Lenders are being much more flexible to borrowers than they were in 2008-09 crisis. Mortgage interest deferrals for 90 days will help retail and hotel owners navigate through the loss of revenue. It can’t go on indefinitely, but at the urging of our government, there’s been some real flexibility there in a way that we didn’t see in the last crisis.

The good news? Interest rates are low. When the markets reopen, the availability of credit for real estate should be a tail wind for the market going forward. Though there is definite damage being done, there will be winners and losers. Our goal is to figure out and adapt to where the opportunities are that come out of this. There are always opportunities on the other side that investors can take advantage of.

Brent Smith’s take on future impacts of COVID-19
Smith encapsulated the effects of this once-in-a-century event by honing in on three themes that provide insight into future trends: habitualization, innovation and recession.

Habitualization is a term coined in 1966 by sociologists Peter Berger and Thomas Luckmann that proposes that any action that is repeated frequently enough gets cast into a pattern. Habits can become ingrained within six months and, in some cases, institutionalized.

Ecommerce and delivery services could become habitualized. Over the last six weeks, Amazon has experienced shipping volume that has approached holiday levels. South Mountain Creamery, a company that delivers dairy products in the D.C. area, went from 5,500 to 9,500 deliveries a week and now has a waiting list of 6,000.

Nationwide Insurance reports that 98 percent of its workforce is currently working from home. Last week, the company announced a plan to permanently transition to a hybrid operating model that comprises working-from-office in four main corporate campuses and working-from-home in most other locations.

Since initiating isolation, workers have created new habits, such as buying online and working from home. A significant portion will retain those habits into the future. This has potential to impact the real estate market.

There is a long history of evidence that, when there is a shock in the economic world and markets are challenged, the weak fail and the strong innovate and adapt.

Telemedicine, for example, has been around for a while, but its use is currently expanding immensely. The entire academic community innovated on the fly to bring online courses to students this past semester. Meanwhile there is cross-firm, employee sharing occurring now (e.g. restaurant workers working in grocery stores) in an attempt to reduce unemployment in the harder hit sectors.

Innovative realtors today are giving virtual property tours from their cars. As potential purchasers walk through, they explain the nuances and amenities without even entering the property. Might we someday see Sunday open houses with realtors hosting a dozen events from their office using a set of computer monitors?

There remains a lot of uncertainty as to whether or not recession is inevitable. In a recent survey conducted by PWC, 30 to 40 percent of respondents said they believed the market would be recovered within three to four months, so there remains optimism in the market. Still, after enjoying the longest period of continual economic expansion in U.S. history, many believe a softening is inevitable.

Perhaps COVID-19 will be the trigger that precipitates this particular economy into a slowdown, that persists beyond the enforced lockdowns, Some signs worth looking at include the savings rate, recently at its highest level since 1981. Increases in saving are a strong sign of decreased spending and typically signal an economic downturn. In the U.K., car sales last month were down 97 percent yet it’s unclear if that was caused by economic concerns or simply a matter of people not being out buying. Unemployment issues will continue into the future. Those unemployed will not be spending and, even after gaining employment, will likely be playing “catch up.”

The national multi-family housing council indicated in April that roughly 25 to 35 percent of renters did not make full payments. In April, nine percent of CNBS mortgages were not paid, up from 1.7 percent in March. Twenty percent of investor mortgages are either in or past their grace period.

Data in the residential real estate market tends to lag a little bit but expect an increase in inventory that will translate into softer prices and a longer time on market. Builders with permits not slowed down by closures in government office buildings have continued to build. And inevitable life changes – such as birth, death, job changes, divorce – all motivate people to move and change their housing situation. Houses will continue to come onto the market but it’s uncertain if buyers, financial institutions and investors will maintain the liquidity, even in the face of low interest rates.

A large source of local governments’ revenue stream comes from sales tax revenues. They now are collecting relatively little compared what they were pre-COVID-19. This will spill over in services that are provided by those local institutions and could influence the interest in and viability for real estate purchases.

These changes, through creating habits, through innovation and the potential for recession will have influence on our real estate market. Yet there will be opportunities for us to move forward and the economy will eventually recover. We will adapt to changes and move forward into the future as we have in the past.

Watch the full conversation and Q&A below or on YouTube.

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