As millions of people self-distanced, stayed home and couldn’t visit businesses or offices temporarily shuttered out of safety concerns, the economic ripple effect could be felt across all sectors of the commercial real estate industry. Illinois REALTOR® talked to three practitioners in retail, multifamily, office and industrial to find out how the sectors adjusted to the unprecedented changes and what could happen next.
Retail: New economic challenges could permanently change the retail landscape
The COVID-19 pandemic brought the country to a halt and the resulting lockdowns and social distancing temporarily closed a wide range of businesses, from restaurants and retail to gyms and shopping malls.
The entire commercial real estate sector has been affected, and the uncertainty hits tenants and landlords alike.
The retail industry had already been fending off internet sales, overbuilding and retail bankruptcies. Now it is getting clobbered by a pandemic-fueled economic crisis. Worse, our industry may be forever changed by it.
In addition to the countless independent retailers and restaurant businesses that may be forced to permanently vacate their stores because they can no longer afford them, a growing number of corporate chains are unwilling or unable to pay their rent.
LA Fitness, Subway and Mattress Firm have also stopped paying rent as a way to strong-arm shopping center owners into rent reductions, lease amendments and other courses of action designed to offset the losses they are incurring because of COVID-19.
That begs the question, what happens next?
While some may look to muscle their way into distressed assets, it is very possible the commercial real estate market will never look the same. While small retailers and restaurants melt away, some of their online rivals are beefing up.
Amazon, despite no shortage of bad publicity, gains market share by the day. In fact, it recently sailed into trillion-dollar territory. Walmart, Target, and Costco are poised to come out of COVID-19 even stronger and more formidable than they were before, as smaller rivals suffer and wither.
The cold, hard reality is that many retailers will not survive. However, retail has always been about survival of the fittest…or the biggest.
This downturn will create new and unpredictable opportunities for retailers who respond accordingly and provide customers with what they want, which is a safe shopping experience at a price they can afford.
Mike Mallon, CCIM, CRX is a Senior Vice President at Draper and Kramer Incorporated, a privately held real estate firm. Mallon has more than 40 years of experience in the Chicagoland market, specializing in retail development, brokerage and consulting.
Multifamily: Restricted access and rent concerns affecting multifamily housing
Besides the obvious health and safety concerns associated with large groups of people living in close proximity, the multifamily housing industry is facing the immediate short-term concern of tenants’ ability to pay rent in the coming months.
Much of the service industry, as well as hourly wage earners, represent a significant portion of the renter pool, many of which are living paycheck to paycheck. The inability to work due to shutdowns and shelter-in-place rules will have a profound impact on the ability of renters to meet their rental obligations.
Long term, even if tenants can pay their current rents, they may not be able to absorb rent increases.
Fannie Mae and Freddie Mac provided mortgage forbearance options to multifamily property owners who suspend evictions. The eviction suspensions are in place for the entire time a property owner remains in forbearance. The forbearance is available to all multifamily properties with an enterprise-backed performing multifamily mortgage that has been negatively affected by the COVID-19 emergency.
From a multifamily management standpoint, all common areas including exercise rooms, business centers, pools, etc. are now closed in some form. Property tours for prospective tenants switched to the virtual world to avoid placing onsite staff and potential tenants in harm’s way. This most likely will result in reduced traffic to the site and potentially delayed rentals.
Altering property tours – or in some cases halting them all together – also affects those on the sales/brokerage end. With many people now in their units working (or not working) from home, the practice of social distancing will not make property inspections and tours acceptable to standards.
The need for virtual tours and video marketing will be extremely important during this uncertain time. Virtual tours and videos are not going to satisfy many of the prospective buyers and their investors in the market, thus resulting in much longer marketing campaigns.
Prospective investors are altering their acquisition strategy by removing the short-term rental increases from their underwriting model. In doing so, cap rates are increasing between 50 to 75 basis points. This may drive up the bid/ask gap during this period as owners have not seen significant delinquencies with spring rentals and will not accept discounted prices if there is not a need to sell.
Beyond the initial site tour, third-party reviews of assets have been affected by social distancing requirements. Examples would include surveys, inspections, environmental studies and architectural reviews, all of which involve access to a percentage of the individual apartment units (both occupied and unoccupied). Not to mention the challenge of onsite staff exposing themselves during the interaction between third-party vendors and tenants.
Reid Bennett, CCIM, is National Council Chair of Multifamily Properties for SVN International and a Senior Vice President for SVN-Chicago Commercial. Bennett is a licensed managing broker focusing on the sale of apartment communities across the Midwest. He also works with members of his council to serve clients across the country in more than 150 markets.
Commercial Office and Industrial: Use and need of office space could change significantly
The initial impact to Illinois’ commercial office market was a rapid depopulation of properties as companies implemented work-from-home strategies for many employees and allowed only essential personnel in properties.
Companies in the leisure and travel industries were immediately affected and experienced significant staff displacement, either through furloughs or termination. Many companies have responded by listing office locations for sublease.
Chicago, home to United Airlines and Hyatt Hotels, will see significant amounts of office space return to the market via sublease just as four to five new office developments are expected to be completed in the city.
The use of and need for office space will change significantly and it is too early to see what the impact will be on occupancy rates and values.
Rent payments have been forgiven, deferred or enforced. The percentage of rents collected in the office and industrial sectors have generally held up.
In the Colliers Chicago portfolio, we saw early collection rates in the 80-85 percent range for office and 90 percent for industrial-based tenants. Most of our clients are now keenly focused on summer rents.
The true economic impact is looming in our industry. Commercial real estate has always been a laggard to react to economic impacts, so the next 12-36 months will be critical when it comes to impact and values.
Illinois, the city of Chicago and Cook County were already on shaky financial footing and the pandemic will only exacerbate their/our financial predicament, i.e. higher taxes. The key for the market will be the continued flow of money via rents into the system from tenants so that owners/landlords can continue to fund their key payments of mortgage, real estate taxes and insurance.
Industrial vacancy has historically been closely tied to, and slightly lagged, the U.S. unemployment rate. With the pandemic and the immediate economic response erupting at the end of the first quarter, the unemployment rate climbed significantly. While certain segments of Chicago’s industrial market will perform comparatively well, the overall vacancy rate is expected to escalate as well.
With respect to industrial real estate, e-commerce demand – especially from Amazon and a few key retailers making a renewed e-commerce push – is strong, but it won’t be enough to carry the entire industrial segment, according to Craig Hurvitz, senior director of research for Colliers in Chicago.
The market already is experiencing a large increase in new sublease listings, and users who have committed to new development coming online will look to shed some of that space. The vacancy rate will rise; however, the industrial segment looks to suffer the least of all the commercial real estate property types.
Rental rates will likely dip, but probably not significantly. The immediate issue for landlords is the same as other asset types: tenants looking to landlords for economic relief.
The approach by each landlord is different. However, many landlords are offering to amend leases, providing relief now and additional lease term to cover the relieved economic value. The response for both office and industrial is usually tied to landlord liquidity.
Every industrial segment is affected in some way by the pandemic.
“While commercial real estate is experiencing a significant impact due to the pandemic, several industrial occupier types including e-commerce, food and beverage users, packaging companies and healthcare-related industries aren’t as negatively impacted by the stay-at-home directives and supply chain adjustments of the current situation. Certain users who are quick to respond to the evolving changes in our daily lives and plan for what is to come, can take advantage of the “new normal,” according to Hurvitz.
Development projects that were already well underway when the disruption and shutdowns occurred will continue as planned, but many planned speculative buildings will be put on hold. Many users will defer real estate decisions in the near term until the impacts of the pandemic and the economic response are clearer.
While the next six months may be unpredictable, Chicago’s industrial market has been stable in past downturns and crises relative to more turbulent coastal markets and is poised to come roaring back once the situation improves.
Lloyd Berry, CCIM, RPA, is Managing Director of Asset and Property Management for Colliers International in Chicago. A 30-year veteran in commercial real estate, Berry oversees the strategic direction and business plan execution for more than 48 million square feet of office, industrial, medical office and retail real estate throughout Chicago, northwest Indiana, and southern Wisconsin. He also runs Colliers International property management.
NAR Commercial Economic Issues and Trends
During the 2020 REALTORS® Legislative Meetings, NAR Chief Economist Lawrence Yun spoke about trends in the commercial real estate market. Download his presentation at