Dramatic headlines and comments will always take center stage in the media, and current CRE challenges are no exception. After reading a few of them, you’d think we were facing the end of the world:

“Commercial real estate is in trouble, and turbulence in the $15 trillion market is threatening to bleed over into the broader financial system just as the U.S. struggles to emerge from a recession. The longer the pandemic paralyzes hotels, retailers and office buildings, the more difficult it is for property owners to meet their mortgage payments.” - Politico

“Billionaire investor Carl Icahn told CNBC on Friday he expects the U.S. commercial real estate market will crumble, much like the broader housing market collapse of 2008.” - CNBC

And the Real Estate Investing Academy posted a YouTube video under the following “modest” title: The Big Commercial Real Estate Crash: Coming March 2021-June 2021.

SIORs, on the other hand, who have been through their share of serious downturns, had much different responses to the question posed in our headline. When asked if we should be worried, their response was “Yes.” “No.” “Maybe.”

You see, while a surface response might tend to be in the negative, the more accurate truths lie deeper; the most appropriate answer is that it depends on the type of real estate you’re discussing, and where it’s located. Beyond that, having seen a number of market “bottoms,” SIORs are convinced that recovery will just be a matter of time.

 

“The answer is hard to give in a singular broad way; I don’t see a crash in the industry,” says Gabriel Silverstein, SIOR, managing director, SVN | Angelic in Austin, Texas and SVN Institutional Capital Markets Chair. “Hotel and retail have already crashed, office may or may not—that’s one of the biggest questions. Meanwhile, industrial real estate is being driven significantly by an accelerated shift to online buying in lieu of in-person, and [business] has been going through the roof.” In other words, he says, to paraphrase Charles Dickens, “It is the best of times and the worst of times.”

“Should we be worried? Where we stand today, the answer is yes, we should be worried, concerned, but just like any other event or tragedy, this too will pass,” says Jay Olshonsky, SIOR, president and CEO, NAI Global, in New York City. “It’s just a question of how much damage will be done and how long it will take to pass.”

But Nora Hogan, SIOR, principal, Tenant Advisory + Workplace Solutions with Transwestern in Dallas, says that while any downward correction to the market is a cause for concern, “just like previous corrections, the passing of time and America’s entrepreneurial spirit always bring the markets back stronger and provide opportunities that were being hidden by the prosperity of the past market.”

She even sees a positive side to the impact of COVID-19, generally seen as a major cause of the current downturn. “This pandemic has challenged the very core of the operational side of business, forcing companies to accelerate the acceptance of digital transformation,” she shares. (For more on the impact of COVID-19 on CRE, see "Across the Globe - One Year Later")

SECTOR STRENGTHS VARY

Hogan succinctly describes the relative strengths of individual sectors of real estate: “The outlook is very different for the various real estate classes with healthcare, industrial, and data centers being positively impacted, while retail, hospitality, and the office markets are negatively impacted,” she says. “Regardless of the pandemic, the office market was headed for change. The difference is the change was involuntarily mandated by the circumstances including government restrictions, talent shortage, difference in workforce generational preferences, providing a safe working environment, and the newfound joy of no commute for employees.”

Healthcare real estate, she adds, will continue to thrive. “There will be a need for additional offsite locations as providers want to be close to the hospital campus but avoid the stigma of being tied to the hospital environment and the restrictions imposed during the pandemic,” she says.

“Industrial is obviously the darling; even without COVID, I’ve never seen industrial take off like it has in the last 10 years,” adds Olshonsky. “It’s done extremely well through the pandemic, but it’s been highly driven by the Amazon factor, the Target effect, the Walmart effect. If you have 14-15-foot-clear, it’s not nearly the same as an Amazon type 36-foot-clear. All sale price numbers are good.”

When it comes to office space, he continues, the market will continue to struggle “until we get occupancy levels back up,” with suburban markets generally doing better than downtown markets.

“In-person brick-and-mortar retail is going through almost a cataclysm because of COVID, but it had problems before,” says Silverstein. “The office market is in limbo; people do not know who’s going back to work and who isn’t, if they need more space or less, or the same amount but just spread out?”

He notes that while SIORs who focus on office must deal with these challenges, many of those in industrial “are having the best years of their careers.” Even when the GDP fell 32.9% in the second quarter, “The demand for industrial real estate was going up,” he says. “In most markets, rents were even going up.”

Even within sectors where trends seem pretty well-defined, however, things can vary significantly from market to market, particularly when it comes to office space. “It’s really a function of where the real estate is,” says Olshonsky. “Dallas is doing really well; Salt Lake City is doing really well. I think New York, San Francisco, and other huge concentrations of CBD office, they have a double whammy; people are moving out, not going back after working at home, and the price of that real estate is high in general to begin with. There’s also the shadow effect with sublet space. Some companies may have a lease, pay the rent, but do not need all that space.”

Another concern, he continues, is that companies that move from California to Texas or Arizona may do better, “but what’s left behind may not be doing well at all. Certainly Northern New Jersey, for example, is doing better than downtown New York.”

“Without a doubt the Great Southwest—and particularly Texas—will outperform most other markets due to the pro business environment demonstrated repeatedly by the government leaders during the pandemic,” adds Hogan. “With corporate relocations being announced daily, the exodus has already begun from the East and West Coasts. This, combined with the reduced cost of living, sunny days, and lower taxation, will once again make our real estate colleagues look wistfully towards the southwest region as it will continue to outperform other markets in all real estate sectors.”

CRYSTAL BALL IS CLOUDY

For Silverstein, uncertainty is probably the key watchword looking to the future, in both the office and, yes, industrial markets. “The real $64,000 question to me is ‘how much [office] space do people need going forward?’” he says. “In the last 25 years there’s been an almost linear trend of per square foot reduction of office space per person. It started with call centers, accounting, back offices, and has spread to some of the most sacred areas, like lead partner space in law firms.” Even pre-COVID, he says, it was getting to the point where the desire to consolidate space was reaching its limits. “You just can’t make peoples’ cubicles three square feet smaller every year,” he points out.

The open work environment, hugely touted in the past, has not worked well at a lot of businesses, says Silverstein. “It gets too noisy; it’s too problematic,” he asserts. “I think we were already starting to bounce on the bottom; we had started to see backlash from employees. The question COVID raises is, do we actually need to give them more space? Or, the same space, with different teams on different days? But those two teams never cross-pollinate. You might as well have two locations. Some people might say you need you more space to allow everyone to come back at the same time.”

Meanwhile, while industrial “is certainly having a moment right now,” Silverstein sees potentially concerning nuances in the market. In many distribution facilities today, “the level of automation is like out of a Sci Fi movie; the amount of robotics is incredible,” he notes. “For certain uses you can’t just go into any old building.”

This has brought with it some new challenges, he continues, like the amount of employee parking involved. “Look at Walmart: almost universally when a lease comes up, they move, because their needs have changed,” says Silverstein. “That will happen in a lot of e-commerce; as leases come up, all of a sudden, companies that needed massive employee parking and special designs will suddenly go back in the other direction.”

In the meantime, says Silverstein, there is a huge demand for space in e-commerce retail. “Amazon knows to the minute where they’re trending and how much real estate it’s going to need in two months, five months, six months, where historically they were planning years in advance,” he observes.

That Amazon space need became “instantaneous” when everyone started buying online, “but if all of a sudden Amazon had grown 25% that came out of somebody else; that’s market shift, not market growth,” Silverstein asserts. “Ten million square feet somewhere else is not being used.”

He says it takes one to two years for that to really get to the market. “All the people Amazon took business from are having their leases start to roll and adjusting their supply chain and getting out as business went down,” he explains. “That space will be on the market.”

If Amazon business were to suddenly plateau, says Silverstein, they might not need more space, and with all those other companies cutting back, “a wave of existing supply that had not yet come to the market over the next 12-24 months is going to come on the market; industrial net absorption will come down, and industry availability will go up.”

CLIENTS FACE UNCERTAINTY

Helping clients deal with such an uncertain future is one of the most critical value propositions an SIOR can bring to their clients, says Hogan. “Assisting my clients in implementing the optimal workplace environment for their organization is where my services will add the most value,” she says.

“Strategically, companies need to incorporate flexibility in any long-term lease commitments. To reduce costs, companies need to streamline operations through technology implementation, which will decrease square foot requirements. Companies not only need to evaluate their preference; just as essential is determining their employee’s preference for working remotely and independently.”

This involves a risk-reward tradeoff, she continues. “If companies mandate everyone must daily report to the office, they may risk their talent will choose a company with more flexible options,” Hogan notes. “As important, companies need to be considering their balance sheet, and during this time of transition, the smart companies are analyzing whether a job is best done by a person or a technology, which may be faster, less expensive, and more efficient. This means that as a real estate agent it is no longer about a specific building product or square footage, but also working strategically with the C-Suite on a data-driven process, understanding their work processes, technology implementation, talent recruitment, employee utilization, and ultimately how each one impacts the balance sheet.”

It is perhaps in challenging times like these that the experience and resources of SIORs put them at the greatest advantage in the market, notes Olshonsky. “As an SIOR, this is where expertise, credibility, and track record come into play,” he says. “Certainly, the aspect of being an SIOR allows that most of us have lived through other ‘off’ cycles, and kind of know what to do. In 2009 we had a financially created off-cycle, and most of the SIORs I know became experts in distressed assets and special servicing. There is a lot of sharing among SIORs, even now that it is virtual, with daily e-mails going out asking for help and advice. This really allows members to access the entire network of SIORs to find experts in a specific situation.”

A lot of this, he continues, has to do with SIOR being an organization with certain criteria for membership. “When you talk from the perspective of an owner, occupier, or lender, it’s a somewhat huge amount of credibility that you bring to the table,” he says. “And having been in other ‘off’ cycles is really important.”

This article was sponsored by the SIOR Foundation - Promoting and sponsoring initiatives that educate, enhance, and expand the commercial real estate community. The SIOR Foundation is a 501(c)(3) not-forprofit organization. All contributions are tax deductible to the extent of the law.

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CONTRIBUTING MEMBERS

Nora Hogan, SIOR

Jay Olshonsky, SIOR

Gabriel Silverstein, SIOR