The uncertainty surrounding the economy has negatively impacted the commercial real estate industry, but the COVID-19 pandemic has also cast a long economic shadow on CRE, economics and investment, strategy consultant Milton Ezrati recently wrote for Forbes.
Although the pandemic’s shadow over CRE is long, the impact is mixed, depending on the category. For example, warehousing has seen a lift, while the retail and office sectors have not been as fortunate, according to Ezrati.
COVID-19’s impact on CRE
It’s easy to see what higher interest rates have done to the CRE industry. As rates have gone up, so have the costs in every real estate project. Investors have shied away from CRE ventures due to these rising costs and the trend does not appear to be changing any time soon as the Federal Reserve will likely continue to raise interest rates.
The pandemic’s impact on CRE is a little less straightforward, however. Initially, every sector looked to have bounced back from the pandemic. Prices in CRE generally increased more than 80 percent from late 2020 to early 2023, while sales jumped approximately 30 percent in 2021 alone, according to Ezrati. By the end of 2022, however, the CRE boom began to slow. Overall CRE prices dropped more than 40 percent during the second half of 2022 — the industry was down 13 percent overall.
“No doubt the rise in financing costs was the major factor creating the turn, but the softening also revealed the differential impact of Covid’s legacy,” Ezrati said.
The pandemic impacted various CRE sectors differently
Not surprisingly, the warehouse and logistics CRE sectors have fared the best following the pandemic. E-commerce was on the rise prior to the pandemic, which meant warehouse space was in even higher demand. As lockdowns occurred, online shopping became many people’s only option, which made an already popular trend even more popular. Warehouse vacancy rates were just 3.2 percent at the end of 2022.
Warehousing pricing was up in every part of the U.S. — the Northeast in particular, according to Ezrati. Additionally, given the strength of the warehousing’s pricing and sales trends, a potential recession might not be enough to return the sector all the way back to its pre-pandemic numbers.
Meanwhile, the office and retail CRE sectors continue to struggle to find their financial footing post-pandemic. A lot of workers have come back to their offices in cities. That should be good news for retailers that have shops near these offices as they count on that employee foot traffic, but the number of shoppers is still below pre-COVID levels.
Online shopping’s continued climb has also played a role in brick-and-mortar retail locations’ difficulties. Ezrati noted the sector may have trouble seeing any significant gains in 2023, even if rents continue to stabilize due to a potential recession on the horizon.
Office CRE has likely struggled the most since COVID-19. Construction costs are up (14 percent) in the past year and developers are hesitant to get involved with projects as long as remote work and hybrid work environments remain prominent.
Meanwhile, office CRE vacancy rates are at close to 13 percent and are only getting higher. Some believe that between 10 and 20 percent of current office space will have to be restructured in the next few years, according to Ezrati. Pricing has not been getting better and there’s a continued lack of enthusiasm for long-term leases.
“The picture can only be described as mixed,” Ezrati said. “Though the rise in financing costs will act as a general drag in the sector in 2023 as will recession, some areas will deal with COVID’s legacy a lot better than others with warehousing in the lead for the time being, and office building, once the darling of the sector, bringing up the rear.”