As 2020 draws to a close, investors are happy to be rid of its turbulence and setting their sights on the promising opportunities the next year holds. With COVID vaccines nearly ready to deploy and only a few weeks until the inauguration, the future seems bright. Yet, 2021 brings new circumstances and behaviors that consumers and corporations are unlikely to shake quickly.
To help prepare CRE investors for the new normal ahead, we interviewed Fernando De Leon, founder and CEO of Leon Capital Group, to gain a clearer understanding of what trends shaped commercial real estate in 2020 and what principles should keep in mind as we march into a new year, a new administration, and the new normal.
Trends Influencing CRE Investing Today
Both before and amid the pandemic's fallout, three significant patterns influenced the way commercial real estate deals were occurring.
First, the accrual of capital over the past three to four decades' compounded growth in emerging markets and created pools of investment dollars actively seeking U.S. property more than ever before in modern times. Far more dry powder valued at $147 billion was ready to deploy into the market in the second half of 2020, compared to the Great Financial Crisis, buoying the commercial real estate sector toward faster recovery and continued transaction volume today.
Next, the ramifications of the coronavirus have pointed to some sub-asset classes in retail, office, and hospitality as undesirable investment choices. According to De Leon, these sub-assets' poor performance, subverted by both structural and consumer behavioral changes, has caused investor demand to shift to more recession-proof commodities. "That leaves industrial, single family and apartment rentals, ... data centers and self storage," as star performers looking ahead, De Leon says. These assets will likely hoard investor attention as demand seeks stable, long-term leases, and steady growth.
Finally, the coastal markets with high tax regulations have become more challenging to underwrite for office investors. Corporations are moving to low tax states, particularly in the Sunbelt and Midwest markets. Similarly, apartment and single family tenants are exiting coastal metros for more affordable secondary and tertiary economies and plentiful employment opportunities. Investors in coastal multifamily markets will likely see similar underwriting challenges with the implementation of rent control policies and other regulatory limitations.
What Investors Should Watch in 2021
As consumers move online and digital adoption accelerates in all demographics, industrial and logistics development will be one of the most in-demand and promising markets in the coming year. "Nearly 10 million seniors are now buying their groceries and goods online in fear of getting COVID," says De Leon. This adoption occurred years ahead of schedule, according to a recent Bloomberg report. "The commercial real estate industry didn't expect this to happen," let alone the surge in adoption in younger demographics in the last decade. As such, we'll likely see a need for distribution and fulfillment spaces to fill an extremely high demand.
Suburban housing will also see success in the long haul -- residential home sales exploded in the second half of 2020 and abruptly ran into inventory shortages. People will move to acquire more space in less dense environments, and markets in the Sunbelt and Midwest are already working hard to meet the upcoming demand.
Indeed, fundamentals for industrial and housing in the Sunbelt markets are likely to be long-term performers, supported by many cities' "Buy" recommendations from PWC's Emerging Trends in Real Estate 2021 report. Lending costs are currently low, thanks to market-specific credit as well as the Fed's historically low interest rates. Given time, sellers can command very low cap rates for substantial assets with little funding cost.
Challenge-wise, De Leon believes the sector will see available inventory challenges as developers race to meet current demand as tenants' amenity requirements shift. Shifting desirability for more open spaces and COVID-safe hygienic specifications, for example, will require existing properties for industrial, office, and retail spaces to retrofit to accommodate these needs.
Investor Strategies for 2021
There are so many different strategies to acquire commercial real estate. Some investors prioritize cash flow over baseline yields, and while others try to position themselves to profit by investing in mispriced assets, still others want to increase property values through work and creativity.
As Mike Tyson famously said, "Everybody has a plan, until they get punched in the mouth." It's always important to remember your values and fundamental investment goals while remaining flexible and fluid in response to a vast amount of real-time market conditions and influences. When asked his advice, De Leon recommended that "...investors should not try to time their markets. We should anticipate what we think the post-COVID world looks like, and make our bets accordingly.” He added one more piece of advice: “You don't outperform, though, if you are not occasionally contrarian."
This applies to the incoming administration, too. While some investors worry about tax policy changes with the Biden administration, De Leon says, "We have governments that legislate tax policies that are later undone by subsequent administrations. Tax policy changes like the wind." The best hedge against tax reform is to make informed decisions and not overpay for assets.
Finally, investors and CRE brokers alike should get used to technological tools to support each step of the investment process. "I use DocuSign 20 times a day now," says De Leon, "[and] self-guided tours, contactless move-ins, and virtual customer service are the new way of things." With improved tools and widespread CRE tech adoption, the industry will see more deals done virtually and more overall transparency in the marketplace. Platforms similar to Crexi that effectively connect buyers, sellers, landlords, and tenants will serve CRE well, accelerating the industry's overall success.