Charting the COVID-19 CRE Market with Clear Vision

By Dennis Kaiser

A familiar storyline is emerging as the COVID-19 pandemic unfurls this spring that uncannily runs in a parallel path to the changes that transpired as the 2008 Great Recession arrived. Data collected by CompStak, a CRE data and insight platform, shows the commercial real estate markets have taken a pause.

A topline trend that is closely being watched is how this health crisis, coupled with the civil unrest that is spreading across the U.S., will impact the CRE markets. Leading up to the stay-home orders, the country’s economic engine was in high gear. Whether the economy can pick back up or remain throttled back as the pandemic plays out remains to be seen.

It is clear that the current economic situation is impacting decisions. It is causing companies to delay some decisions and in other cases firms are making short-term decisions, Michael Mandel, CEO and co-founder of CompStak notes.

“When we look at historical CompStak data from the last downturn in 2008, once the market absorbed the downturn, landlords were doing short-term deals that were in the 1- to 3-year range rather than the 5- to 10-year deals that had been done,” Mandel said. “There also was more leasing velocity in the few years coming out of the recession.

“Back then, tenants sought short-term deals because they believed they needed the flexibility and there weren’t options like co-working that are now available, points out Mandel.” Landlords also sought short-term deals so that they could avoid locking-in lower rents for the long-term and could secure new deals on the market’s upswing.”

In the current environment, companies are spending time thinking about how to redesign space to accommodate social distancing requirements. If occupancy levels need to be reduced 50% from what is currently leased by a company because of those guidelines, it may need to double its space requirements, and unless rents decline, that would carry a higher occupancy cost. Some companies have and will continue to allow remote work into the future because they’ve discovered workers can be productive. But once a vaccine is available, Mandel believes occupancy densities will return to levels close to what they were previously. He predicts any space reductions will be temporary, and there won’t be permanent reconfigurations of workspaces, either.

Mandel believes once the initial crisis begins to subside, companies will resume with similar-sized offices because it is cheaper and more cost efficient than the alternatives. Thus, the net decrease in office occupancy is expected to be minimal.

Even though it is too early to draw firm conclusions about the ultimate impact, CompStak’s data reveals an interesting strategy being deployed today by large tenants. Mandel says there are no big renewals on the horizon, as most companies execute extensions or make relocation decisions well before a lease termination. A case in point is New York City. CompStak is currently tracking 3,300 leases that are set to expire in the coming 12 months, yet there are just 109 of those deals that exceed 50,000 square feet, and of those 109 deals, many have already negotiated renewals or relocations.

“The large leases have already been dealt with, so I don’t expect to see a major impact from big deals since companies already made their decisions,” Mandel said. An area of leasing activity that is expected to increase is the sublease market. Sectors such as technology deployed a distributed workforce prior to COVID-19 hitting, so they have a workforce spread across markets. Tech companies tend to follow where the best talent is in the world, and that’s a trend Mandel expects to accelerate because of COVID-19, which could impact a market like San Francisco more than others.

The impact from COVID-19 could also vary by industry or job type, notes Mandel. For instance, back-office functions like accounting had already been an adopter of hoteling. If those desks aren’t required now, they wouldn’t need them in the future.

One factor that will be required in the future is accurate data to make informed decisions. CompStak data allows companies to track granular nuances on lease transactions as detailed as rent escalations, TI allowances and concessions. Those can be key indicators that guide a landlord’s leasing strategies for a property if a downturn arrives. They can see if concessions – typically an early sign of clouds – are increasing in the market’s competitive building set, and balance rent and other terms accordingly.

“Our data indicates an impact of downturns more quickly,” Mandel said, who notes he saw a decrease in concessions and starting rents at the beginning of Q1 2008. It wasn’t until Q3 2008 when Lehman Brothers filed for bankruptcy. Yet the historic data shows rents started decreasing in Q1, which ultimately predicted the downturn of the Great Recession, Mandel noted.

Currently, Mandel doesn’t believe there is sufficient data to reveal any statistically significant trends. Anecdotally, he does see landlords favoring short-term deals in the five-year range, though no downturn is reflected in rents, yet.

He has noticed a shift in CompStak’s user profile, though. There has been an increase in hedge funds seeking out research to help guide them where the market may be headed. Activity by appraisers has increased as they work to re-value assets, too. On the investor and owner side, activity has decreased, as they have elected to take a pause on acquisitions to get a better handle on where the market may be in the future.

Mandel points out opportunistic, distressed buyers tend to favor buying into distressed markets, but sellers are not quite willing to sell yet. And non-distressed sellers are not looking to dispose of assets since they can’t get the price they want now. “This COVID-19 economy will affect the sales market more so than the lease market since sales will fall into two categories, necessary transactions or opportunistic deals,” Mandel said.

As Mandel looks back at the data from 2008 and compares it to the current situation, he sees some differences. He points out at the beginning of 2008 the market dropped for a while then in May 2010 it went back up and continued on in a gradual recovery. The Great Recession wasn’t a V-Shaped recovery. The recovery shape may be different.

He advises paying close attention to the new deals being executed today. By applying the concept of same-store-sales, real estate experts can see what direction a market may be heading. That means seeing if companies are taking more or less space with a renewal, or if they are paying a higher or lower price than before. Concessions and starting rents can be good bellwethers that indicate market direction, he says.

“Ultimately, bear in mind, the various asset classes and markets were impacted in massively different ways in the Great Recession,” Mandel said. “It hit the New York finance market harder than other markets. That’s not necessarily proving to be the case in today’s COVID-19 market. We’re not seeing individual industries being impacted so much as we are specific asset classes.

“For instance, the industrial property type has hardly skipped a beat, yet the hospitality asset class has been destroyed. Retail is destroyed for now, and office and multifamily assets are hurting to some extent,” Mandel said.

Savvy CRE landlords, investors and those making decisions about properties understand the disruption occurring within the current marketplace can be navigated. It may take time, patience and a solid data partner such as CompStak to pick the best course through what continues to be a volatile and uncertain time.

For comments, questions or concerns, please contact Dennis Kaiser