Hope for hospitality?
“We’ve been devastated.”
Brutal honesty from Craig Davis, CEO and president of VisitDallas, set the tone in a discussion about the state of the Dallas retail, restaurant and hospitality market. Joined by United Commercial Development president Robert Dorazil, Steve Williamson (Transwestern’s senior vice president in agency leasing, retail services and land services) and Jeff Binford (managing director of CBRE’s Hotels Advisory South Central Division), the group dug into the challenges facing a market dependent on people going out during a time when they’re being told by health experts to stay in to slow the spread of COVID-19.
Davis said that Dallas tourism has taken a big hit, especially because so few people are flying to their destinations these days. Instead, he said Dallas has seen people driving into town and VisitDallas has repositioned its marketing to target the drive market.
“We know there is a backlog and people will travel when the time comes,” said Davis.
He said he expected that bump to come within the next six months, though he added that research suggests large conferences likely won’t return until there is a sweeping change, such as a COVID-19 vaccine.
As a result, the hotel industry is struggling. Davis said occupancy rates plummeted from 85 percent pre-pandemic into the single digits. That led to at least 20 hotels in Dallas proper to close their doors, which echoes what other Texas communities are experiencing.
“This is the worst setback by far,” said Binford.
Lenders are stepping up to help hotel properties that haven’t been able to get visitors in the door, he said. Rather than foreclose, many are refinancing or modifying loans to keep the industry afloat for the time being. The reason, Binford said, was that there are few bad actors in this case. COVID-19 is exclusively to blame for the lack of income and few lenders want to be stuck with a property in the current environment.
Similarly, landlords for retail centers are largely working with their tenants to help ease the burden of the pandemic’s impact.
“Most of the landlords I talk to are doing what makes sense to keep everybody healthy,” said Dorazil, adding, “In my world, most of my tenants are going to make it.”
To date, he said two restaurants have closed in his centers, but diversity of tenants has helped draw foot traffic when it is so sorely needed. Along with grocery anchors, he said nail salon, workout studio and fast food business are picking up.
Those businesses that have failed, Williamson suggested, were likely undercapitalized or had a poor concept or poor management.
“Any kind of weakness they had, this is exacerbating it,” he said.
Responding to the challenges faced by tenants, Williamson says Transwestern offered them a moratorium on base rent, but asked them to continue paying triple-net charges on their space. He said that provided at least some income and a commitment from the tenants that they intended to remain open.
“If you own retail centers, you’re in business with your client, whether you want to be or not, because their entire livelihood depends on people walking in and buying stuff,” Williamson said.
Industrial investments and office opportunities
As the pandemic created new challenges for the traditional retail sector, e-commerce sales boomed and generated opportunities for industrial growth.
“The online world just picked up a whole generation of people who never shopped online,” said Conrad Madsen III, founder of Paladin Partners.
He explained how his parents, who are part of the Boomer generation, had never purchased anything on Amazon or used an app such as UberEats before the pandemic. Madsen laughed as he shared what they told him: that it was amazing to be able to order something one day and have it delivered the next.
“Right now, e-commerce is only 11 percent of the total retail sales in the United States. Only 11 percent is online today,” he said. “It’s never going to go 100 percent, but think about how far we’ve come and it’s only 11 percent.”
With more consumers relying on e-commerce for their needs, online retailers are searching for distribution centers, driving the industrial sector.
“I think we’re going to end up with another outstanding year,” said Art Barkley, Prologis senior vice president.
He said he expects Dallas will wrap up 2020 with 20 million square feet of industrial absorption, twice what the region reported when he moved there in 2005.
“It’s definitely trending in the right direction,” Barkley added.
What will no doubt help with that trend is the anticipated increase in nearshoring and onshoring as a result of the U.S.’s tumultuous trade relationship with China.
“We’re realizing as a nation that we can’t depend on China. Onshoring is going to happen in the United States, but Mexico is going to be the biggest beneficiary,” Madsen said, explaining that labor costs would keep most manufacturing south of the border.
That has the potential to fuel the industrial sector in North Texas as manufacturers examine the best markets through which they can distribute their goods, according to Alfredo Gutierrez, founder of SparrowHawk Real Estate Strategists.
“I think in ten years, people are going to be talking about Dallas rather than LA as a distribution hub,” he said. “You’re going to see cap rates like we see in California.”
As industrial rates increase, office rents are going the opposite direction.
“How long that lasts, we don’t have those answers,” said Susan Arledge, executive managing director of site selection for ESRP Real Estate. “With the uncertainty in the market, every client we have is asking, ‘Is my office space going to be obsolete?’”
She said it’s not a question of if employees will continue to work from home as millions are doing now, but how much of the workforce will never return to the traditional office.
“Right now, I have clients who want to downsize immediately because they found working from home to be productive for their employees,” said Emily Hoffman, director of Cushman & Wakefield’s tenant advisory group. “I think that it’s probably best to wait and see exactly what you want to do with that office space, whether you want to grow or shrink.”
That wait-and-see approach emphasizes the importance of flexibility in lease negotiations. Companies that would typically commit to a five-or-more-year lease are hesitant to do so, leaning instead on short-term extensions.
“Right now, companies don’t want to make long-term commitments based on the cost of bringing people back,” Arledge said, citing a Deloitte study that found it could cost anywhere from $12,000 to $18,000 to bring each employee back into an office.
Property owners are also looking at added costs, including improvements to HVAC systems to prevent the spread of the virus. Arledge said it remains to be seen if those costs will be viewed as operating expenses that can be passed along to tenants or if they’re simply improvements that incentivize tenants to come on board.
“That conversation about what the pass-through cost will be for the tenants is just beginning,” said Hoffman, who stressed that the focus now is getting tenants into office spaces rather than discussing operating expenses. Looking ahead, she anticipates renewed interest in subleases as well as satellite offices in suburban areas.
Moving in on multifamily
Similarly, suburbs are where multifamily developers are shifting their focus as people relocate from the urban core.
“I’m not sure there are going to be a lot of capital sources eager to do an urban core tower at this point,” said Greg Willett, chief economist at RealPage. “I think it will be more suburban-focused and there is going to be some sensitivity about the price point.”
One reason for the exodus, he suggested, was the prevalence of roommate households in urban areas. If one roommate loses his or her job, the household disintegrates and, depending on the age of the tenants, they may return to their parents’ home.
Another trend Rastegar Property Company founder and CEO Ari Rastegar has noticed is an increased interest in vintage multifamily properties, which his firm focuses on.
“On these garden-style properties, you walk up the stairs [instead of taking the elevator],” he said. “It has this kind of inherent social distancing built into it that has boded well. Our tenants find a lot of safety there.”
Michael Kolshak, director of investments for Cortland Partners, pointed out the emphasis on design goes beyond just the overall layout of a multifamily property. In deals where Cortland has influence, he said the company is encouraging developers to plan for more tenants working from home.
“The thinking is that work-from-home is not going away,” Kolshak said.
That means closet space is less of a draw compared to office space or a built-in desk. Technology access also has increased importance and not just for tenants. Property managers are shifting to virtual leasing, offering up digital tours of vacant units.
“I’m pretty impressed how the entire industry adapted almost overnight,” said Kolshak. “It’s a paradigm shift for the industry that probably doesn’t go back regardless of how long this lasts.”
According to Willett, occupancy took a small hit because of the pandemic and he’s watching Class C properties closely. Those tenants, he explained, are more likely to face economic challenges during a downturn.
“I think people who live in bread-and-butter Class B product are pretty well positioned and I don’t think affordability will be a challenge in the Class A product,” said Willett. “It’s the new supply coming in. It’s going to be a competitive leasing environment in the A product because of the new supply.”
And there is a lot of new supply. He said of the approximately 600,000 units under construction across the country, 44,000 are in Dallas alone. It’s an indicator to him and Kolshak that deals aren’t slowing down.
“Deal flow is back. Folks who were on the sidelines are all pretty aggressive,” Kolshak said. “That’s what we’re seeing in real time.”
“It’s as competitive as ever,” said Suzanne Jones, senior vice president of NorthMarq Capital. “It seems like every day, we’re seeing properties going under construction in Dallas. The market is still moving.”
She said she’s closely monitoring the moves lawmakers are making related to evictions, hopeful some kind of assistance program is approved so the multifamily sector doesn’t take a harder hit. But ultimately, she’s staying positive.
“To me, when we experience these downturns or uncertainty, that’s when there are the most opportunities,” she said. “I think it’s a safe bet to come.”