Each year, global law firm DLA Piper releases its State of the Market survey, compiling predictions on the state of the commercial real estate market from the biggest names in the industry. This year, of course, is different: This is the first time DLA Piper conducted this survey during a global pandemic.
Not surprisingly, the commercial real estate leaders surveyed had plenty to say about the COVID-19 pandemic, business shutdowns and the economic downturn they have caused. But here’s the surprising part: CRE leaders were, for the most part, optimistic about the future of commercial real estate, even with the pandemic still hitting the globe.
The survey found that more than half of respondents anticipate a return to pre-COVID-19 economic growth within 18 months to two years. A total of 76 percent of survey respondents said the development of a vaccine will have the greatest impact on the global CRE industry. And in good news for many markets across the Midwest, the CRE leaders said that smaller cities will emerge as the top U.S. markets for investments during the next 12 months.
Midwest Real Estate News recently spoke about the survey, COVID-19 and the commercial real estate market with John Sullivan, partner and co-chairman of global real estate and the U.S. real estate sector for DLA Piper. Here is some of what he had to say.
The survey shows that a majority of commercial real estate respondents expect the economy to return to normal growth levels within two years. Can you talk a bit about why they think this?
John Sullivan: That was what I was most interested in seeing from this survey, when do executives think we can get back to pre-pandemic levels of economic growth? If you think back to this same survey when we conducted it a year ago, it was a vastly different time. The market was strong. The economy was good. The respondents were largely bullish on the future. The big question we faced was how long the strong market would last. But with COVID-19, it’s all different. What are the rules of the game now? No one really knows.
When I read the prediction of 18 to 24 months before we get back to pre-pandemic GDP growth, I felt some relief. I think this is actually an optimistic view, and one that’s not unreasonably optimistic. The response could have been worse. You think about what was happening in March, April and May with the global economy in general and real estate in particular. Very few investors were going to buy significant real estate properties without looking at them in person. The market, then, came to an absolute standstill. Real estate is inefficient in how it trades. You can’t just get out of real estate like you can in the public markets. Once you shut the machine down, it takes a while for it to gear up again. That is one reason for the 18- to 24-month time horizon when you look at a return to normalcy from a real estate perspective.
Also, because of the severity of the economic impact, with the drops in the stock market and high unemployment, it stands to reason that it will take some time for the economy to climb up.
How do you think the timing of the survey affected the answers from commercial executives?
Sullivan: We are fortunate we didn’t do the survey in March and April. We benefited from being through the initial shock phase of things. I remember when this started and people thought the sky was falling. People said that no one would ever want to work in big cities again. I remember after the 9/11 terrorist attacks. People predicted that no one would ever want to work on the higher floors of skyscrapers ever again. At the time, that was not a crazy thing to say or think. Fortunately, it proved not to be true. So you have to be careful about making predictions when you are in the middle of something so big.
We do have eight months experience dealing with this now. We do have more information. But there is a lot that we still don’t know. It is still difficult to make long-term predictions at this point.
Not all commercial sectors are affected equally by the pandemic. Which sectors are performing the best today?
Sullivan: The results from the survey are not surprising. Logistics and warehouses were already very strong performers before the pandemic thanks to the digital economy and ecommerce. They have, if anything, gotten a boost from the increase in Internet sales we’ve seen during the pandemic.
One thing that is interesting is the emergence of life sciences as a favored category. We are seeing that in the survey. A lot of people are thinking that a focus on life sciences will not just be a short-term thing. It’s not just about the race for a vaccine.
Then there is the real estate with a public component. This real estate will struggle for a while. Think of hotels, sports, entertainment centers and seniors housing. This type of real estate will face a lot of difficulties for a while. Retail was struggling before the pandemic happened. People in the retail sector are certainly facing a lot of challenges today.
The commercial real estate market and the economy in the United States were both strong before the pandemic hit. Do you think that will help the economy and industry bounce back faster once the pandemic is under control?
Sullivan: With some exceptions, the basic fundamentals of the commercial real estate business were in good shape prior to the pandemic. There is no doubt that this is going to help the commercial real estate sector when the economy starts to come back from the pandemic. Of course, there is the footnote that certain property types, depending on how the pandemic plays out, will be more challenged than others.
But before the pandemic hit, we didn’t have significant overbuilding in most markets or sectors. We didn’t have a real estate problem prior to the pandemic hitting us. We are already starting to see an uptick in investment activity, mostly in the logistics, warehouse, life science and multifamily sectors.
There has been plenty of talk of people leaving the urban core of big cities and moving to the suburbs because of this pandemic. Do you think this will be a long-term trend?
Sullivan: In my personal view, I think the narrative of the death of the gateway cities is overstated. I think that cities like New York, San Francisco, Boston, Los Angeles, London and Hong Kong will be fine. There is just so much going on in them in terms of capital, education and innovation. I think they are going to remain strong in the medium to long term. The pandemics that Asian cities have gone through in the past were not to the magnitude of COVID-19, but they were not insignificant. These pandemics did not result in people moving away from the major cities in Asia.
What about remote working? Are we seeing a more permanent shift to remote working, or will workers return to the office once the pandemic is behind us?
Sullivan: It’s interesting to think about big cities versus smaller cities. Is this a permanent shift to remote working or is it temporary? Before the pandemic in the United States, about 3 percent of the workforce worked remotely on a permanent basis. Early in the pandemic, there was a study saying that in May 42 percent of U.S. workers were working remotely. That is pretty remarkable.
Look at outdoors retailer REI. The company built a brand-new, shiny headquarters in Bellevue near Seattle. REI put that campus on the market. REI officials have said they are not going to have a large headquarters space like that. Meanwhile, Facebook just opted to lease significant space in New York City. It’s hard to predict where remote working will go.
How much concern is there that remote working will reduce the demand companies have for office space?
Sullivan: Even if you assume a permanent increase of some amount in the number of people working remotely, you have to counterbalance that with this need that companies now have for more space per person when they do have people in the office. Sometimes for me it’s hard to remember life before COVID. But if you remember, it was all about open office plans and bench seating. That has been flipped 180 degrees. Now the focus is on finding more square feet per person.
There was a high percentage of people who identified a healthy and safe workplace as something that will be impactful in the future. That was already happening in some respects with respect to green buildings. But clearly, the pandemic will accelerate this. When you are designing new office space or any space that people will be in, the attention to safety and air quality and how you manage traffic flow will become much more important.