The economic slowdown resulting from the COVID-19 Great Lockdown has softened the Commercial Real Estate market01. Real Estate, in general and Commercial Real Estate in particular, still provides an inflation hedge and diversification benefit02because of its low correlation with other asset classes, such as stocks and bonds.
Commercial Real Estate investments come in two major forms, which are publicly traded as Real Estate Investment Trusts, commonly referred to as a REITs, and privately held Real Estate investments. A good article titled “When Your Lookalike Funds Don’t Act Alike” 03 explains the difference between the two. A quick summary of said article is that publicly traded REIT securities trade on investor sentiment, which is affected by the greed and fear emotions of the stock market. Privately held Real Estate investments, like the TIAA Real Estate subaccount04 discussed in said article and available in many nonprofit employer 403b plans, is valued through a periodic appraisal process, which is considerably less volatile.
Commercial Real Estate has a long market cycle05, which historically has been around 18 years06, because of supply unresponsiveness resulting from the lag time between permitting, building to occupancy. The last market correction for Commercial Real Estate happened in 2008, which affected ALL properties. Commercial Real Estate as an Asset Class was up marginally in the 1st quarter 2020 according to the NCREIF website, which is a website that monitors Commercial Real Estate valuation07. Commercial Real Estate is typically broken into categories, such as Office, Industrial, Retail and Apartment Properties. If desired, the NCREIF website is capable of can breaking down the valuation changes by region and/or category.
Online commerce and the virtual workplace became much more prevalent as a result of the shelter-in-place mandate, which benefits some properties, while hurting others, such as retail and leisure properties. Because the forced transition to a virtual workplace has gone relatively smoothly, some CEOs may evaluate the benefits&drawbacks08 of the virtual office and employees working remotely. Fortunately for landlords, Commercial Office space is usually under multi-year lease09 contracts, of five years on average, with cancellation penalty clauses. Vacancy rates may creep higher as leases come up for renewal. However, if large companies go bankrupt en masse, which is NOT anticipated, that would lead to increased vacancy rates09.
As the virtual workplace gains momentum10, less physical office space needs will be detrimental to commercial office properties but beneficial to telecommunication, streaming and video conferencing services and associated properties and infrastructure, such as internet backbone facilities and communication towers. The build out of the 5G communication network with higher bandwidth may likely hasten the trend to the virtual office. For these reasons, where possible we have increased exposure to these industries as a part of our client’s overall asset allocation plans.
It’s impossible to build products without the necessary parts with many parts currently imported. Because of tariff inflicted supply chain problems11 that were further exacerbated by COVID-19, corporations may alter supply chains between countries and possibly even continents. Corporations may consider switching from just-in-time to just-in-case inventory12 to shun fragile business models13 as well as sourcing some supply production domestically. Changes to the supply chain in regard to where products are sourced will benefit production facilities and warehousing properties as well as increase employment associated with those activities. These changes will have long lasting implications but take time to implement.
It’s truly different this time and how the world does business will likely change because of this pandemic and the many problems that it uncovered. As mentioned in numerous prior Newsletters, we monitor asset class valuations on a periodic and on-going basis, especially when conditions warrant doing so, like now. Commercial Real Estate valuations, in particular, is something to be monitored more closely for the foreseeable future because of the many recent developments.
Chance favors the prepared mind14! A sustainable global economic recovery will depend on consumer confidence and their willingness to resume activities. If you have any concerns about Commercial Real Estate valuation and how it may affect your overall portfolio, a member of the Iron Belt Partners Team will gladly discuss any concerns with you. Our contact information is:
Lindsay M. Turchetta lturchetta@wradvisors.com (724) 493-9473
John D. Martin JDMartin@wradvisors.com (412) 925-7031
Working as a team in an effort to better serve our clients!
This communication is meant to be general in nature and should not be construed as investment or financial advice related to your personal situation. You should consult your tax, legal, and/or financial advisor prior to making any financial decisions. The views expressed here are those of the authors, John Martin & Lindsay Turchetta, and not necessarily those of the broker dealer. Information is based on data gathered from what are believed to be reliable sources. The opinions, and other information contained in this article are subject to change continually and without notice of any kind. Forward-looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time and may not come to pass. Past performance does not guarantee future results.
Investments are not guaranteed and are subject to investment risk including the possible loss of principal.
The index references herein are unmanaged and cannot be directly invested into. Past performance does not guarantee future results.
01 Source: ”What Does a Softening Market Mean for Commercial Real Estate Investing?” on montegra.com
02 Source: ”Why Real Estate should be in your portfolio” on Barrons.com by Jan Willem Vis
03 Source: ”When Your Lookalike Funds Don’t Act Alike” on jasonzweig.com by Jason Zweig
04 Source: ”TIAA Real Estate frequently asked questions” on TIAA.org
05 Source: ”Where are we in the Commercial Real Estate Market?” on pioneerrealtycapital.com
06 Source: ”The GREAT 18 year Real Estate Cycle” on CATO.org.com by Steve H. Hanke
07 Source: ”Quarterly Returns under NCREIF Property Index (NPI)” on ncreif.org/data-products/property
08 Source: ”Understanding the Pros and Cons of Virtual Office Spaces: Part 1 & Part 2” on stat.international
09 Source: ”What does COVID-19 mean for Commercial Real Estate?” on geophy.com by Nils Kok
10 Source: ”The Pros and Cons of Virtual Offices” on business.com
11 Source: ”The United States Needs to Reshape Global Supply Chains” on foreignpolicy.com by Aaron Friedberg
12 Source: ”Just-in-time vs “just-in-case parts inventory management” on acumentfl.com
13 Source: ”Companies should shift from “just in time” to “just in case”” on ft.com
14 Source: ”Chance favors the prepared mind” quote by Louis Pasture