COMMERCIAL REAL ESTATE REBOUNDS FROM PANDEMIC RECESSION

BY MICHELE LERNER

The impact of the shocking spread of COVID-19 and accompanying economic shutdown beginning in March 2020 continues to reverberate through commercial real estate markets more than a year after it began. Virtual schooling, social distancing, and remote work changed lifestyles and habits—some of which are expected to continue for the long term.

It’s an interesting time for commercial real estate in New Jersey,” said Adrian Ponsen, an economist and director of analytics with the CoStar Group in Philadelphia. “Prior to the pandemic, the market was slow moving for most property types. Now there’s a big divergence depending on the region and property type.

While the pandemic’s impact was swift and deep, commercial developers and investors were well-positioned before the pandemic, which made them better able to handle the crisis, said William Pattison, head of the real estate research and strategy team within the risk, research, and analytics group of MetLife Investment Management in New York.

Investors were better prepared than they were before the dot-com bust in the early 2000s and the 2008 financial crisis,” said Pattison. “The construction pipeline was already a little depressed because of the tariffs that raised the costs of materials and high labor costs, so the pipeline of projects was slow. Vacancy rates were low, and rents were up in most sectors. Even the retail sector was in better shape because there was so little construction of retail sites over the past decade.

Photo by mandritoiu – stock.adobe.com

As the country begins to emerge from the pandemic and the economy rebounds, the industrial and multifamily sectors are the healthiest in commercial real estate, while retail and office sectors continue to face challenges, said Ponsen.

Everyone wants industrial properties right now,” said Bud Emig, a Realtor® with Long & Foster Real Estate in Devon, Pa. who works with commercial investors in seven counties in South Jersey. “Multifamily buildings and medical offices are strong, too, but very few people want to buy a retail site or restaurant right now.

Joe Ridolfi, a Realtor® and commercial real estate broker owner of Ridolfi Associates in Hamilton Township, said he’s seeing a crescendo of interest in commercial estate investing from everyone from mom-and-pop investors to wealth managers.

Looking ahead, Emig anticipates continued economic growth to help the commercial property sector. “Some developers are holding off a little now because construction costs are so high, but there are still opportunities in a variety of property sectors,” said Emig.

PERFORMANCE BY THE SECTORS

Regional variations exist in New Jersey for some property types depending on whether they’re located in the New York metro area or central and southern counties.

INDUSTRIAL

The rise of e-commerce and expectations for fast delivery was already driving demand higher for industrial spaces and when the pandemic began online shopping soared, said Ponsen.

New Jersey has a heavy concentration of large warehouses along the I-95 corridor because it sits between New York City, Philadelphia, Baltimore and Washington, the number one largest market in the world for consumers,” said Ponsen. “Developers can’t keep up with the demand for warehouse space and rents are up 6.5 percent year-overyear.

Northern New Jersey is nearly built out, so industrial developers are expanding to central and southern New Jersey, said Ponsen.

Thousands of acres of farmland and vacant land are being converted to warehouse space in New Jersey, especially in Gloucester County, said Emig.

Most investors think the demand for industrial space is growing because of ecommerce sales, but we think the real driver is consumer demand for faster delivery,” said Pattison. “Right now, people expect one- or two-day delivery but in the future, we think people will demand delivery within a four-hour window.

MULTIFAMILY

Unemployment rates spiked early in the pandemic, reaching a record 15 percent in April 2020. The assumption was that tenants would be unable to pay their rent, but federal and state programs allowed many to continue to pay. Rents were up 3.5 percent year-over-year statewide, the biggest increase in years, said Ponsen, but there was also a wide divergence in performance by location.

For example, Monmouth County saw rents rise 7 percent to 10 percent because renters relocating from New York and Burlington County benefitted from people relocating from Philadelphia,” said Ponsen. “But in Hudson County, rents dropped 2 percent and occupancy rates dropped 5 percent to 10 percent because of people leaving New York.

Transactions have slowed since the pandemic, partly because many owners of apartments in strong suburban markets want to keep reaping the rewards of rent increases

and high occupancy rates, said Ponsen. Owners in urban markets anticipate a rebound and don’t want to sell at a lower rate.

There’s a huge shortage of housing statewide and demand is high, too,” said Ridolfi. “Developers can’t build apartments fast enough and investors will pay top dollar for apartments. That’s great for apartment owners but hard for new investors.

Demand for apartments is especially high for both millennials and baby boomers in town center locations that offer amenities such as restaurants, bars and shops without the density of a city, said Emig.

Rent increases were highest for two and three-bedroom apartments because of the demand for more space,” said Pattison. “Studio and one-bedroom apartment rents were mostly flat. Probably the lowest demand is for a studio in New York City, while the highest demand is for a 1,200-square-foot apartment in the suburbs.

OFFICE

The ability to work remotely depends on the industry, but a recent report by benefits consulting firm Willis Towers Watson found that employers expect 37 percent of employees to still be working remotely at the end of 2021, compared to 11 percent before the pandemic. That means that many companies will need less space. “Some of the studies I’ve seen say that baby boomers want to continue to work at home, but millennials prefer the office,” said Emig. “We’re in the middle of a big shift in offices and it’s hard to know whether existing offices will get restructured.”

Monthly surveys of Fortune 500 companies have been gradually turning more positive to returning to offices since last summer, said Pattison, because companies feel that productivity has declined, and turnover has increased among remote workers.

Offices have long-term leases and lower interest rates, so they’ve been surprisingly holding their value so far,” said Pattison. “There’s no measurable difference between the performance of offices in different parts of the state, either.

When the pandemic began, approximately 60 percent to 70 percent of the companies in MetLife’s portfolio were anticipated to renew their lease for the same space, said Pattison.

Surprisingly, 75 percent renewed their leases, which is in line with a normal market,” said Pattison. “Expansion of office space has slowed though, so vacancy rates are rising.

Ponsen is less optimistic about the office market.

We’ve seen a widespread pattern of tenants putting up their office space for sublet for the rest of their lease in both suburban and urban locations,” Ponsen said. “It’s hard to know about the long-term impact, but we anticipate that trophy office space will fill up quickly when tenants are ready to downsize but willing to pay a higher price per square foot.

RETAIL

The retail sector was in a difficult environment even before the pandemic, said Ponsen, especially malls and department stores.

Initially, vacancy rates jumped 20 percent, but those rates are declining in 2021 as the economy gets back on its feet,” said Ponsen.

Even before the pandemic, shopping centers and malls were being repurposed or reconfigured, said Emig.

Some of the malls have been converted to storage facilities or warehouses,” Emig said. “At shopping centers, we sometimes see a big anchor tenant like a Target take over the whole space.

Cooper University Health Care announced that it will open a health care center in the former Sears location at Moorestown Mall, said Ponsen, just one example of mall space being converted to non-retail use.

Older Class B and Class C retail sites are priced for redevelopment into warehouses, apartments, or self-storage facilities, said Pattison, which could be an opportunity for investors.

One opportunity in the retail sector, especially for smaller investors, is to own a franchise such as a Dunkin Donuts or other small restaurant or business,” said Ridolfi. “We’ve worked with a number of investors who start with one and then build wealth by owning several locations.

HOSPITALITY

The pandemic hit the hotel industry hardest, said Pattison, in part because hotels don’t have any long-term leases such as the typical 5 to 10-year leases for office and retail sites and the one-year leases typical of apartments.

“The majority of hotels shut down completely for a few months, but they still had to pay their mortgage, insurance and utility bills,” said Pattison. “The hotel industry continues to be distressed because business travel has yet to come back even as domestic leisure travel slowly restarts.” However, hotels in New Jersey’s beach communities appear to be making a comeback this spring and summer, said Emig, since so many people want a vacation at a destination within driving distance. Beach house rentals have been snapped up at a fast pace in 2021, which means that more people may return to hotels, he said.

INVESTOR OPPORTUNITIES

While the full measure of the economic recovery remains to be seen, Ponsen believes that investors can find some opportunities in the industrial, apartment and even the retail sector.

As larger companies gobble up industrial sites, that creates a market for some older and smaller properties that are needed to serve contractors and smaller businesses,” said Ponsen. “I expect strong rent growth in older and smaller apartment buildings, although investors need to recognize that it’s a sellers’ market.

The retail sector could begin to see more transactions as shops, bars and restaurants begin to make a comeback and developers look for ways to repurpose larger spaces, Ponsen said.

Economists anticipate strong GDP growth in 2021 and beyond as well as a return of consumer spending, all of which bodes well for the rebound of the commercial property sector.