The Pandemic’s Impact on Commercial Real Estate

BY DAVID GIBBS, CPA, CCIFP, CRE, MBA, McCARTHY & COMPANY

The commercial real estate industry was bouncing back when this article was written on Dec. 16, 2021. Restaurants, stores, fitness centers and malls were open and busy. Although inflation was high, consumers were spending money, which was good news for the commercial real estate industry. Tenants could finally pay their rent. Everyone was hopeful that the end of the pandemic was near. But the reality was that the wrath of this pandemic was beginning again.

Commercial real estate was hit hard in the beginning of the pandemic. Government mandates, shutdowns, nonpayment of rent, layoffs and then labor shortages all had a negative impact.

March Construction Consulting reported in its “2022 Commercial Real Estate Market Forecast” that throughout 2021 investors seized lucrative opportunities due to re-openings and lower interest rates. As people began to emerge from isolation, they treated themselves to dinners, concerts, movies, other forms of entertainment and, of course, shopping. The problem was that labor and material shortages made it difficult for businesses to meet consumer demand.

CONSTRUCTION INDUSTRY FORECAST

Overall, Dodge Data & Analytics anticipates modest growth of 6 percent in the construction industry for the next year, despite challenges with labor, supply chains and productivity. Anirban Basu, chief economist for Associated Builders and Contractors and CEO of consulting firm Sage Policy Group agrees that “the construction outlook for 2022 is looking positive.”

Meanwhile, Moody’s Analytics predicts that the vacancy rate for retail space will climb to 11 or 12 percent as businesses reexamine their need for space. The vacancy rate was 10.6 percent in the first three months of 2021, up from 10.2 percent the prior year. The average effective rent (what’s left after taking out concessions to entice tenants) dropped 1.5 percent.

INFLATION AND OTHER VARIABLES

The inflation rate in the U.S. increased to 6.8 percent in November 2021, the highest since June 1982. It marked the ninth consecutive month inflation was above the Federal Reserve’s 2-percent target. Basu expects inflation will remain high in the beginning of 2022 but will decrease later in the year.

The price of construction materials has risen rapidly over the past year. As of October 2021, the 12-month producer price index for steel mill products was up 141.6 percent, according to the U.S. Bureau of Labor Statistics. “A lowering inflation rate, along with expected rising interest rate and the recovery of manufacturing and supply chains, could help lower the prices of materials like steel, copper and aluminum,” said Basu. This is good news for commercial real estate.

LOOKING AHEAD

While economists agree that the commercial real estate industry will expand somewhat in 2022, it is difficult to pinpoint which sector will experience the greatest growth. The National Association of Realtor’s Commercial Real Estate Outlook 2022 suggests that there will be a steady demand in industrial and retail space, but that is dependent upon the Federal Reserve controlling inflation.

Coldwell Banker Richard Ellis Group Inc. (CBRE) points out in its market outlook that specific commercial real estate sectors grew during the pandemic. These included cold storage facilities, data centers and life sciences. Logistics real estate was also in high demand, as well as warehouses due to the increase in online shopping. The expectation is that these sectors will continue to expand throughout 2022 if inflation is under control.

Multifamily construction, which led the industry out of the Great Recession, contracted in the past couple of years. People moved from urban to rural areas in the beginning of the pandemic. This trend is finally turning around, and it is expected that the build-to-rent market will increase. Occupancy levels may not return to pre-pandemic levels before 2023. Furthermore, CBRE suggests that Revenue per Available Room (RevPAR) may not return to its pre-pandemic highs until 2024. Even so, it appears that, overall, the commercial real estate industry will slowly recover over the next several years, although it might not reach the same pre-pandemic high.

David E. Gibbs, CPA, CCIFP, CRE, MBA, is a tax partner with McCarthy & Company, as well as the leader of the firm’s real estate niche. He can be reached at David.Gibbs@McCarthy.CPA.