The Impact of COVID on Commercial Real Estate

The Impact of COVID on Commercial Real Estate

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No one could have guessed just a year ago what the world would look like today. The COVID-19 pandemic has changed our way of life. From how we interact, how we shop, to even how we get our work done. Commercial real estate is no exception. With such large changes to our economy over the past few months, commercial property has certainly been affected as well.

Commercial property is, at its very base, where we conduct business. Whether it’s our favorite restaurant, or favorite shop, or even where we go to work everyday, commercial real estate is where our nation conducts business. WIth business itself being very much impacted by the COVID-19 pandemic, it’s no surprise that commercial property for sale and commercial property for rent have followed suit.

The Impact of Working From Home on the Commercial Real Estate Market:

As we all became aware of the COVID-19 virus and how it was spreading, many states, including Arizona, ultimately issued stay-at-home orders, in hopes to temporarily limit human interactions, and therefore slow the spread while services and systems were put in place to adapt to a changing healthcare environment. Perhaps the largest impact of this was that employers and organizations that were considered “non-essential” per Governor Ducey’s Executive Order, were required to close their offices. However, this didn’t mean an end to productivity, as many employers and employees were able to adapt and complete job tasks at home. Most of us rapidly became familiar with online video conferencing to maintain coordination of tasks and kept our industries working.

At the national level, this shift from central offices to individuals working from home had a significant impact on commercial office space for sale, as well as commercial office space for rent. The larger, central markets have seen the greatest impact. According to the CoStar Commercial Repeat Sales Indices, prices in the US Office Index fell .9% in the second quarter of 2020. The Prime Office Metros Index fell 2.7%, demonstrating the negative impact the pandemic has had on large office buildings in major metropolitan markets.

This however isn’t the case in smaller markets like Flagstaff. In Flagstaff, and even nationally, smaller office space has been much less affected by the pandemic. In general, smaller commercial transactions are actually up 2% over the past 12 months nationally. Like the housing market, commercial property in Flagstaff is also experiencing a lack of inventory, currently keeping sales and prices up.

 

Video conference callHow the Commercial Real Estate Market is Adjusting to COVID:

Like most aspects of life, the commercial real estate market has adapted to the current pandemic. While many industries like retail, restaurants, and hospitality have seen significant declines in 2020 nationally, other property types remain strong. For instance, nationally the US Retail index fell 1.9% in the second quarter, being the hardest hit and lowest performing sector. Of course, this is directly related to many physical locations being required to close for extended periods of time, or safety protocols such as social distancing significantly limiting the number of patrons and sales that can transact. Because of this, many have skipped the in-person retail experience entirely, doing most of their shopping online instead.

The U.S. Hospitality Index has also been negatively affected, falling 2.9% in the second quarter. However, over the past 12-months, the U.S. Hospitality Index has actually still shown an increase of 3.5%. This demonstrates that the travel and hospitality sector was booming prior to the pandemic, and will hopefully resume that trend once the virus is under control.

Unlike other sectors, the U.S. Industrial Index increased 2.4% in the second quarter, which contributed to an increase of 6% over the past 12 months. While many industries were negatively affected by the pandemic, industrial activities were largely considered “essential,” and continued operations. With the shift to online purchases as well, properties related to warehousing of goods are in critical demand.

This is true in Flagstaff as well. Industrial-zoned properties are very much in demand. This, coupled with a lack of properties that fall under that zoning code, have resulted in a very competitive industrial market!

Commercial Real Estate Forecasts for Life After COVID:

To many of us, it may seem like living with the “new norms” of the pandemic has been going on for ages. Unfortunately, we very well may have a long road ahead. While many small businesses in Flagstaff are struggling, especially in the restaurant/retail sector, we luckily haven’t seen an influx of commercial properties for sale or commercial properties for rent as a result of business closures yet. However, on a national level, the first half of 2020 saw a negative net absorption of retail space for the first time in 11 years. What that means is that, on a national level, more retail space was becoming vacant and available than was filling up.

This doesn’t bode well for any market, Flagstaff included. Undoubtedly as the pandemic draws on, it is likely that some of our favorite establishments won’t be able to weather the storm, which should result in increased vacancy in the retail/restaurant sector.

For the Industrial sector, however, the sky appears to be the limit. With many consumers becoming accustomed to the convenience of online shopping, warehousing space will continue to drive prices upward, with pent-up demand resulting in stiff competition.

The good news is retail and restaurant sales themselves are actually performing better than expected nationally. In May, retail sales, including food service, jumped 18.2%, followed by a 7.5% increase in June. What does this mean? That the demand for goods and services is still there, and should hopefully resume when the virus is under control and restrictions are lifted. At this point it is simply a race against the clock. The sooner the virus can be controlled, the sooner small businesses in Flagstaff can resume normal operations to (hopefully) make back the losses accrued through the pandemic and once again thrive.

Large office space may not get back to pre-pandemic levels anytime soon, though. With human resources departments around the U.S. realizing that productivity can be maintained with employees working from home, the cost savings of eliminating or reducing physical office space may become the new normal. Again, thus far this hasn’t shown an impact necessarily in Flagstaff, with most office spaces being smaller and necessary to continue to drive business.

Perhaps more than any other sector, commercial real estate is tied directly to, and impacted by, the overall economy. The COVID-19 pandemic has impacted the global economy in ways that were completely unforeseen. But the U.S. economy is resilient. It adapts. It adjusts. And it keeps moving forward. While commercial real estate has been greatly impacted by the pandemic, it too adjusts, adapts, and keeps moving forward. Ultimately, we will rebound from this. We’re too strong not too. But we may see shifts in the way businesses, and commercial properties themselves, operate. Drive-thru and curbside restaurant demand may forever change development design. Online shopping may forever reduce the physical footprint that retailers demand. Warehouses and storage may become as commonplace as large malls. There may be a huge increase in movie-theater, concert, and sporting event ticket sales once the virus has been controlled, as many long for the days in which they could gather in large groups for entertainment.

The virus will not last forever. There will be a return to normal life. And we will indeed, adapt, adjust, and move forward together.