A Look at the Commercial Real Estate Market in 2021

by Matthew Roberts, Certified General Real Estate Appraiser

March 2021

We Are in Uncharted Waters.

While 2020 is over, commercial real estate investors find themselves still in uncharted waters. It is difficult for market participants to conduct planning when there are such great uncertainties present. Although markets are now in recovery mode after the shutdowns and lockdowns of last year, investors may be more cautious about the future.

Many Owners Have a Wait-and-See Mentality.

According to the PricewaterhouseCoopers (PwC) Investor Survey, holding properties seems to be the most popular strategy entering 2021. Given the challenges to investors starting last year, if past global or national events are any indicator, most will likely be in a holding pattern.

“46% of investors surveyed suggest holding assets in the year ahead while 31% recommend buying and 23% suggest selling. When looking more closely at these figures by property sector, the industrial sector receives an equally strong preference for either buying or holding.”

Industrial – Strong and Evolving

With online sales increasing dramatically, the industrial sector is forecasted to be strong in 2021, especially for warehousing and distribution facilities. Industrial properties with leases may be very attractive to active investors during the year who cannot find worthwhile returns from other property types.

In some areas, former retail structures are being converted to industrial use. Increasing use for e-commerce fulfillment will require new features in industrial buildings and in new construction. Sales volume is expected to be strong during 2021.

Retail – Bad and getting worse

The retail sector and hotel sectors may be some of the hardest hit during the pandemic. Retail demand is expected to be low and coupled with high levels of supply. Expect increasing cap rates, higher vacancies, and potential negative rental growth. Getting customers off their computers and into a store will remain a challenge for tenants.

A recovery for the retail sector is not expected anytime soon. Retail could be a buyer’s market if the buyer is able to put together lucrative uses. Creative investors may experiment with converting retail properties to alternative uses.

Retail landlords should take care to be on top of upcoming lease expirations so they can plan accordingly if tenants are not going to renew. The earlier the landlord has this information the better. Existing tenants who can still pay may be given white glove service by landlords in order to attract other tenants and avoid the costs of vacancy. If vacancies occur, it may take considerable time to find new tenants. New tenants may also be more demanding in terms of lease rate and landlord responsibilities.

Office – Uncertain

The office space sector finished 2020 surprisingly well. Office space trends will be under the microscope in 2021. ‘Work from home’ has become permanent for some office workers. Some will return to the office, and others already have, but the office space they come back to may look different. Expect fewer open-concept office floorplans and a return to private workspaces where possible. Tenants may demand new layouts and amenities. Leasing demand may not be as strong as in previous years. With many unknowns about how office space will be used in the future, investors may perceive uncertainty and risk in the office market.

Multi-Family – Least disrupted to date

The multi-family and apartment market has been hot in recent years. Many market participants remain cautious given the eviction moratoriums. The duration of the moratoriums has likely delayed pain for some and made things riskier for owners. They are set to expire on March 31st, but it is possible they may be extended again. The holding mentality may be the least painful option for owners with mortgages and tenants unable to pay rent. While rents are being paid, the multi-family properties remain in demand by investors. In markets where tenants were hit hard economically, and where property taxes are rising, property owners may feel the squeeze as they experience more risk than what their low cap rate at purchase reflected.

Commercial Real Estate Activity

In the most recent NAR’s Commercial Real Estate Quarterly Market Survey at the end of 2020, Realtors reported that their sales transactions volume contracted in the fourth quarter. They reported the largest declines in sales volume in the hotel/hospitality market, retail malls, and retail strip centers. Industrial generally saw no negative change. The largest increase in sales was for land. Among land transactions, the largest gains in volume were for sales of recreational land, ranches, and residential land.

Realtors also reported slight decreases in commercial property prices, except for apartments, industrial, and land, for which they reported increased prices. Lease volumes were also reported slightly decreased except for industrial properties. Vacancy rates were also up compared to before 2020, but apartment rental vacancy remains stable.

Trends in construction activity reflect similar demand levels across the sectors. Apartment and industrial saw the most increases in new construction.

Looking Forward

Real estate markets may react more slowly than equities or bond markets. The length of time needed to close a transaction reduces liquidity compared to purely financial markets. For this reason, we have yet to see the same type of volatility or impact in the commercial real estate markets as we have witnessed in other financial sectors in parts of 2020. We may see last year’s impacts work themselves out in commercial real estate over the next couple years, both good and bad.

The world may look different for some time compared to the world we knew in January or February of 2020. The events of 2020 accelerated trends already present in many areas of life. As similar challenges and opportunities face commercial real estate in 2021, look for some of these trends to continue.

Keep an eye on interest rates. The Federal Reserve and commercial banks have kept interest rates low, seeking to keep credit available. Asset classes like real estate may not perform as well under a rising interest rate environment. However, at this time, commercial interest rates are still near all-time lows. Low interest rates in recent years have made investment property purchases affordable to more participants and have no doubt fueled rising real estate prices.

Spurgeon Appraisals

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