The pandemic turbocharged e-commerce and work-from-home movements, reshaped the markets, and created winners and losers across commercial real estate sectors. What will this mean for investors? John Murray, PIMCO’s global head of private commercial real estate, and Francois Trausch, CEO and CIO of Allianz Real Estate, discuss their market views, particularly within the office sector.
Q: Before diving into your views on the office sector, first give us a sense for global transaction volumes in the first quarter across various regions, and what asset types held up best.
Global transaction volumes fell 26% and 27% in the U.S. and Europe, respectively, and 12% in Asia. This was not surprising, given the pandemic. Multi-family properties, however, held up incredibly well in the U.S. and Europe.
In Europe, the dollar amount of multi-family transactions jumped 66% in the first quarter of 2021 from the year before, with two of the first quarter’s biggest deals in residential properties. In Asia, the industrial sector, primarily logistics, performed best, with volumes rising 5% from last year and 22% from 2019. Multi-family was the best-performing sector in terms of transaction volumes in the first quarter in the U.S. Volumes were off just 12% in multi-family; this compares well to retail, down 42%; office, down 36%; and industrial/logistics, off 41%.
The disruption from the pandemic has accelerated secular forces such as urbanization. Young people want to live in cities, close to jobs, education, and healthcare. Another trend that has been accelerated is rapid technology adoption, including e-commerce and teleconferencing. Alongside these, the disruption has sent investors in the core and core-plus space looking for quality and stable yields, while seeking to benefit from pandemic-related dislocations. If they cannot find existing core property investments, they are ready to generate yield pickup by “producing” the core (e.g., finding high quality, long-term tenants for a building with little to no deferred maintenance and moderate debt to capitalization).
Winner and losers
The hotel sector has been a short-term loser but should, in our view, recover gradually, albeit unevenly. While the sector is improving dramatically in the U.S., pressures remain in Europe as lockdowns there extended longer. These assets have massive capital shortfalls, which we think are temporary. In the U.S., revenue per available room (RevPAR) has rebounded to roughly 75% of 2019 levels, portending recoveries in Europe as their quarantines are lifted.
In contrast, we believe the retail sector is a long-term loser. Retail landlords are suffering along with their tenants and we do not think rescue capital will be enough to save many of these struggling assets. In fact, distress appears set to pick up in 2022. Many tenants are not going to come back or, in the U.S., they will likely vacate when Paycheck Protection Program (PPP) loan funds run out. Adding further pressure is a wall of loan maturities coming due, including for U.S. malls and a wave of core funds looking to reduce retail exposure. In our view, retail is arguably no longer a core portfolio asset. We expect to see opportunities for properties that are being repurposed but only at much lower prices than the previous retail values.
The industrial sector has been the big winner, with institutional demand at record highs supported by secular e-commerce tailwinds. Other strong performers include the residential housing sector. Longer term, a rise in rates may pressure single-family appreciation. But we expect multifamily-for-rent products to continue benefiting from favorable demographics. One thing to watch in the U.S. rental sector is the numbers of tenants who are unable to pay when stimulus programs end. Nontraditional residential sectors such as senior and student housing are seeing growing institutional demand. Lastly, the office sector – which we will dive deeper into next – is expected to hold both winners and losers. Tenants aren’t defaulting on their leases, even though they are not in the office, but clearly pressures will build as smaller tenant leases rollover.