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Outside the Box: The future of commercial real estate — the weak get shaken out and the strong take over whole new markets
Commercial Property Investing in Property Property

Outside the Box: The future of commercial real estate — the weak get shaken out and the strong take over whole new markets

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Outside the Box

Once the pain subsides, well-heeled companies will be kings of the city

An aerial view of Chicago’s Lake Shore Drive.


iStockphoto

The world of commercial real estate is getting turned upside down by the coronavirus pandemic.

We’re seeing the first signs of stress in the industry as clients are seeking to move out of office spaces they can no longer afford and the number of accounts receivable ticks up.

While some semblance of normality could return by early next year, there’s likely to be a lot of pain in the meantime that will result in a new landscape of companies and different business models.

Read: This one niche of the sagging real estate market is growing rapidly

And there will probably be a long tail to the downturn as people and businesses take time to rebuild their confidence even after a vaccine becomes available.

The reality facing companies required to lease space to operate their business is in a flat-out crisis. A crisis in confidence and clarity about what’s safe and what isn’t. And about what their teams and everyone from vendors to partners to customers that they deal with will want or expect.

The likely result will be a huge premium on flexibility, which could be an existential threat to the traditional industry practice of five-year or 10-year lease terms.

Pain opportunity too

All three of the flexible real estate models that have enjoyed rapid growth in recent years have seen demand suffer or simply evaporate in a matter of weeks. As in other parts of the economy, it’s been a harsh awakening from complacent assumptions that the good times would keep on rolling.

• The co-working industry, where some of the better-known operators are Knotel, Industrious and Convene, has ground to a halt for obvious health-related reasons. The near-implosion of industry giant WeWork had already cast doubt over the sector and dampened investors’ optimism over its potential.

• The co-living niche, with players like Ollie, Quarters and Common, could be in for some rough sledding depending on how quickly a reliable coronavirus test and an eventual vaccine are available because of such close living arrangements.

• With U.S. travel down about 90%, short-term accommodation operators such as Domio, Zeus and StayAlfred are also going to be struggling.

The brutal nature of this downturn will surely leave psychological scars on companies and make many of them extremely wary of committing to anything long term.

More than a few will be looking for any credit opportunities and aiming to commit the lowest amount of cash possible.

As for landlords, they will likely have to consider much shorter lease terms than they have in the past and think of more creative ways to use their space in order to attract tenants back.

The flipside may exist for commercial real estate owners. As asset holders, they’ll be in a prime position to take advantage of the opportunities that arise from the coming shake-out.

While the crisis will cement society’s shift to more flexible working and living arrangements, it will be a tough period that some of the current players won’t survive intact.

Demand in these sectors has almost entirely dried up, a situation that will put property managers under severe stress if, as seems certain, it continues for several months. Most companies can’t survive three to four months without revenue, and we may be looking at an eight- to 12-month dry spell.

Recipe for consolidation

In the new world we’re entering, the well-capitalized will be the beneficiaries of the new opportunities. Commercial real estate owners should be in a strong position to acquire some of these short-term rental and other operators for a bargain. Valuations are likely to take a big hit, meaning there will be some very good deals out there.

Another alternative will be for them to get into the business themselves.

After all, they’ve now had ample opportunity to see the alternative use cases for their properties that in good times have been proven to generate higher yields than long term rentals.

In the post-coronavirus world, there will be competing forces at work for how companies will use space. Given the health and hygiene awareness raised by COVID-19, there will clearly be greater demand for working arrangements that allow for more personal space.

There will be more resistance for “hot-desking,” an expectation of comprehensive precautions and a greater acceptance of home-working in order to reduce numbers at the office. But the desire for more square footage per head will clash with the straitened financial circumstances and need for belt-tightening that many companies will be facing in the deepest recession of modern times.

Although landlords have had the pleasure of taking advantage of working with property managers running businesses that provide master leases to owners, trying times may force the hand of the owner to do the work themselves.

Ariel Maidansky is the CEO and co-founder of Envizzo, an online provider of interior design and furnishings for commercial and residential spaces.

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