Prior to the COVID-19 pandemic, the United States was in one of the longest economic recoveries in history. GDP was anticipated to grow by 2.3%, almost all real estate asset classes were performing well, and New Jersey was seeing many redevelopment projects come to fruition.
By March, we were in the middle of an economic shutdown—the likes of which we have never seen. Financial markets tumbled, non-essential retail establishments closed, restaurants were limited to pick-up and delivery, and non-essential construction was halted. Millions have since been laid off as the unemployment rate continues to escalate to unprecedented levels. As the COVID-19 pandemic continues to affect our communities, especially in the New York/New Jersey market, the full impact has yet to be seen.
While the real, long-term solution rests in the development of a vaccine, as analysts, we are constantly looking at the past for parallels that may help provide a look into future market performance. For example, the most telling, long-term effect following the 9/11 terrorist attack was increased concern for public safety through the implementation of expanded security measures. While much of the overt security measures have subsided, airports, courthouses, some public and private office buildings have maintained a higher level of security. The financial crisis of 2008 demonstrated how an economic downturn could accelerate real estate trends that were already in place. For example, prior to 2008, technological innovation was the leading reason firms began to reduce office space requirements. When the financial crisis hit, there were massive layoffs. As the economy recovered, the re-hire rate for office workers lagged, which accelerated the decline in demand for office space.
With these two past events in mind, the following is our anticipated outlook for the New Jersey real estate market in the time of COVID-19.
Hotels, Travel and Leisure
Safety will be the most significant issue affecting the hotel, travel and leisure market. In this regard, the effects of 9/11 may be a barometer. While it took the travel and hospitality industry time to recover, it eventually returned to normal levels and then continued to grow, exceeding pre-9/11 levels. As the fear of a reoccurring event subsides, the industry will be on track to return to a full recovery, subject to long-term effects and ingrained trends.
Some technological trends that may be accelerated by COVID-19 include:
- Zoom conferencing instead of travel for in-person meetings
- Decreased demand for corporate meetings and industry conferences
Long-term operational issues may include:
- Increased requirements relating to room cleaning, sanitizing and housekeeping
- Labor safety requirement from Unions, franchisors and operators
- Customer safety requirement from Unions, franchisors and operators
Prior to COVID-19, the apartment market was strong. The sector should not see any long-terms effects from COVID-19. Rent relief, collection issues and rent forgiveness are anticipated to be short-term issues.
The demographic shift from suburban to urban living was beginning reverse back to the suburbs as millennials began to form families. Given the need for social distancing in the time of COVID-19, apartment demand in suburban locations may be accelerated.
From an operational perspective, landlords will need to provide some assurance to tenants that fitness centers, pools, community centers, other amenities and common areas are safe. This may be a difficult and costly endeavor. There will be many possible outcomes, such as an increase in square footage per treadmill, or perhaps a reduction in these types of amenities overall.
Prior to COVID-19, new and renovated office assets were seeing record-high values. The office market was still reemerging from the trend away from obsolete office parks, antiquated building designs and buildings that had a limited nexus to support services such as retail, restaurants and hotels. Developers were not only reengineering buildings, but the office park itself. While we expect this trend to continue, office assets will experience a new set of challenges that may create an entirely new supply and demand paradigm:
- A reversal of the trend towards more employees per square foot as social distancing may require larger cubicles designed with more and higher partitions between employees.
- The current trend towards an open floor plan is anticipated to continue with interior individual offices and open offices around the perimeter that allow for natural light to benefit everyone. However, demand for more individual office may increase.
- Janitorial expenses may escalate as landlords will be required to provide safe amenities and common areas. Fitness centers, cafés and elevators will require an increased level of cleanliness and sanitization. Likewise, tenants will be required to do the same to ensure safe and clean employee work areas.
- Employee work schedules may be staggered. Employees may alternate their workdays in and out of the office. While one worker is working at the office, the other may work at home.
- Work-at-home, while viable for some industries, is not viable for others. Decentralization of firms causes reductions in productivity, collaboration, team building and corporate culture. There has been a significant amount of discussion about this issue prior to COVID-19 and, in fact, the work-at-home trend was accelerated by the 2008 financial crisis. The issue being debated now focuses on the extent to which the work-at-home concept will increase. Time will tell.
- Office hoteling, another concept that emerged prior to the 2008 financial crisis, may now be an impractical concept since it may be difficult to ensure employees’ safety.
- Collaborative spaces, another concept that emerged prior to the 2008 financial crisis, may not be as widely utilized for the same reason.
- The biggest potential challenge facing the office sector may be the reabsorption of space created by failing businesses.
Industrial space has demonstrated to be the most desired asset class, driven by the significant growth in online spending and New Jersey’s strategic location in the northeast. Industrial assets may also be the biggest benefactor of the current crisis. As online spending continues to increase, the demand for industrial space will increase. Furthermore, industrial employers may need to implement social distancing measures, which may increase the employees-per-square-foot ratio, resulting in a need for more space.
The manufacturing sector may also see a boost in demand as products currently being manufactured in other countries are brought back to the United States for production. This may be more speculative, but national security and safety of the supply chain has become an issue of concern.
Pre-COVID-19, the retail sector exhibited the most transition out of all the asset classes. Online spending, while benefitting the industrial market, was hurting brick-and-mortar stores. Retail properties have similar economic and technological issues that office properties encountered prior to the downturn of2008. Technology continues to change the way we work, live and shop. The retail real estate sector will see most likely undergo the most dramatic changes due to the COVID-19 pandemic.
- Many retail properties are susceptible to social distancing challenges, which may cause significant operational changes, such as store layouts and protocol to ensure employee and customer safety. Restaurants, for example, may need to have less seats per square foot, while movie theaters may have occupancy restrictions. In all instances, social distancing measures and new sanitizing requirements will increase occupancy costs and potentially reduce operating margins.
- Online spending was up 25% in March from the same period last year. While shoppers were mostly quarantined, the trend towards online spending should increase over what was anticipated prior to COVID. This will continue to decrease the demand for brick-and-mortar stores.
- Department stores and marginal centers will close at a faster rate than originally anticipated. Highest- and best-use may become the central question in valuation and redevelopment efforts. Planning initiatives will increase in a similar fashion, as seen with obsolete office parks after 2008.
- Green Street Advisors predicts 50% of all department stores will close by the end of 2020. Iconic brands such as JCPenney, Lord & Taylor and Neiman Marcus are on the brink of bankruptcy. Macy's was dropped from the S&P 500 index in March after its market capitalization fell by 75% in one year. Macy’s has also hired advisors to explore ways to recapitalize its finances, according to Reuters.
- Remaining regional malls will need to create new environments to attract shoppers. The solution may be difficult to ascertain as social distancing creates new challenges. Malls like the American Dream in New Jersey and the Mall of America in Minnesota have been developed to create a unique retail/entertainment environment. While the Mall of America has seen success, the hope was the American Dream would follow suit. Social distancing may make this possibility difficult. Regional malls may become the biggest loser as pre-COVID-19 trends accelerate and new COVID-19 concerns present themselves.
Overall, real estate development has been experiencing some very interesting trends since 2008. The average size of a single-family home has decreased, apartment living is in higher demand, and the now obsolete, traditional office park is giving way to more mixed-use projects that are dependent on high-density housing. Projects intend to capitalize on proximity, socialization and experiential retail users. During the 2009 recession, redevelopment planning did not take a step back. The simple fact that “even bad times end,” encourages developers to take time and reevaluate plans to accommodate new market demands or move forward with development projects. This is occurring in many municipalities in New Jersey including Sayreville, Orange, East Brunswick, and others.
It will be interesting to see how current mixed-use projects reengineer themselves to accommodate the lasting impact of COVID-19.
About the Author:
Arthur A. Linfante is Managing Director of the Northern New Jersey office of Integra Realty Resources (IRR). He has extensive experience in asset valuation and advisory functions. Current projects include redevelopment planning and feasibility, municipal impacts, affordable housing studies and estate and property tax planning. As the Northeast practice leader in the Hotel and Litigation Specialty Practice Groups, Linfante is actively involved in real estate matters directly affected by COVID-19. Working closely with Integra’s COVID-19 National Response Team, the IRR-Northern New Jersey is conducting daily research on the current pandemic and economic impacts to provide timely information to clients that enables them to make informed decisions for their real estate assets.