Tysons Corner Center, Virginia
One year ago, financial markets were peering over the edge of a cliff of unprecedented magnitude. Commercial real estate markets braced for impact as the pandemic caused a complete shutdown of many stores and businesses, starving them of the cash flows they needed to pay their employers, their suppliers—and their landlords.
Today, markets are getting another surprise as recent earnings news from publicly-listed real estate—REITs—shows that an earnings recovery is already well underway. Indeed, in the overall U.S. listed REIT sector, earnings (as measured by funds from operations, or FFO) have recovered half the decline that took place last spring as shutdowns spread across the country. Significantly, this recovery was well underway even before the rollout of vaccines against Covid-19 had begun, and promises to continue as shops, travel, and other businesses return to more normal operations over the rest of this year and into 2022.
Large parts of the commercial real estate universe are held in private portfolios, and public information on the performance of these properties is scarce. In contrast, publicly-listed REITs, which hold about one-fifth of all institutional-grade commercial real estate in the country, are highly transparent and report their quarterly earnings and operating performance to investors and in detailed filings with the SEC. REITs hold properties in the traditional sectors that dominate private portfolios, including retail, office and apartment, as well as newer sectors that support the digital economy but have little presence in private portfolios, like data centers, cell towers and logistics facilities. Earnings performance of REITs, as summarized in the Nareit T-Tracker can yield insights into the property markets overall, including private real estate (full disclosure: I work at Nareit and designed and created the T-Tracker, a quarterly summary of earnings and operating performance for the entire listed REIT sector).
The pandemic had quite different repercussions across the various property sectors within the commercial real estate universe. One can divide the REIT sectors into three broad categories according to the impact of the pandemic:
Earnings began to recover across all three of these categories as the economy began to reopen in the second half of 2020. The pickup was tentative in the retail and lodging/resort area, where a reopening of shops and malls contributed to a modest pickup in retail FFO, and a partial recovery of business and personal travel cut in half the losses in the lodging/resort sector. Together, earnings of these sectors recovered just one-quarter of the declines suffered in the first half of 2020.
Digital economy real estate sectors saw earnings surge during the second half of last year, with FFO in the fourth quarter 25% above its second-quarter level.
Perhaps most important for the outlook for commercial real estate, however, is the recovery among the broader group of other property sectors. FFO in this category rose $780 million from the second quarter through to the fourth quarter, recovering fully half of the decline that occurred during the shutdowns.
A recovery in REIT earnings was well underway in the second half of 2020.
These gains occurred while large parts of the economy remained well below capacity. Vaccine distribution is ramping up to more than 2 million doses per day, and health officials project that by the end of May, every adult in the country will have access to the vaccine. It is highly likely that by the second half of this year many types of activity, including shopping, travel, restaurants and entertainment, will be recovered more fully and perhaps even approaching pre-crisis levels. This will likely fuel a further recovery in real estate and REIT earnings, especially among the hardest-hit property sectors.
There are concerns, however, that it may take a long time to get back to normal, if we ever do. This is especially true in the retail property sector and the office sector.
The pandemic accelerated a long-term structural shift from bricks & mortar retail to e-commerce and online shopping. The e-commerce share of retail sales surged from 21% of total sales excluding food service, autos and gasoline at the end of 2019, to 26% in the second quarter of 2020. The e-commerce share has subsequently retreated a bit as stores have opened up again and bricks & mortar sales rebounded, but e-commerce is likely to remain on a higher long-term path.
E-commerce will continue to reshape the retail landscape, but bricks & mortar stores will still play an important role. There may be further expansion of hybrid models that combine both the physical and online platforms, including shop online/pick-up in store, visit store showroom but purchase online, and the newest addition, buy online with curbside pick-up. Malls and shopping centers are also likely to continue to emphasize experiences once the pandemic under control.
Office markets have undergone one of the most visible structural shifts, with Zoom meetings facilitating work from home (WFH). The big questions in office markets are how many workers will return to the office, for how many days a week, and how much space will they use?
1350 Avenue of the Americas, New York City.
It is too soon to tell what the office of the future will look like. It seems clear that WFH is here to stay, but the office is here to stay as well. Surveys report that a majority of employers expect most of their workforce to be physically present by the end of the year, and most employees are ready to return as well. Flexibility will be key, with some essential tasks and group projects held in the office, but others performed on days an employee works from home. WFH may have a long-term shift in demand from expensive downtown areas of big cities to the suburbs and smaller cities where real estate is less expensive and commutes are shorter.
I am Senior Economist and Senior Vice President for Research & Economic Analysis at Nareit, the worldwide representative voice for REITs. I follow stock returns and