SHOULD I INVEST IN RETAIL COMMERCIAL SPACE AFTER COROVANIRUS?
While the world has experienced a fair amount of upheaval during the last year due to COVID-19, and life has seemingly been put on hold, people are once again starting to look towards the future with their investment portfolios. Commercial real estate (CRE) was one of the hardest-hit industries, leaving lingering uncertainty around how the industry will move forward.
However, when some investors hesitate to move forward with a particular asset class, those who can take a more long-term approach to their portfolio gain an opportunity. Investment groups responsible for growing other people’s money have been tasked with becoming quick and proactive in an ever-changing CRE climate, ultimately uncovering some seemingly pandemic and recession-proof property types that have continued to grow while others have seen major losses across the board.
Furthermore, new technologies are being developed to allow new routes for investors to gain access to CRE. A few companies, like Liberty Real Estate Fund, lead the way in what is sure to be the future of real estate investing — blockchain-backed tokenization that allows investors more flexibility and liquidity in an otherwise illiquid asset class.
How COVID-19 Has Affected Commercial Real Estate
Headlines have highlighted a dire situation for commercial real estate and the effects the pandemic has had on tenants, landlords, the banks holding mortgages and all the ancillary businesses that service CRE (property management, facilities management, etc.). Have the negative effects reached the entire CRE industry? What have been the main contributing factors?
There are seven conventional property types of commercial real estate — retail, office, industrial, multifamily, land, hospitality and mixed-use. Let’s walk through how COVID-19 has impacted each:
- Retail, Hospitality and Mixed-Use – When shelter in place rules were imposed across the country to try to slow the spread, people stayed home instead of visiting restaurants, bars and shopping centers they would typically go to. The travel bans also limited the number of people staying in hotels and resorts. This reduction in foot traffic led to a reduction in revenue, ultimately making it difficult/impossible for tenants to continue paying rent. Some smaller tenants were forced to default on their leases and landlords were stuck holding all the liability for holding costs associated with the real estate.
- Office – Pre-pandemic, companies were experiencing record levels of growth, hiring more workers to meet the rising demand for their products and services. As employment rose, companies continued to take on larger office spaces to accommodate for more workers. Emphasis rose on all employees working from the same location with hesitancy toward incorporating work-from-home policies that allow more flexible work schedules. But as COVID spread, one way companies adapted was by allowing employees to work remotely. In the process, some companies realized increased productivity from employees and are now reconsidering the need for large offices. Some companies will downsize while others may eliminate their office spaces altogether.
- Industrial – Early on, warehouse production slowed down while the world adapted to new policies and procedures to provide safe working environments. After the initial slowdown, warehouse output seemed to ramp back up and even exceed what it was pre-COVID.
- Multifamily – With one of the harder-hit areas of CRE, landlords saw dramatic increases in late payments and lease defaults from people being laid off and having to make decisions about what bills they could pay. Eviction moratoriums were imposed in some places, reducing recourses that landlords had to backfill their properties with tenants who had the ability to pay.
- Land – Progress on development projects that began before COVID seemingly continued but land sales and projects in the midst of negotiation and planning seemed to slow down. Now that we are getting back to a sense of normalcy, developers are announcing new projects—though new development projects may continue to be slow as we see how life will change post-pandemic.
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Commercial Real Estate Investing
The barriers to entry and associated risks for investing in commercial real estate have deterred many investors who may have opted for safer and more attainable real estate investments, like flipping houses and owning single-family rentals.
Liberty Real Estate Fund is actively working to change the way people invest in CRE, introducing digital tokens backed by blockchain technology for investment shares. Instead of buying into a highly illiquid asset—as traditionally happens in CRE—investors buy security tokens, which are digital symbols of ownership. Each token represents a fractional ownership interest that the owner can further trade, sell or divide for its relative value. This allows investors access to high-quality investments that previously would have been accessible only to accredited investors, and gives them flexibility to structure their portfolios how they see fit.
Reasons You Should Invest
Historically, CRE investments have provided reliable and consistent returns, bolstering investor portfolios and supporting many private equity firms and hedge funds. Many individuals have remained hesitant to invest in CRE, as opposed to other real estate investments, because of high upfront capital requirements and risk related to vacancy, market conditions, liquidity and leverage. But, there are many reasons CRE is a great investment:
- Competition – Demand for purchasing CRE is lower than the demand for other real estate classes. For example, the demand for single-family residential property is much higher than the demand for a neighborhood retail center. Lower demand may mean more opportunity to discover great deals when looking at CRE properties.
- High Return Potential – While the cost of ownership may be higher than other asset classes, the potential earnings from a CRE investment can be substantially higher. Rental rates on commercial properties are higher compared to residential properties, have more tenants in one building (aside from multi-family) and place more responsibility on the tenant.
For instance, a Single-Tenant Net-Lease (STNL) building is a stand-alone building in a prominent location with high visibility. A location like this—ideally rented to a creditworthy company with high brand recognition—would yield a prime rental rate and have a lease term typically at least 5 years with built-in renewal options.
The company leasing the property will also be responsible for rent, property taxes, property insurance and maintenance. The owner of the building would receive truly passive income while having minimal management responsibilities for the building. An investment in a neighborhood retail center would have a similar outcome but with multiple tenants instead of one.
- Less turnover and fewer problem tenants – As mentioned above, lease terms for commercial properties are usually longer than for residential properties. One reason is because businesses often make a substantial investment to create a space that fits their needs. Before they leave a space, they want to see their investment realized to its full capacity so they don’t leave any money on the table.
Even after the initial lease term expires, it is common for tenants to renegotiate their contract to stay in the same location. Thus, there are fewer problematic tenants since this is their place of business where they’ve worked hard to create an environment that consumers want to visit.
Types of Real Estate to Invest In
As commercial real estate continues to heal in the coming months and years, we can use what we learned through COVID-19 to build a portfolio meant to withstand the cyclical nature of CRE. While we have seen some property types struggle to stabilize from the events of the last year, others have proven their stability.
- Neighborhood Retail – Unlike shopping centers that rely on big-box retailers as anchor tenants, neighborhood retail generally comprises smaller strip centers and stand-alone building with individual suites between 5,000 SF and 15,000 SF. These centers serve to support the surrounding communities and often include a variety of businesses, not just retail. Professional services, restaurants and dentist/doctor’s offices are common tenant types in neighborhood retail.
These smaller strip centers include businesses that provide for the needs of the surrounding communities, keeping the mix of tenants more resilient and recession-proof than larger developments and properties with tenants who cater to the wants (rather than needs) of the community. Demand for neighborhood retail should remain steady over time, even with higher buy-in to online retail.
Neighborhood retail investments are also typically Triple Net (NNN) properties where the tenant pays rent plus property taxes, maintenance and property insurance. A system like provides minimal management responsibilities for investors and places the burden on the tenant of the property, significantly reducing the hassle and cost of ownership.
- Last-Mile Warehousing – Certainly not new to the industrial real estate world, the demand for last-mile warehousing has continued to rise during the last several years, including during the pandemic. Demand will likely continue to increase as consumers have grown accustomed to finding anything they need or want online with the ability to have it delivered to their doorstep within days, and sometimes hours. Last-mile warehouses play an essential role in company logistics and supply chain systems; they are the last place a package goes before it is delivered.
If a retailer can’t fulfill online orders, consumers will find another retailer who can. Whether a company adapts to the change in demand, companies will require last-mile warehouses if they choose to operate as a direct-to-consumer business without the need to have an in-person store.
These warehouses are typically centrally located within a city to allow quick delivery once a package has left the facility. Like neighborhood retail, tenants in last-mile warehouses most often sign NNN leases, placing the responsibility of rent, property tax, property insurance and maintenance on the them rather than the building owner. As demand for this type of space also increases, rental rates are likely to increase.
- Micro-Apartment Buildings – Affordable housing, especially in larger cities, can be challenging to find and renters are forced to compromise on location, amenities or quality to find an affordable apartment. Micro-apartment buildings are satisfying the affordable-housing problem and allowing investors stable returns. Micro-apartments are often loft-style apartments generally between 200 SF and 400 SF, designed with younger singles in mind.
To make up for the small apartment size, micro-apartment buildings offer amenities that encourage community between tenants. From an investor’s perspective, micro-apartments keep per-square-foot prices high during development, while maintaining a more affordable option for renters by keeping rental rates low.
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In today’s climate, it is understandable to approach investments with caution. We have experienced unforeseen changes throughout the economy, some that may have lasting effects on how people interact with each other and how they conduct business. However, we have learned invaluable lessons about the resiliency of people and our ability to adapt to the world as it changes around us.
The need for specific types of commercial real estate and the assets we invest in moving forward may look different, but commercial real estate still offers a proven and stable investment. Looking at neighborhood retail, the last-mile warehouses and micro-apartment buildings could provide your portfolio with the returns you are looking for.