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The Lasting Impacts of COVID-19 on Real Estate – Part 2

March 10, 2021

This article is a continuation of last month’s look at residential and office trends.

Retail: E-commerce has rocketed but will not replace bricks and mortar.

For the retail sector, the story has been one of uneven impacts and recovery, with impacts to date and future prospects highly dependent on retail category and physical location. The headline impact for the sector has no doubt been the unprecedented spike in ecommerce, a rapid acceleration of a trend that had been steadily gaining steam for decades. Overall, year-over-year spending is up 5.8% as of January 2021, buoyed in part by government stimulus checks, and non-store retail (i.e. ecommerce) is up 22.1% over the same period. Other categories exhibiting notable increases in sales include sporting goods, hobby, and book stores; building material and garden dealers; and grocery stores. Meanwhile, restaurant spending is still down nearly 16% from a year ago, and sales at clothing and accessories stores and electronics and appliance stores are also below pre-COVID levels.[i]

The retail industry has continued to transform quickly as a result of COVID, including the rapid acceleration of trends that were already taking shape. Retailers have continued to adopt in-store fulfillment of online orders (2 out of 3, as reported in a recent survey). The survey also found that 73% of small retailers implemented a “click-and-collect option.”[ii]

Shopping centers and malls have continued to struggle. In Q4 2020, U.S. shopping center net absorption was negative 2.7 million square feet. Throughout 2020 there was a loss of 26 million square feet of occupied space, the largest annual decline in occupancy ever recorded.[iii] Several retailers continued to speed or expand plans to close stores.

Prime high streets and shopping centers are expected see a gradual return of customers, with pent-up demand driving sales. Bricks-and-mortar retail will continue to dominate overall sales, but hybrid models will continue to grow. Ecommerce spending as a share of total retail spending will settle at “new normal” levels, sliding slightly from 14.0% in Q4 2020 (seasonally adjusted), which was up from a pre-pandemic 11.8% in Q1 but below its all-time peak of 16.1% in Q2.

Economic conditions will continue to cull weak retailers. Bankruptcies hit high levels in 2020 as traffic to stores plummeted. Quality, well-located retail space will continue to attract tenants while suboptimal space will languish and be repurposed for other uses as the nation’s outsized retail footprint realigns itself with modern shopping preferences.

Retailers want to be where the customers are, and given shifts to suburban/rural living and remote work, there is some expectation that retailers may adjust their locations accordingly. The surbanTM model—defined as “a suburban area that has the feel of urban, with walkability to great retail from a house or apartment”—will increasingly be in demand by those who have traded the city for the suburbs but still want easy access to amenities within walking distance. [iv] Moreover, a permanent reduction in office worker presence in traditional employment centers (both urban and suburban) means reduced demand for retail amenities in these locations as well.

Lodging: Pandemic-friendly destinations thrive but most hotels expect a long rebound.

Examined at the national level, tourism plummeted in 2020, with US tourism industry revenues declining by more than a third and domestic trips by US residents falling by more than half in 2020.[v] Lockdowns, restrictions on travel, and a desire to minimize any unnecessary human contact among many consumers have all contributed to this trend.

As a result, hotels and motels have seen historic lows in occupancy levels. In Q2 2020, occupancy and RevPAR (revenue per available room) fell to levels not seen since the Great Depression of the 1930s. Some operators have used the past year to make renovations to properties, aided by low financing costs, while others have been forced to close either temporarily or permanently.

Upscale properties have generally performed worse than midscale and economy properties due to their dependence on business and group travel.[vi] Business travel will recover to some degree, but may be permanently reduced compared to pre-COVID levels as videoconferencing becomes a more accepted alternative in certain industries.

As with other sectors, lodging demand has been uneven geographically. Visitor destinations boasting outdoor recreation opportunities—especially those within a manageable drive of population centers—have seen only modest decreases in visitation and in some cases increases. The reduced ability to travel either internationally or domestically to locations typically reached by plane means travelers have substituted nearby drivable alternatives that they may not have otherwise considered. Mountains and beaches proved popular last year.

Travel will slowly ramp up again as vaccines are rolled out, consumer confidence rises, and unemployment declines. Domestic trips will recover first, followed by international travel. Therefore, US destinations reliant on a foreign visitor base could rebound more slowly. Full recovery in occupancy rates may not be achieved until 2024 or 2025.

Industrial: Logistics and distribution breaks records as COVID accelerates demand.

Industrial real estate continues to be the bright spot across commercial sectors, fueled by growing demand for logistics and distribution space from both ecommerce as well as other industries. The 22.1% increase in ecommerce consumer sales in 2020 compared to 2019 has translated into seemingly insatiable demand for fulfillment space. National leasing activity across the industrial sector leapt 26.9% in 2020, lease rates have risen, and net absorption reached record highs in Q4.[vii]

The pipeline of new construction is also incredibly robust, with record-breaking inventory expected to be delivered in Q1 2021. A healthy share of this inventory is already pre-leased. Beyond e-commerce, other drivers of demand include other users of general logistics and distribution space, 3PL (third-party logistics) tenants, food and beverage warehousing (cold storage in particular), traditional retailers, and construction materials and building fixture distributors.

The seemingly economy-wide growth in demand for warehouse and distribution space is driven by the shift among many industrial sectors in the way that supply chains and inventory are managed. Many firms have shifted from a “just-in-time” inventory strategy to a “just-in-case” strategy. COVID-19 has exposed the risk of “just-in-time,” which can leave companies without enough inventory during circumstances when supply is interrupted. “Just-in-case” means higher inventory carrying costs, and therefore higher industrial real estate demand, but builds resiliency into the system.

Warehousing and distribution facilities of all sizes are in demand, depending on market size and proximity to consumer bases. Demand is strong at both ends of the spectrum: 1-million-square-foot-plus mega distribution centers, as well as local and hyper-local “last mile” facilities that are highly size-constrained due to their need to be in dense, urban environments.[viii]

With the supply of sizable, well-located sites for distribution limited, the repurposing of existing underutilized commercial properties is becoming more common. In particular, vacant or near-vacant shopping malls and strip retail centers have been successfully reincarnated as warehouse space. Since they are often large sites with excellent highway access and proximity to consumers, they are well suited for a second life as ecommerce fulfillment centers. Local land use regulations and entitlement processes can be hurdles to such plans, and communities are weighing the pros and cons of allowing such developments. While distribution centers bring truck traffic and do not contribute much aesthetically, they may be preferable to neglected retail sites with few other development prospects.