There Is Light At The End Of The Tunnel For Commercial Real Estate

As recently as the 1980s, commercial real estate (CRE) ownership was dominated by private investors. In general, CRE was highly cyclical due to generally highly leveraged assets and highly fragmented private ownership, which created a serious lack of market knowledge and transparency, which also meant lower liquidity.

In the early 1990s, CRE entered the “Modern REIT Era.” When credit dried up in the late 80s following the S&L Crisis, private CRE companies were essentially forced to go public in search of capital, with most being structured as REITs. In the 2000s, the REITs entered the financial indices. For institutional investors who measure themselves against industry benchmarks, this now made CRE almost a required investment, which led to the rise of permanent capital in the CRE space. This evolution, primarily driven by institutional investors, greatly increased financial transparency and market knowledge.

From the early 2000s to the mid-2010s, there were not as many pronounced structural changes in the industry. As crazy as it sounds, it was only a few years ago when real estate became a separate asset class on the Global Industry Classification Standard (GICS) and the S&P 500. Up until 2016, real estate was lumped in with the Financials Sector. 

A decade of economic expansion and a strong job market boosted the $16 trillion commercial real estate market where CRE prices and equity markets, transaction volume, and mortgage originations all saw positive growth. With the onset of the COVID-19 outbreak in Q1 2020, the CRE markets froze and remained in a state of uncertainty into the summer. 

The Impact of COVID-19 on Commercial Real Estate

Stay-at-home orders, social distancing requirements, and businesses being forced to close doors have put a heavy strain on CRE landlords and their tenants. CRE investments are typically long-term holds, but landlords who lost their occupancy due to the pandemic realized that their tenants may not be returning in the next several months, if at all. After a downturn in the market, what does this mean for the future of CRE?

The U.S. Bureau of Economic Analysis released a study in July 2019 which estimated that the finance, insurance, and real estate markets make up the biggest chunk of the U.S. GDP, holding slightly over 20%. 

In real estate, the largest segment includes office buildings, multifamily housing, hotels, and retail (which includes dining) — all of which suffered throughout the pandemic. However, industrial properties, data centers, and technology-supporting properties have been thriving.

Furthermore, a significant portion of CRE is held in income-driven investments such as large investor funds, real estate investment trusts (REITs), Delaware statutory trusts (DSTs), and other passive investment vehicles. Some investors who invested in brick-and-mortar retailers, office space, and hotels suffered due to business disruptions caused by COVID-19 over the past year.

The Future of CRE Investments

With the rollout of the COVID-19 vaccinations, we believe there’s a light at the end of the tunnel for those who wish to invest in or hold investments in CRE, and the trends are starting to follow suit. According to the Mortgage Bankers Association, commercial and multifamily mortgage bankers are expected to close $486 billion of loans in 2021, an 11% increase from 2020. While the 2021 projection still falls below the record high of over $600 billion in 2019, the volume of investments is expected to increase through at least 2022, when the projection for lending volume will increase to $539 billion.

As CRE allocations increase in the institutional world, we believe it becomes more and more of a “mainstream” investment as individual investors tend to follow the institutional leads. Our experience is that investment advisors will increasingly allocate a portion of an individual’s investment portfolio to both public and private CRE, which we believe creates the need for investment diversification and analysis of how specific real estate investments interact with each other and the investor’s overall portfolio holdings. 

While the last year has been anything but expected for CRE, investment volume is expected to rebound in 2021 and on as investors discover new uses for existing CRE holdings. Similar to REIT benchmarking in the early 2000s, with the shift as a now-official asset class, we believe CRE will continue to be considered a more mainstream investment vehicle. 

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to the accuracy, does not purport to be complete, and is not intended to be used as a primary basis for investment decisions.

There is no guarantee that the investment objective of any particular program will be achieved. All real estate investments have the potential to lose value during the life of the investment. 

This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events or guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. 

The actual amount and timing of distributions paid by programs are not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return on their capital.