With U.S. offices, retail shops and hotels still largely shuttered due to the Covid-19 pandemic, we would have expected commercial real estate (CRE) to be in deep distress. Yet, by most measures, CRE has been resilient, thanks in part to policies by the Fed and the U.S. Treasury. The NCREIF Property Index (NPI), which measures unleveraged return for primarily “core” real estate held by U.S. institutional investors, declined just 1.0% in Q2 2020 and recovered lost ground by the end of the year. Concern about inflation has also contributed to investor interest in real estate, due to its traditional role as a hedge against rising prices. (To learn more about the return drivers for each property type, please read “The Outlook for the Private Commercial Real Estate Market is Positive.”)
Not All Sectors Are Equal
Looking beyond aggregate CRE returns, it is clear that some segments have fared far better than others, and going forward, secular trends – the growth of e-commerce, potential changes in consumer behavior, deurbanization or work-from-home (WFH) – will benefit certain sectors while challenging others.
• Alternative Sectors
Industrial properties were the best performing CRE sector during the Covid-19 crisis, gaining 14% year-over-year (YoY). The growth of e-commerce should continue to drive demand for warehouse space in the near-term.
Multifamily housing has historically been a defensive sector and has held up well, gaining 3% YoY. The pandemic boosted the appeal of suburbs over the urban centers, and favorable supply dynamics suggests that the most attractive opportunities over the next three to four years will be in suburban markets.
Specialty real estate sectors, such as life sciences, health care facilities, senior housing, and self-storage, are also attractive, due to their countercyclical nature, relatively high yields, lower turnover.
Hotels were hurt the most by Covid-19. The NCREIF Hotel index has fallen nearly 27% since the beginning of 2020 as both leisure and business travel dropped.
Similarly, the retail sector has continued to struggle, losing nearly 8% since Q4 2019. Lockdowns and social distancing accelerated the decline of many traditional malls. However, in-store shopping still accounted for 80% of retail sales at the end of 2020, and high-quality retail centers anchored by grocery and entertainment offerings should do well.
Office, the biggest CRE sector, has weathered the pandemic fairly well, with the NCREIF Office index up 3% YoY. But the impact of WFH may take longer to be realized as companies try to find the right balance between in-person and remote work.
What About Inflation?
Inflation forecasts may also be contributing to real estate’s attractiveness. The consumer price index (CPI) rose 4.2% YoY in April — the highest since September 2008. Historically, real estate returns have been positively correlated with rising CPI as property income also increase.
Changes to consumer behavior as a result of the pandemic will continue to impact property types going forward. iCapital remains constructive on the real estate sector although investors will need to be selective. The combination of stable income and potential value appreciation give real estate bond-like characteristics with potential for equity upside and an inflation protection boost.
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