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Federal stimulus programs helped buffet commercial real estate from the economic fallout of the COVID-19 pandemic. But the prospects of some real estate sectors are better than others.

More than a year into the COVID-19 pandemic, with offices, retail shops and hotels still largely shuttered across many parts of the U.S., we would have expected commercial real estate (CRE) to be in a state of deep distress. Yet, by most yardsticks (prices, cap rates, delinquencies, etc.) the CRE market has been remarkably resilient, thanks to assertive measures taken by the Fed and the U.S. Treasury to support the economy but also due to the asst class’ relatively strong position going into the crisis. Consider that while the United States experienced one of its worst quarters of economic output in Q2 2020 – with GDP shrinking by 31.4% on an annualized basis – the NCREIF Property Index (NPI), declined by just 1.0% and had fully recovered lost ground by the end of the year. (The NPI measures unleveraged return for primarily “core” real estate held by institutional investors in the United States) By comparison, during the Great Financial Crisis, the NPI fell almost 24%, peak-to-trough, between Q2 2008 and Q2 2009, and took two years to return to recover. Worries about inflation have also aided real estate’s rebound. Real estate is positively correlated to inflation as long-term leases usually have built-in inflation escalators. As a result, commercial property values tend to rise during such periods.

ncreif-property-index-annualizedNot All Sectors Are Equal

Yet, looking beyond aggregate CRE returns, it is clear that some segments have fared far better than others. Going forward, both secular trends, such as the growth of e-commerce, and potential changes in consumer behavior – deurbanization; and work-from-home (WFH) – attributable to COVID-19, will benefit certain sectors while challenging others.

Winning Sectors

  • Industrials/logistics
  • Multifamily
  • Alternative sectors

Industrial properties were the best performing CRE sector during the COVID-19 crisis, gaining 14% year-over-year (YoY), driven by accelerating e-commerce demand. In fact, nearly all of the overall positive NPI returns over the last 12 months can be attributed to the strength of the industrials sector, which makes up 23% of the NPI by market value. Industrial assets are properties where goods are made, stored and/or shipped. They include bulk distribution warehouses, manufacturing warehouses, etc.

Demand for warehouse space in the near-term will continue to be driven by the growth of e-commerce. According to management consultant McKinsey & Company, mass retailer’s online sales were 93% higher in 2020 than in 2019, and the firm’s consumer-sentiment surveys forecasts strong intent by consumers to continue online shopping after the pandemic subsides.1 This trend is likely to continue to drive the need for warehouse space, especially for properties located near major urban centers, solving “last mile” distribution challenges.

Multifamily housing has historically been a defensive sector and once again has held up well through the current crisis, gaining 3% YoY. According to Freddie Mac, a buyer of mortgages in the secondary market, rents and vacancy rates last year were, in aggregate, only modestly lower, compared with 2019 levels. Class A properties experienced YoY declines in rents, while Class B and C properties realized marginal gains.

At the same time, the pandemic boosted the appeal of suburbs over many urban centers. Lower costs, the ability to work remotely, and desire for greater space led a high proportion of Central Business Districts (CBD) renters to migrate to less dense suburban markets, particularly from expensive gateway markets, such as New York, San Francisco, and Los Angeles. Most of the markets posting the biggest rent declines in 2020 were CBD, while many suburban areas experienced YoY rent increases.

Whether young professionals will continue to trade city life for bigger living options once the economy fully reopens remains to be seen, but shifting demographics, work-place flexibility, and favorable supply dynamics suggest that the most attractive multifamily opportunities over the next three to four years will be in suburban markets.

Alternative sectors continue to be another bright spot. These are specialty real estate sectors, such as life sciences, healthcare facilities, senior housing, and self-storage. They have attracted growing investor interest due to their counter cyclical nature, relatively high yields, and lower turnover. Furthermore, these property types tend to be fragmented which can help limit competition. COVID-19 has provided a boost to the life sciences industry, due to growing demand for R&D labs and biomanufacturing facilities. The pandemic has also increased the demand for medical offices and health-care facilities as substitutes to hospitals for minor surgeries and elective procedures. While COVID-19 negatively impacted the senior housing market, aging demographics should continue to drive demand for senior housing and care over the medium to long-term.

Losing Sectors

  • Hotels
  • Retail
  • Office

Among real estate sectors, hotels, not surprisingly, were hurt the most by COVID-19. The NCREIF Hotel index has fallen by nearly 27% since the beginning of 2020 as both leisure and business travel dried up. The sector continued to struggle into 1Q 2021, losing an additional 1.6%. Pre-pandemic, the average hotel occupancy rate is close to 70%. During Q2 2020, it was closer to 30%. High-end chains and convention hotels that rely heavily on business travelers were the hardest hit, and the outlook for the sectors remains challenging. Economy and midscale chains are poised to recover faster, but U.S. hotels are not expected to see a full recovery before 2024, according to research firm STR and Tourism Economics forecasts.2

Retail is another property sector that is struggling, losing 6% YoY and nearly 8% since Q4 2019. A number of iconic retailers filed for bankruptcy in 2020, including Ascena Retail, Brook Brothers, J.C. Penny, J. Crew, Lord & Taylor, and Neiman Marcus. Retailers were already facing significant challenges (falling foot traffic and rents; oversupply of retail space) before the onset of COVID-19. Lockdowns and social distancing have simply accelerated the decline of many traditional malls. However, this is not the end of brick-and-mortar stores. In-store shopping still accounted for 80% of retail sales at the end of 2020,3 and high-quality retail centers anchored by grocery and entertainment offerings should do well as we believe people will continue to seek places to come together as a community. Investors will have to be selective before investing in retail and adjust their growth assumptions given the long-term challenges of the sector.

Office, one of the biggest CRE sectors, has perhaps the most post-COVID ambiguity. The sector has, for the most part, 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 across industries try to find the right balance between in-person and remote work. Still, there is optimism that even with a larger proportion of the workforce shifting to WFH, overall demand for office space may not be dramatically impacted as tenants consider new layouts that require greater square footage per employee.

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 CPI as property incomes also increase. Sectors with shorter-term leases, like multifamily housing, student housing and self-storage, should benefit the most. Office and other property types with longer-term leases will usually have rent increases tied to inflation. However, tenants may have greater bargaining power this time around, due to higher vacancies and other pressures on rent.

Lastly, rising inflation supports appreciation in the value of real estate properties. Construction and labor costs tend to rise during inflationary periods, leading to an increase in values of new and existing properties. According to Freddie Mac, the supply of single-family homes in the U.S. is 4 million less than the calculated demand,4 providing additional boost to real estate values.

ncreif-npi-vs-consumer-indexAs the U.S. economy begins to reopen, there remains a good deal of uncertainty, including 8 million fewer jobs today than before the pandemic started.5 Moreover, changes in both consumer and business behavior as a result of the pandemic will continue to impact CRE going forward. However, iCapital remains constructive on the asset class as prices and deal volumes rebound. With more than $300 billion of dry powder at the end of Q3 2020,6 nearly 60% more than in 2009, real estate funds have significant capital to deploy. But not all CRE opportunities are equal, and investors will need to be selective about the sectors and property types on which they focus. Real estate’s combination of stable income and appreciation potential provide bond-like characteristics with the potential for equity upside and inflation protection to boost.

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(1) Chapple, L et al., “High growth, low profit: The e-commerce dilemma for CPG companies.” McKinsey & Company Insights, March 22, 2021.
(2) Airoldi, D. “STR, Tourism Economics Upgrade 2021 U.S. Hotel Forecast.”, May 11, 2021.
(3) Ali, F. “A decade in review: E-commerce sales vs retail sales 2007-2020.”, January 29, 2021.
(4) Friedman, N. “U.S. Housing Market Is Nearly 4 Million Homes Short of Buyer Demand.”, April 15, 2021.
(5) Cohen, Patricia. “Job Growth Slowed in April, Muddling Expectations.”, May 7, 2021.
(6) “Q1 2021 “Private Fund Strategies Report.”, May 18, 2021.


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Shan Hasnat

Shan Hasnat

Shan is a Senior Vice President on the Research & Education Team, focused on private markets. Prior to joining iCapital in 2020, he was a Vice President and Senior Investment Analyst with Voya Investment Management, where he co-managed the alternatives portfolio for Voya’s insurance business. Previously, Shan spent eight years at Bank of America Merrill Lynch. He received an MA in International Economics from Brandies University.