Analyzing Real Estate Trends in a Post-COVID World
The value of real estate has historically been driven by the collective actions made by individuals in response to societal trends. Going back all the way to industrialization, migration to cities by workers from farms in search of higher paying blue-collars jobs, led to one of the first waves of real estate wealth creation in large cities. This was disrupted by a flight to the suburbs, that became mainstream post-World War II during a pick-up in household formation, widespread ownership of the automobile, and government assistance in the form of the GI Bill. The result was a significant increase in the value of housing and massive investment in other forms of real estate such as office and retail space, that came at the expense of the urban core. At one-point, regional shopping malls were the most coveted assets, which is ironic considering they are the least desired real estate assets today. Following a flight to the suburbs and the emergence of an economy that revolved around industrial production, globalization again turned the market on its head, as jobs went overseas, and the service sector replaced manufacturing. This led to economic activity going back to being concentrated in the urban core and the emergence of downtown office buildings as one of the most coveted assets, which again ironically is not the place to be today in the age of work from home.
At present there are again strong undercurrents driving the performance of real estate, many of which existed already and accelerated following the COVID-19 global health crisis. The biggest winner thus far has been industrial, which had already been seeing a renaissance prior to COVID-19 as supply struggled to keep up with demand. Online retailers like Amazon now need to lease distribution and logistics centers that are close to the consumer to be able to guarantee shorter delivery times as well as cut supply chain costs. To put some numbers into perspective, according to CBRE, roughly 1.25 million sq. ft of additional real estate is required for every incremental $1 billion in e-commerce revenue. The trend has much more room to run as e-commerce still only represents 16% of retail sales as of last year, up from 6% a decade ago. Where industrial real estate has gained ground, retail has given it up, with a significant spike in delinquent rents and vacancy being seen for second-tier locations.
Although COVID-19 has disrupted economies around the globe, the disruption has not had a significant impact on the housing market thus far, aside from the margins of several highly priced metros such as New York City and San Francisco. Historically, housing has been a popular investment among investors, with the value of real estate located in urban cores having trended steeply upwards over the last decade. In Canada, the entrance of the novel Coronavirus led only to a hiccup in the market where activity quickly rebounded in July, with record breaking transactions in certain regions of Canada. A side-effect has been a growing affordability crisis that forced Canadians into the rental market, which has also seen an exponential climb for the last decade. As of January 2020, rental prices in Canada had grown by 4.3% (Rentals.ca, December 2019 report) annually for the last 10 years.
With the arrival of COVID-19, the real estate market has been introduced to a great deal of uncertainty. New social distancing rules led to a new work from home regime, the implications of which have likely yet to be realized. Amid the pandemic, a vast majority of workers were required to shift from working in their cubicles to setting up workstations remotely. Businesses quickly noticed that working from home did not decrease productivity or efficiency. Most companies began to extend their timeline for returning to the office, delaying the return to previous working environments. Downtown office buildings which were once considered prized assets with yields close to that of government bonds are now facing significant pressure from lack of incremental demand. Few tenants are looking to increase their office space with many looking to downsize. In addition, the flexibility of working from home led many workers to re-evaluate their lifestyle choices and changed the utility of many forms of real estate dramatically. The satisfaction of living in small spaces within expensive metros diminished quickly and we began to see a new trend of individuals taking advantage of the flexibility from working remotely and low borrowing cost to relocate to rural areas where prices are not as high. The trend is being seen locally in Canada with rental inventory surging over (+82%) within Toronto in July. In addition, home sales rose (+26%) month-over-month leading to more homes being sold in Canada during July than any other month in the past 40 years! It is safe to say that having over 35 million individuals confined in their homes has caused some cabin fever with most people wanting more space.
In conclusion, societal trends are highly relevant to investing in real estate especially during times of “unprecedented” change. Whether we see another flight to the suburbs or countryside on the same scale as the post-World War II period has yet to be determined, although it’s clear that the pandemic has shifted society’s perception of what is valuable. The ability to work from home could be one of the biggest game changers for individuals and families in decades and could create attractive opportunities for investors. Moreover, there has been an acceleration of trends like e-commerce and an expansion in industrial real estate that is being felt today. Historically investing in trends has led to significant wealth creation, for those who were there before the end.
Author: Dennis Ly