On the real estate horizon
Something has changed for everyone in the past 12 months. “Business as usual” was no longer applicable, and when the shock subsided last summer, the question began to intrude into conversation. At awkwardly detached gatherings muffled by two-layer masks, or from the person sitting on our laptop in Hollywood Square at the fifth Zoom meeting of the day, we all heard, “How does your company manage this mess overcome?”
Real estate professionals get more than our share of such cocktail party questions simply because people are interested in what they see and they see real estate all the time. Fortunately, our pandemic response to “the question” was an honest “surprisingly good” one.
But what about all the empty parking lots, failing malls, and restaurants asking us to buy another foam-filled roadside meal that’s cold before we can eat it? How can real estate do well when the businesses that rent buildings are completely disrupted?
First a qualifier: The full answer should be more spirited “surprisingly good for the time being”. We do not know what lies ahead and there is reason to be careful. Some paradigm shifts that were in pre-pandemic childhood but grew practically overnight to puberty in 2020 are undeniably ongoing. More and more people are working from home and shopping on their computers. Exacerbated by the virus in particular, the potential impact of these two trends on demand for office and retail space alone is evident. Ignoring it would be a serious mistake.
On the brighter side, several factors contribute to the surprising relative health I see in commercial real estate. First, this is Arkansas. Every location or state has strengths and weaknesses, and I believe Arkansas is less at risk from changes in office space than the major metropolitan areas. An important trend is the increasing discomfort with densely populated towers with overcrowded elevators and park structures. If renters look for buildings that are more accessible and have less forced interactions with strangers, Arkansas will benefit over time. We have fewer “tower” features to worry about, and we have the land and development patterns available that are best suited for building more accessible structures. Look for accelerated migration from corporate users to low-rise solutions in states like Arkansas.
Jeff Hathaway, President and CEO of the Hathaway Group.
Second, working efficiently is collaborative, and physical proximity enhances collaboration. For every announcement of how wonderful teleworking has been for a company, there is a corresponding executive comment on a new signing in group work environments outside of residential areas. Our experience has shown that office users, whether a medium-sized law firm moving from the city center to a suburban building, or a large financial services company extending a large lease, are currently not interested in giving up their space. Even if they are not sure when or how often they will use the space, they want to have it available and can afford it. The balanced reality is that teleworking has increased and is not disappearing, but neither is traditional office space – the only question is the mix. Judging from the deals and discussions in the trenches, I’m confident that office space is a solid asset class.
We are also seeing interesting trends in other building types. Apartment building has been sizzling for years. While values may cool slightly, new home construction is advancing strongly and quality projects are easily attracting investment capital. The market for industrial warehouse space is very healthy. All the goodies you buy from Amazon need to be sorted and loaded somewhere. The need for high quality medical rooms of all kinds is growing steadily as the healthcare industry is innovative. The delivery of health services will always be a predominantly physical interaction, which is reflected in the demand for buildings.
Hospitality has suffered greatly from the slowdown in travel but appears to be recovering. In the second week of March, US hotel revenue per room reached its highest level since the pandemic began. The worst sore point is retail, which has been badly hit by the coronavirus. Restaurant restrictions sparked a tug of war between restaurants and their landlords. Both sides tried to do the right thing without going broke. And with the already fragile personal shopping experience, which is being further challenged by COVID concerns, large chains and mom and pop shops alike have problems. Even in retail, however, not all news is bad.
One bright spot is the discount store category, where Dollar General performed very well during the pandemic. And sometimes there is simply quality. Our company is a large Class A lifestyle hub in Little Rock where vacancy rates remain very low despite the challenges facing retailers.
From March 2020 to March 2021, the commercial real estate industry initially felt a shock and then opted for survival and stability. But what will we experience in the future? I assume that the next few years will be characterized by caution and innovation. Developers, owners, and lenders will, of course, conservatively provide capital to real estate companies as a landscape of changing building uses takes shape. Will corporate office users continue their commitments in the same space? Will there be a surplus of free restaurant and shop space as many brave entrepreneurs feel that the risk is simply not worth it? Will there be sufficient alternative uses to absorb the ocean of available space in regional shopping centers and department stores?
The answers are influenced by the innovation that has always been a hallmark of American business. A trend will be creative repurposing of buildings as shopping malls become fulfillment / distribution centers or are converted into mixed-use destinations that combine living space, shopping, office, entertainment and accommodation in ways not tried before. Similarly, vacant retail spaces with unexpected uses will emerge, such as the impressive Premier Medical Plaza on Rodney Parham Road in Little Rock, a beautifully redesigned former Kmart store. Another trend will be “well buildings” in which new or renovated office spaces provide functions such as foot-activated elevators, touchless bathroom fittings and temperature scanners – good ideas that have been turned into reality by a health crisis.
Our company and our customers are still buying real estate. While it is more important than ever to be selective and strategic in choosing opportunities and structuring business, one crucial fact remains: whether at work or at home, everyone must have a place on the planet, and the planet is not getting any bigger .
Editor’s Note: Jeff Hathaway is President of the Hathaway Group, an independent commercial real estate company based in Little Rock. The opinions expressed are those of the author.