Before the pandemic, the NCREIF Property Index, a real estate index that tracks the unlevered gross returns of over $742B in real estate properties throughout the United States, posted average annual returns of 8.28%(1) from 2015 to 2019. At the height of the pandemic (March 2020), returns fell to less than 2% for the first time in a decade.
Despite falling returns, real estate was better positioned during the pandemic than during the 2008 financial crisis. During the last recession, returns across all property types fell by at least -10% with retail falling the least at -10.95% and hotels falling the most at -20.41%(1). During the pandemic, returns were not uniformly impacted across the different real estate sectors.
Hotels: Given the short-term (daily) nature of hotel leases, hotel returns usually fluctuate the most through economic cycles compared with other property sectors like office and industrial. During the pandemic, hotel sector demonstrated this sensitivity. As vacation and business travel fell due to the spread of COVID-19, most hotels supported lower occupancies, which generated low to negative income. Liquidity on the transaction side also dried up with only 71 hotel properties changing hands during the second quarter of 2020, a fall of 85% year-over-year(2). This resulted in returns falling -25.70%(1) which came from a combination of income deterioration and pricing collapse.
Source: Costar, STR
Retail: With the rise of e-commerce, retail performance has been abysmal relative to the rest of the real estate industry since 2017. There were a record number of retail bankruptcies in 2019 as consumers’ ordering behavior shifted primarily to online. Those companies that were unable to migrate over to or incorporate an online platform saw significant decline in sales. This resulted in less of a need for retail space and more than 9,800 store closings(3). The negative trends seen in retail have caused investors to seek higher returns in other real estate sectors. Accelerated by the pandemic, retail returns in 2020 fell by -7.48%, its second worst performance on record (dating back to 1978)(1).
Industrial: As the top performing real estate sector, industrial witnessed no quarterly drop in returns during the pandemic. The explosion of e-commerce created the need for more last mile delivery facilities and distribution centers across the country. With a low supply of current space and high demand from tenants, fundamentals have been extremely strong for the industrial sector. This has translated into a strong investor appetite and performance for 2020. Investor demand continues to be strong as returns in the most recent quarter (Q2 2021), were 8.88%, the highest on record (1).
Multifamily: Demand for multifamily housing has remained high throughout the country as people continue to seek lower cost cities paired with high amenities. This coincides with a general movement out of high-cost gateway markets. Although returns fell to 1.82% in 2020, it was the second-best performing sector due to the low number of deliveries and a high demand for urban and suburban multifamily space(1).
Office: The future use of the office sector is still uncertain. Most companies have formalized preliminary plans on teleworking and hoteling; however, the medium-to-long-term implications of these strategies are still unknown as the feasibility and success of telework in the long-term remains to be seen. Most job growth is occurring in the non-gateway, sunbelt markets, where there is a lower cost of living and higher business incentives (4). Returns and investor demand reflect this as suburban quarterly volume are up year-over-year while central business district locations have yet to recover. Moreover, pricing in non-major metros have recovered faster than the 6 major metros(2).
To summarize, the hotel sector, barring complications from the new COVID variant, could see a quick turnaround as business travel recovers. Vacation locations have, so far, faired best in the short term. Retail seems to have a long road to recovery depending on the future growth of e-commerce, while industrial shows no signs of slowing down. Although multifamily was originally hit hard due to uncertainty in rent payments, it has rebounded well. Office remains the sector clouded with the most uncertainty, but sunbelt and suburban locations seem to be the most attractive locations for investor capital.
Even though the returns in these sectors are heavily dispersed with a range of 37.47%, the highest on record, subsectors within these industries are all exhibiting different stories (1). Grocery-anchored retail and single-family rentals are faring well, while high rise apartments and central business district offices in gateway markets are underperforming. In the end, performance comes down to the location of the asset and the micro, subsector trends.
(1)NCREIF Property Index
(2)Real Capital Analytics
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Ken Kilpatrick, CFA
Assistant Vice President, Senior Research Analyst
Boyd Watterson Asset Management, LLC