Archives for November 2021

Battered by COVID-19 — some more than others — retailers are looking to rebound with increased creativity, flexibility, and agility

The figures vary, but between 12,000 to 15,000 physical retail stores closed in 2020, and many predict that figure could be higher this year. But the pandemic only accelerated a change in retailing that had already been underway — the U.S. had 9,300 store closings in 2019, up from 5,800 the year before. E-commerce sales were already steadily rising when homebound COVID-19 shoppers gave them a powerful push. Colliers’ spring 2021 retail report, “Retail Moving Forward,” noted “four years of e-commerce growth compressed into a single quarter, as nearly 150 million people shopped online for the first time.”

This year, as spring flowers bloomed, so did signs of optimism. Millions of people got vaccinated and were eager to return to some sense of normalcy, including shopping in stores. They had money to spend as well, thanks to stimulus checks and a sharp increase in personal savings that weren’t spent during the pandemic.

But as recovery continues, the retail industry and CRE professionals who work in it are using lessons learned during the pandemic and looking ahead to navigate an altered playing field.

Nimble retailers instituted a wide variety of COVID-related practices that are likely to carry through in some form during recovery. “Retailers that were able to continue to serve their customers through options like delivery, curbside pickup, and connection via social media are likely to benefit the most as economies open up,” says Scott Crossman, CCIM, founder and CEO of Crossman & Company in Orlando. “Some consumers have adapted to the limited in-person experience and will continue to use these alternatives in the future, but others will be anxious to return to a more open shopping experience. Smart retailers will be prepared with sufficient inventory to meet this demand and appropriate staffing to maintain a high level of customer service.”

Retailers and landlords alike also learned to be flexible, developing creative solutions to keep the doors open. Examples abound. Restaurants shifted to selling premade meal kits; specialty retailers started subscription services featuring local products; shopping center landlords rented out their empty parking lots for drive-in movies or graduation parades. Jennifer Ott, CCIM, executive vice-president of ROI Commercial Real Estate in Las Vegas, says that in one of her leasing projects, a doughnut shop got permission from the landlord to stay open late to make pizzas after the doughnut trade tapered off. Another shopping center tenant couldn’t do outdoor service at lunch because of traffic, but they received permission to set up outdoor pods for the dinner hour, once other stores in the center had closed.

Businesses learned the fine art of partnership as well. Ott points to one franchise owner who started working with local vendors to determine ways to save costs, whether it was adjusting payment schedules or working with other franchisees to order items in bulk. “He thinks now he can operate with fewer employees than he did before because of the changes he made, and he thinks he’ll be more efficient and successful because of what he learned,” she says.

And paradoxically, considering the wave of store closings, Ott adds that she’s actually seen more entrepreneurs looking to start a small business over the last year. “I think there’s been a really big push in the franchise sector, with more and more people buying franchise concepts,” she says. But she’s also seen more inquiry calls from people who are simply working on business plans and are asking questions about how retail leasing works. She speculates that some would-be business owners may have lost jobs in the pandemic and want to assert more control over their occupations.

In Touch With Tenants

The drop in retail sales, though, produced ongoing anxiety for landlords and tenants. Crossman’s firm leases or manages more the 360 shopping centers — primarily grocery-anchored — across the Southeast. The pandemic’s disruption, he says, “has underscored the importance of a healthy landlord-tenant relationship. Retail landlords who stayed in communication with their tenants through capable property managers and knowledgeable leasing agents have fared much better at mitigating the effects of the pandemic.”

Still, he adds, some businesses — particularly those that heavily rely on in-person services — have been slower to recover. In these instances, planning and communication have been especially important. Tenants were urged to develop recovery plans in exchange for rent reduction. “We recognize that for a tenant to regain the business, they need to be spending some money on advertising and promotion,” Crossman says. “As we look at their plan, we may reduce the rent, but encourage them to put the money toward trying to get business back.” To help measure tenants’ recovery, Crossman & Co. uses Placer.ai, a platform that measures foot traffic and patterns. “It helps us understand who needs the help, and we try to focus our assistance.

“Our tenants, as a whole, have substantially recovered. We have done very well with our accounts receivable and our occupancy levels — all our metrics are doing well right now.”

Going forward, he says, “expect to see new lease language around force majeure and more detail surrounding business interruption and its impact on tenant obligations. Savvy landlords may opt to require tenant sales reports and monitor tenant foot traffic activity. Savvy tenants will want to have a plan for any future shutdowns.”

Ott notes that while the southern Nevada market was hit hard with its dependence on tourism, “we really didn’t lose a lot of tenants. Our vacancy topped out [at] about 7 percent.”

“I’m optimistic,” she says. “My hope is that landlords and tenants have figured out how to better work together. We’re seeing all these pushes for force majeure clauses in leases that we didn’t have before. We’re starting to see a little more that they’re fair to both parties — one party is not penalized more than the other for something that’s outside of their control. I’m hoping we can see more of that.”

She also says she sees more openness — on both sides — to shorter terms. “That can be good and bad,” she says. For tenants, a shorter term could lessen risk, but the market could improve, and they could face higher rents. For landlords, a three-year lease could affect valuation if they’re looking to sell or refinance.

Alterations Ahead

The pandemic created some changes in stores’ physical appearances and layouts. Some of those will stay in place with additional changes ahead, particularly as retailers large and small incorporate more e-commerce into their business model. The Colliers report predicts that over the next three years, nearly 80 percent of brick-and-mortar stores will modify their footprints in some way as they “add or extend their service to include an online collection and ship-from-store feature,” and more than 60 percent say they will test or open new store configurations to address changing consumer habits.

“Everybody thinks they need a drive-thru,” Ott says. It’s an expensive feature, though — they use up space, they require additional permitting, and “from a new development standpoint, it’s challenging, because it affects the rents,” according to Ott. Crossman adds that such obstacles could slow the trend, “but no question — we do have tenants who are willing to pay the premium for a drive-thru, and so we’re looking for ways to accommodate that.” One trend that will also likely remain: Additional short-term parking spaces dedicated to curbside or parking lot pickup. A recent report from Digital Commerce 360 found that by early 2021, more than 50 percent of top 1,000 retailers offered curbside pickup.

Malls, already staggering from department store bankruptcies, took a further blow during COVID-19, particularly those that included tenants offering in-person elements such as entertainment and restaurants. The Colliers report, however, pointed out that among surveyed consumers, almost 70 percent said they weren’t visiting entertainment-oriented malls because of health concerns — and a majority said they’d be willing to visit again after pandemic protocols are loosened. Fitness features, in particular, seemed to hold promise in attracting younger visitors. Ott says that she’s seen several instances in the last year of fitness users moving into a mall and repositioning the space to include an exterior entrance to accommodate the facility’s increased hours of operation. Other malls have experimented with immersive entertainment; one Houston mall opened a 40,000-sf interactive art museum in a vacant housewares store, and a mall in suburban Chicago offered an interactive tour of Sistine Chapel frescos in an empty Sears.

There’s also been interest in using excess vacant mall space for fulfillment centers. While this has been tried in some empty freestanding big-box stores, mall retailers are less enthusiastic, and an October report from Barclay’s posited that such a move could reduce the value of the property from 60 to 90 percent.

Moving Ahead

There’s no question that e-commerce will continue to challenge brick-and-mortar retailers, but the initial surge during COVID may decline slightly, according to Cushman & Wakefield’s “U.S. Retail Market Outlook,” published in March. The report notes that core internet sales will continue to rise, but likely slower than they have in the past 10 years. At the same time, the report forecasts an annual retail sales growth rate of 3.7 percent over the next five years — identical to the five years before the pandemic. Sectors that showed particular promise for growth include smaller-format or specialized groceries, fast food, dollar stores, and thrift stores.

Retailers may also need to recognize that some consumer habits die hard. “Retail consumers are social creatures by nature, and most will embrace a return to their routines, including interactive retail experiences,” Crossman says. “At the same time, consumers have adapted to online and social media-driven communications to inform their purchasing, so retailers should benefit from maintaining these channels with their customers.”

Customers will be at the core of retail recovery, but that’s not news. “What I think retailers need to do right now is get back to basics — to the fundamentals that they’ve always needed to focus on,” says Ott. “They need to have quality employees, people who are educated about their products and services and who care about the customers. You need to provide a quality customer experience and make sure people know you exist.”

Crossman agrees. “If you’re competing solely on price in a world with Amazon and others who can provide product at a low price, that’s problematic,” he says. “As we look at high service, we see that as the competitive edge for the space we work in. Going forward, we’re looking at tenants who are doing that, and we see that those tenants are thriving more in our centers. So, as we look to who we’re going to lease to, we have a preference to those who we think meet that standard.”

Commercial real estate professionals will need to focus on the basics as well. “Stay connected with your peers in the business, become a student of your customers — your tenants — and remember that relationships transcend transactions,” Crossman says. “Technology is your ally, as new software and communication methods provide an ever-increasing ability to the monitor, measure, and project market trends.”

“It’s important to continue to educate yourself. Not only to hone your skill set, but also to know the political and financial environment,” says Ott. “Understand what the trends are — what landlords and tenants are doing and which investors are active and why. Always find those resources and be able to add value to your clients.”

The pandemic created some changes in stores’ physical appearances and layouts. Some of those will stay in place with additional changes ahead.

“There are so many unknowns right now,” she adds. “There’s opportunity and a reason to have optimism, but it also affects our communities, so that makes it challenging to advise clients. All you can do is find the best information that you can and make sure they understand the potential effects of their decisions.

“And be open to change — that’s probably the hardest. Be adaptable. Be willing to try new things.”

Source: “Retail’s Road to Recovery“

Despite ongoing pandemic-related turbulence, construction starts and development paint a hopeful picture for commercial real estate.

As the economy continues to emerge from the effects of the COVID-19 pandemic, commercial real estate construction, buoyed by the continued loosening of pandemic restrictions, has been on the rise as well. Through 1H2021, Dodge Data & Analytics reported a 10 percent rise in total U.S. commercial and multifamily building starts, up to $108.5 billion, compared to the same period in 2020. But many of the issues that slowed construction in 2020 remain a concern, even as the economy continues to improve.

At the onset of the pandemic in March 2020, labor that was considered essential was allowed to proceed, but the definition of “essential” varied widely across the country, and construction was halted in many areas. According to JLL’s 1H Construction Outlook Report, 26 percent of ongoing construction work was in a jurisdiction where work was shut down, including seven states where the average shutdown lasted 41 days. The effect was dramatic — 1.3 million construction jobs were lost from February through April 2020, a contraction of more than 17 percent, according to the report.

However, as shutdown orders were lifted in May 2020, the report says, the construction industry “shifted from immediate crisis management to developing medium-term solutions for working through a pandemic that was a known and persistent challenge for the year ahead.”

Among the primary challenges are the increasing costs of materials and a dearth of skilled construction labor. As a result, according to JLL, 2020 nonresidential building construction starts were down 24 percent from the previous year.

As the economy reopened, new construction challenges popped up as well, primarily the implementation of new COVID-related safety protocols and a learning (and spending) curve for newly introduced construction technology. Certain sectors — primarily warehouse and industrial — encountered increased demand, while others, such as retail and hospitality, slowed down.

Material Concerns

In the early days of the pandemic, construction projects were hamstrung by a shortage of materials. During the pandemic — from 2Q2020 through 2Q2021 — “the story was really one of disruption, of supply chain challenges, of shortages in production and shipping,” says Henry D’Esposito, construction research lead for JLL and author of the JLL report. “All the way through the supply chain, from early production of raw materials through production through distribution, there were delays and cost increases all along that chain.”

As a result, prices increased. For some commodities, he says — particularly lumber and steel — prices went up two or three times from where they’d been. In the 12 months leading up to April 2021, for example, lumber prices rose 86 percent and steel jumped 67 percent. By this summer, prices had come back down somewhat, but D’Esposito adds, “we’re forecasting a more broad-based widespread inflation going forward rather than a one-off issue. Last year, lumber went up, but concrete, drywall, and other commodities were flatter. What we’re expecting now is we’ll see mid- to upper-single-digit increases across the board.”

Labor Shortages and Competition

“I think labor is going to be the bigger issue going forward,” says D’Esposito, despite material costs dominating much of the discourse recently. Even before the pandemic, many markets had shortages of skilled construction labor. As building activity resumed, commercial construction faced increased competition for labor on several fronts.

On one front is the boom in residential construction. The National Association of Home Builders reported that residential construction employment increased by 15,200 in June, while nonresidential construction lost 22,600 jobs that month and 21,700 jobs in May. By July 2021, notes NAHB, residential construction employment exceeded its February 2020 level, while only 55 percent of nonresidential construction jobs lost in March and April 2020 had been recovered.

Construction could also encounter competition from other industries that have increased wages, where there’s an overlap in the labor pool, adds D’Esposito. And as government infrastructure efforts ramp up, they will also impact both labor and materials costs, he says. While infrastructure work is “obviously different from a typical commercial construction project, at the end of the day, an infrastructure project will use the same concrete, the same steel, and many of the same workforce that would go into a commercial project.”

One longer-term trend from the pandemic is an increased use of construction tech adoption, as builders had to shift to remote environments. “We thought that would stick around and serve as a springboard to faster growth across the industry,” says D’Esposito, “and that is so far what we’ve seen.” While the technologies took time and money to roll out, “once you do that work, they’ve proven very effective.”

Sectors to Watch

Construction did, however, continue at a rapid pace for some commercial sectors. The increase in e-commerce has spurred warehouse construction, and Jeff Engelstad, CCIM, points to strong activity in logistics as well. Engelstad, professor of the practice at Franklin L. Burns School of Real Estate and Construction Management at the University of Denver, says that the pandemic-related disruptions in supply chains “tell us that we need better solutions to supply chain management — and a lot of that has been last-mile logistics.”

Engelstad also notes increase activity in multifamily. “Pandemic or no pandemic, people still need a place to live,” he says, “and even with the eviction moratorium lifting, it really hasn’t hurt the investment value of apartment buildings at all.”

As the economy reopened, new construction challenges popped up as well, primarily the implementation of new COVID-related safety protocols and a learning (and spending) curve for newly introduced construction technology.

A midyear report from Marcus & Millichap noted that more than 175,000 apartments were completed in 1H2021, which raised the annual total to about 363,000 units — the largest completion volume over four quarters in at least 20 years. Top multifamily markets included Dallas-Fort Worth, with more than 27,000 completions, and Houston with 20,200. Other metro areas included Atlanta, New York, Washington, D.C., and Austin, Texas.

D’Esposito adds development in life sciences and health care to the list, “but that tends to be more clustered” in markets such as Boston, San Diego, and the Bay Area, he says. “Where it’s busy, it’s extremely busy.”

Other sectors are seeing activity for more focused needs. While overall office construction slowed, projects related to temporary health measures — social distancing, sanitation accommodations, etc. — retrofitting projects, and other requirements were still necessary as people returned to office from working remotely. D’Esposito sees potential buildouts where companies take a critical look at their office spaces as hybrid home-office working arrangements become more common. “What are the long-term shifts going to be in terms of how people work?” he asks. “A lot of companies view moving toward a hybrid model where they need flexibility in how the office is used, rather than a sea of desks.”

Overall, the top 2021 U.S. markets for commercial and multifamily starts, according to Dodge Data & Analytics data, are New York-Northern New Jersey-Long Island; Dallas-Fort Worth-Arlington; Washington-Arlington-Alexandria; and Boston-Cambridge-Quincy.

Legal Issues

The pandemic has made its mark on how construction contracts are being written going forward. “Everybody up and down the chain is still very focused on force majeure provisions and standard force majeure delays, which typically have included epidemics,” says Deborah Cazan, a construction attorney and a partner at Alston & Bird in Atlanta. “In drafting new agreements, you have to consider that we’re not living in the same world that we were in three years ago. So those force majeure provisions look very, very different now than they did three years ago. In particular, a real hot button right now is whether material delays and escalation constitute a force majeure event.

“Traditionally, material escalation and delays were put into the contractor’s bucket. That was the contractor’s risk because they had control over that. They determined when they were ordering materials [and] the price they negotiated with their vendors. They were the appropriate party to take that risk. That is no longer the default. What you’re seeing now is parties coming up with innovative ways to reallocate the risk so that the contractor isn’t taking the risk for material delays and escalation over which they have no control, and the owner isn’t taking the risk for those items over which the contractor does have control. Control is obviously going to be the focus in drafting provisions going forward.”

While overall office construction slowed, projects related to temporary health measures, retrofitting projects, and other requirements were still necessary as people returned to office from working remotely.

She adds that she’s seen many ways in which clients have handled the situation in the past year. “I’ve had some owner clients write into their agreement that, broadly speaking, unless the contractor is negligent in what it’s doing, the owner is open to change orders for increased material costs.” Other clients concerned about the availability and price uncertainty of a commodity like steel may pay 100 percent of their steel costs upfront to lock in the numbers.

“I’ve had other clients who have written into their contract that if material costs go up more than 5 or 6 percent, then we’ll okay a change order,” Cazan says. “But you’re going to take the risk up to that, and in conjunction with that, if they go down by more than 6 percent, then we want money back.”

She notes that COVID-19 has also added additional work-site safety measures that have increased construction costs. For projects that were ongoing during the outbreak, “contractors and developers were very good about working together to be fair about that,” she says. However, as such requirements become more standard, contractors will now need to include them in their contracts.

Cazan says that she hasn’t seen the construction labor shortage shift risk to owners from contractors. Instead, owners and developers expect contractors to develop appropriate schedules based on their knowledge of the local labor market. “It might be that your project is going to take longer, but that additional time needs to be built into the initial schedule” she says. So, while the shortage may have an impact, “the risk of a labor shortage isn’t typically being shifted to the owner or serving as the basis for a time extension.”

Source: “Building Something New“

This month the Fed is reducing Treasury and mortgage-backed purchases by $15 billion to $105 billion.

Commercial real estate is one of the best inflation-hedge investments with interest rates expected to rise in the next six months in part from the Federal Reserve tapering of Treasury and mortgage-backed securities purchases, according to John Chang, Senior Vice President and National Director Research Services at Marcus & Millichap.

Chang noted in the third quarter commercial real estate volume is up 19% compared to the third quarter in 2019, adding that the rise in rates isn’t expected to lower CRE volume because there is too much capital looking for yield.

At the start of the pandemic the Federal Reserve restarted its quantitative easing program to put more cash into the economy by buying $120 billion a month in assets which has kept interest rates low, Chang said.

In January 2020, the interest rate on 10-year Treasuries was at 1.5% but dropped to .7% by March with the purchases and the rate stayed below 1% for the remainder of the year, which has helped boost spending and investment.

But in 2021 with vaccines kicking in and the economy improving, interest rates started to rise again to the 1.3% to 1.5% range, while inflation was picking up to two times pre-Covid levels.

This month the Fed will reduce purchases by $15 billion to $105 billion with another $15 billion reduction each month until the buying ends in June.

Chang said the tapering had not led to a shock wave in the markets because investors were anticipating it.

Opinions, of course, vary across the board about the effect tapering will ultimately have.

In September, David Pascale, senior vice president at George Smith Partners, told GlobeSt.com that the tapering of bond purchases could result in a selloff of Treasuries, which could increase interest rates for virtually all CRE permanent loans, which are typically priced over the 10-Year Treasury. “Higher rates could lead to higher cap rates and therefore lower values for CRE assets nationwide.”

Robert Frick, corporate economist at Navy Federal Credit Union, however, says it is a weak correlation to assume that tapering will boost the ten-year rate, just because the Fed will stop buying so many treasuries. He maintains that mortgage rates are not likely to rise given the ten-year is not likely to rise much from tapering.

Source: “CRE Expected to Remain Solid Inflation Hedge Amid Fed Tapering“

Armed with a new 20-year strategic plan, the New Mexico Economic Development Department is asking legislators for a substantial investment that its leaders believe will help the state diversify and bolster its economy.

During an event hosted Wednesday by the New Mexico Chamber of Commerce, Economic Development Secretary Alicia Keyes and Deputy Cabinet Secretary Jon Clark outlined some of the findings from the state’s recently released 384-page economic plan, which charts an economic strategy over the next two decades.

In order to help meet some of the objectives laid out in the plan, Keyes said the department will be asking for a “huge” budget increase during the upcoming legislative session in January, including a $50 million appropriation toward the state’s incentive program under the Local Economic Development Act, and $2.5 million to establish an office of diversity, equity and inclusion within the department. Such an expansion would help reverse staffing losses in the state agency and help the state reverse negative economic trends over the previous decade, Keyes said.

“New Mexico has an opportunity to, finally, get some momentum,” she said.

The Economic Development Department commissioned the report, which was paid for through a $1.5 million federal grant, to help New Mexico recover from the near-term impacts of the COVID-19 pandemic while guiding longer-term efforts to diversify its economy and become more competitive.

Clark described the period between the Great Recession and the COVID-19 pandemic as a “lost decade” for New Mexico in terms of job and wage growth, which lagged behind neighboring states. Keyes added that the state ranks 47th nationally in per capita income and 46th in gross domestic product per capita.

“We need to take action now, and we feel like we’re doing it,” she said.

The state hired nonprofit research firm SRI International to interview stakeholders and analyze the state’s strengths and weaknesses. The report identified six main impediments to the state’s economic growth, including misalignment between higher education and industry and public-sector dominance in the state’s innovation ecosystem.

“They help us pinpoint what is actually holding us back so we can move forward,” Keyes said.

One advantage the state has is an influx of federal funding coming out of the pandemic, including a newly announced $1 million grant from the U.S. Economic Development Administration. Still, Keyes said growth will require investment from state leaders, businesses and other stakeholders.

To that end, Keyes said EDD will be asking for $50 million to expand the state’s LEDA program, allowing New Mexico to build infrastructure that can make sites more shovel-ready for businesses. LEDA allows the state agency to administer grants to local governments to help qualifying businesses that are expanding to or relocating in New Mexico. Keyes said the state often gets inquiries from businesses seeking sites that are ready for development.

“We have a hard time pointing them to infrastructure-ready sites here,” Keyes said.

Separately, the state agency is asking for $12 million to support its Job Training Incentive Program, which funds classroom and on-the-job training for newly created jobs in expanding or relocating businesses. The department has argued the expansion is necessary to meet the needs of expanding companies.

Keyes said the agency is also seeking $4.5 million to fund marketing efforts that can build awareness of New Mexico in other states and countries. An additional $2.5 million would go toward establishing the proposed Office of Justice, Equity, Diversity and Inclusion (JEDI), which Keyes said could help address New Mexico’s issues with disengagement in economically disadvantaged communities and income inequality.

“The rich are getting richer and the poor are getting poorer,” Keyes said. “The gap is growing.”

Source: “NM Unveils 20-Year Economic Strategic Plan“