Covid-19 And The Surprising Urban Real Estate Winners
The work-from-home trend has people calling for the end of cities and an anticipated reversal of the rural-to-urban trend of human civilization that really dates back from the beginning of industrialization and transportation innovations in the 18th Century.
Real estate, as an asset class, has survived years-long revolutions and world wars. Global pandemics will have major impacts, both short and long term, and liquidity issues will shake out many industries and landlords. There will be major transformations, but not necessarily what you think.
Cities are not going anyplace. The difference is in who can survive in them, who can afford them, and who wants to be there.
There will be two primary shifts and they’re already happening and calcifying. One is the end of a workplace-oriented life, in which where you live is driven by convenience to where you work. The second will be the prioritization of a desirability for safety and health. This used to mean “good neighborhoods.” Now, it will mean perceived safety from contagion.
People will insist on healthier living spaces and working spaces, and separation from those deemed risky. This will mean that people who can afford it will make “the home” a self-contained sanitary environment. They will pay for more space, with space representing a buffer (like the moat around the medieval castle) and they will pay for the privacy and safety barriers to create their comfort zone. The new desirable real estate will be more expensive, yet overall population density in cities will decline as more space is used by fewer people. The collateral impacts of these two shifts will be far more dramatic.
Office space will remain a premium, but again, only for commercial tenants which can afford the luxury of a “corner office” in a showplace building and whose owners and managers (read: decisionmakers) insist on walkability or other amenities that fit in with their other living concerns. So prime office space will retain its value, often moving hand-in-hand (and also in physical proximity) with prime living space. I see many tenants (both commercial and residential) paying the same rent, but getting far more space, while landlords should expect to see significant double-digit declines in gross rents and rates, and for a long, long time to pass before pre-pandemic rates are realized. Population density is going to drop, but the sector should be supported from an outright crash by those people and companies which have the liquidity to pay for the extra space they need and want.
That raises the question of how much more space companies will need. Take the average conference room as an example. Applying a six-foot social-distancing rule and then a little more space for comfort, I foresee conference room tables with occupants separated by at least two chairs from their neighbors, with this implying a reduction in realizable occupancy by at least two-thirds. Therefore, tenants reducing their in-office workforce by two thirds would still require the same amount of space as space-per-person increases.
Yet I believe overall demand will decline (also a function of affordability), with rents and values potentially crashing for non-exclusive or Class B properties in marginal areas. As with residential real estate in cities, commercial office rents in central business districts (measured by space) will decline, but remaining tenants will simply pay more, for more space in order for the insulation of social distancing and perceived safety. Again, fewer people will pay more, for more space and safety in their homes and offices.
While working from home becomes the default option for companies needing to retain talent, there should be long-term declines in the demand for office space for use by middle-managers and others whose jobs (or status) do not require their physical presence in higher-rent, central-city offices. We should see more geographically-decentralized office footprints, and workplaces on an overall basis should shift towards the suburbs where, again, the ability to use private cars should be a major amenity insisted upon by workers who can afford to own and operate their vehicles. As entire industries have workers who no longer need to live close to the office, overall demand in certain central city districts will fall, prices and rents will drop, and the population mix among remaining workers and residents should shift towards more of the ownership and executive classes whose members can afford (and who see the value in) the privacy and insulation discussed earlier.
What about service industries whose clients are the commercial tenants and executive class? Some stores catering to this select clientele surely will survive, in numbers far reduced from 2019, but the business district merchants accustomed to making lots of sales on thin margins made up with volume sales to a diverse three-pronged customer base of office workers, tourists and downtown dwellers will be dead in the water when all three prongs reduce dramatically and most of the remaining few end up being rent-control tenants and lower-income service workers unable or unwilling to pay the premium prices that used to be common.
The urban retail of yesterday is beyond rescue and should be allowed to fail, and landlords should aggressively reimagine existing space for any use which clients may have. I predict most previously-high-demand real estate in every sector, from street-level retail to so-called luxury condos, may go vacant for many years until landlords agree to take new types of tenants and for just a fraction of their pre-pandemic rent rates, or unless pandemic fears totally dissipate and social norms return to 2019 tastes. In fact, the urban centers of Western Europe and North America may see “ghost neighborhoods” where entire business districts — and even residential areas — go abandoned. It is not inconceivable to see outright de-construction — teardowns of once prime properties — in a new, government-supported drive towards “urban renewal” and “open spaces” (i.e., parks).
The business districts which do survive — and which can in fact become highly-sought-after — will trend away from the mass transit seen as “unclean” virus Petri dishes, and in a radical shift from the pre-pandemic animus against combustion engines, become overtly welcoming towards privately-driven cars. But what about parking? Who will trust parking attendants dealing with dozens of cars and drivers? That can be solved by self-parking or “self-lock” garages, similar to curbside parking. And the supply for that parking? Why, it can come from all that newly-vacant street-level retail. Turn it all into parking garages. It might be the only way to get anyone to come work in your office. But I caution that this new demand will accelerate only among select classes which can afford it, and these numbers will not compensate for the other trends I foresee.
The return of the private automobile as central to the work commute for the managerial and professional elite — and that is an important limitation — in major cities will change where residential real estate is most valued. I see demand shifting to suburbs which are close enough to cities to allow for easy drives (think under 30 minutes one way) to take advantage of the leisure, cultural or educational opportunities that are likely to remain in the big cosmopolitan centers, and to a select few walkable residential strips adjacent to the high-level office centers I just described. Then, among these residential clusters, people who can afford to drive, who can afford to take advantage of what cosmopolitan centers offer, will also insist on moving away from high-density, multi-unit buildings. Any real estate with common areas will become toxic, at any price, in any place. Lots of 2019-style “luxury” apartments will be shunned — even at fire-sale prices — and I foresee actual teardowns of some recent “showpiece” properties.
The world has changed. The era of the “luxury” high-density apartment building or condo is over, as luxury will now mean low-density. The new luxury, in an era where physical privacy equates with health safety, will be the private-entrance apartment (perhaps with private elevators going only to one unit), and to a more achievable extent, the simple, single-family, detached house. It is this class of real estate, located in driveable places near cities with the new prime desirable office space, which will become the new prime real estate and remain in highest demand.
The collateral effects of these trends will be profound for both residential and commercial real estate. I predict residents, with both disposable income and options for driving or working from home, will not return to using mass transit at levels anywhere near pre-pandemic levels. They will flee the commuter corridors and adjacent neighborhoods, which will become the refuge of lower-income riders without affordable alternatives; in turn, ancillary businesses will struggle to survive as their prospective customer base transforms into people with little to no disposable income.
I predict that in the wealth centers — think the big cities internationally and their desirable surrounding suburbs — existing living spaces will be retrofitted to meet this changed expectation and demand. Construction activity should explode as remaining apartment buildings are renovated to create larger apartments and private entrances. Indeed, any and all space is subject to a re-imagining. Who says mothballed luxury condos cannot be turned into light manufacturing factories, or convention centers that allow for social distancing? And certainly the halcyon communal days of the “efficiencies” of people jammed into a shared work space, shared living, communal spaces and so on, as some sort of upper-class amenity are over — even if a covid-19 vaccine is developed soon. Shared or common spaces have acquired a stigma and become places to avoid, becoming the environment of last resort for those with no other option.
Likewise, the trend of smaller bedrooms within an apartment (which evokes dormitory living for young and often mobile, rootless white-collar professionals just starting out) as a panacea for lack of affordability is going to reverse. I think the old apartment, originally designed for occupancy by one or two and in recent decades converted (often with abominations like “temporary walls”) into spaces for three or four, will return to a single-use or couple-use occupancy. People simply won’t tolerate living with more people than is absolutely necessary, and affordability concerns will resolve by people moving to wherever they can afford the safety they will insist upon. The consumer’s compromising on space yesterday (i.e., doing with as little space as possible) will reverse, with more space and privacy demanded even if at the expense of greater cost and more remote location.
We could see a death spiral, in which mass transit and surrounding real estate become the domain of only those without other options, the districts of last resort. The urban tenements whose dank, dark conditions and lack of sanitation were identified as major incipient civic challenges some 100 years ago by the urban reformer Jacob Riis, may return.
There is plenty of real estate infrastructure in and around established cities. No one is expecting mass migration or some other depopulating event. Demand for real estate persists. However, some radical rethinking as to what’s possible to use the existing structures can go far in addressing perceived market mismatches between supply and demand.