Empty Offices Threaten Landlord Earnings
For office owners, the WFH revolution has rattled a once-stable business. Yet even as millions of workers no longer commute to the office, the earnings of landlords haven’t yet been hit too hard because of long-term leases and the creditworthiness of large tenants. Actual physical utilization, however, remains well below pre-pandemic levels.
Will office occupancy pick up in the coming months? It’s hard to say, as ongoing waves of the coronavirus entrench the WFH culture and hamper many companies’ return-to-office plans. Clearly though, the US commercial real estate landscape is shifting dramatically. And future office demand is likely to weaken, especially in the large, expensive coastal markets. This process will take years to unfold.
Industrial Property Sees Surge in Demand
In contrast, the acceleration of e-commerce is already generating booming demand for industrial real estate companies, which provide logistics and warehouse facilities.
With supply chains disrupted, many businesses have been seeking to fortify inventories and reconfigure manufacturing and distribution to be closer to customers, pushing up demand for industrial facilities. The increasing popularity of e-commerce has also become a catalyst for last-mile logistics facilities positioned to serve the huge populations along the US coasts.
To be sure, parts of the US retail real estate market remain mired in uncertainty. And the lodging sector, which has enjoyed a recovery of leisure travel, is still suffering from extremely weak business travel. Revenues may not fully recover for years, though companies are creating operational efficiencies to adapt to the new environment.
A Diversified Inflation Hedge
But weakness in these areas shouldn’t overshadow the substantial pockets of strength within US real estate. In addition, property stocks provide access to real assets that tend to do well when inflation rises because real estate owners can charge higher inflation-adjusted rents for long-lived assets—land and existing buildings—that are already owned. Inflation also drives up the cost to develop new properties, which in turn constrains supply growth. Real estate landlords can then charge higher rents as property fundamentals tighten.
Investors should actively target real estate businesses with strong fundamentals while monitoring the knock-on effects of the pandemic. With a portfolio of diversified property stocks, we believe investors can benefit from a measure of inflation protection as well as attractive, diversifying return potential for the next stage of the recovery.
