Ever since states and provinces started enacting emergency measures in response to the COVID-19 pandemic, real estate investment deals have ground to a halt. It’s turned into a real-life standoff situation with buyers and sellers digging in their heels and refusing to budge.
On one side, there are buyers; these are investors with money who know how valuable that is in recessionary times. They’re salivating at the thought of all the distressed assets bound to hit the market and are not getting their checkbooks out for anything less than steep, steep discounts.
Facing off against the buyers we have the sellers. Looking at offers well below what their properties were worth merely weeks ago, most are holding on to see how everything plays out.
Given the uncertainty about what the future holds and the inability for buyers and sellers to find common ground, deals have ground to a halt.
The question is, as the economy at large starts to open back up, who blinks first?
When the Only Certainty is Uncertainty
There’s an old adage that says the only certainty in life is change. That could not be truer than today. The world has been turned upside down by this pandemic in a few short months and no one knows exactly how everything will play out.
It is this uncertainty that is causing such a chasm between the price at which buyers are willing to buy and sellers are willing to sell.
Speaking to Bloomberg TV, Sam Zell, chairman and founder of Equity Group Investments, expressed doubts about the validity of public market valuations for assets, as those prices are based on expectations for the future. “I am not sure that public valuations reflect the reality of what’s going on. Public markets have historically been a reflection of expectations of the future. But I don’t think anyone has any certainty which is why we are seeing incredible volatility.”
Those expecting a devastating economic fallout believe assets prices should be a fire sale, while those who think the economy will bounce back rather quickly want to get as much for their assets as possible. As beliefs are a difficult thing to change, only time will tell whose forecast is correct. Only when there is some certainty about how the future will play out will we see price expectations of buyers and sellers start to converge.
Rise of the Rural Office Tower?
Many real estate professionals, including M Commercial, don’t believe that the COVID-19 lockdown will lead to a permanent exodus from downtown office towers. However, it is likely that a significant amount of commercial real estate will hit the market soon, not because workers have migrated online, but because many small- to medium-sized businesses just won’t make it through the pandemic. Will this bring prices down? Maybe, but not on the scale many buyers are anticipating. Lots of big tenants are still out there looking for downtown space.
Mark Fieder, president of Avison Young Canada, told the CBC that some of his larger commercial tenants are actually looking to expand their downtown space to help with social distancing. He also doesn’t believe this pandemic will lead businesses out of downtown, comparing the situation to 9/11 when it was believed that no one would fly again or lease the top floors of office buildings - of course, neither came to pass. It may take some time, but businesses will always migrate to “where the action is.”
Retail: Its Own Worst Enemy
Owners of commercial space, in general, have been hit hard, but none so much as owners of retail space. Retail space is only as valuable as its ability to attract paying tenants and amidst the COVID-19 pandemic, a retail tenant that can pay its rent is not an easy thing to find.
The loss of key tenants and the inability to find new ones is tanking the price of retail assets as investors are unwilling to take on an investment if there’s a real good chance 25% or 50% of the tenants will default soon after closing; especially in an era where attracting new retail tenants is next to impossible.
This pandemic is wreaking havoc on retail, with several large retailers filing for bankruptcy and countless small- to medium-sized retailers shuttering their doors for good. M Commercial sees this less as “the Amazon effect” and more like a culling of the herd - COVID-19 simply sped up the inevitable. The ‘death of retail’ isn’t a new prediction - it’s a rhetoric that’s been repeated since the early 90s, yet here we are 30 years later, and retail is still a going concern. Pre-pandemic, there were just too many retailers selling virtually identical products; post-pandemic we think what we’re going to see is those with the strongest unique selling proposition pulling through and those simply offering a ‘me-too’ product falling by the wayside.
Retail isn’t dying; it’s reinventing itself.
Having the right retail tenants could be a key differentiator for sellers moving forward. Of course, the retail landscape coming out of the COVID-19 pandemic is anyone’s guess, which is why it’s hard to predict who will blink first - buyers or sellers.
Buyers vs. Sellers: Who wins?
In an industry based on very long investment horizons, the uncertainty of the future makes it harder than ever to price commercial real estate investments. Even with attractive interest rates and asset prices, investors still need tenants for cash flow. The uncertainty around the solvency of retail tenants at the moment makes any retail investment a risky one and therefore buyers feel they should be compensated through favourable pricing. Sellers, on the other hand, don’t want to give away valuable real estate at rock bottom prices only to see the economy level out and return to normal in a few short months.
As the future starts to become clearer, price expectations from both sides will start to converge. For investors simply looking for a fire sale on distressed assets, no doubt there will be lots of opportunities, but there will also be opportunities for buyers looking to invest in solid retail or office real estate at attractive prices. For sellers, the risk of ‘waiting it out’ is greater, as declining economic conditions could further depress prices.
For now, the standoff continues, and until the future becomes a little less murky, that’s the way it’s going to stay.
By Steve Peres
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