Creative destruction tells us that eventually the new replaces the old. However, sometimes the imperative to change is imposed suddenly and unexpectedly, often at an inopportune moment. When that happens, we enter a world of created destruction. In an ongoing series, the FTI Journal looks at distressed M&A opportunities for PE investment in various industries arising from the created destruction of COVID-19. This article snapshots the real estate industry.
lthough the effects of COVID-19 on real estate are accelerating many trends (like a shift from brick-and-mortar to online shopping), other trends are poised for an about-face.
Just a few short months ago, commuting to work and having a desk in an office space was deemed both safe and essential to a company’s success. Six months into the COVID-19 pandemic, and millions of offices sit vacant as the long-anticipated telecommuting movement has finally blossomed. Where once we spent an average of 25.4 minutes commuting from home to work, we now arrive in just 25.4 seconds (from bedroom to home office).
Nearly every industry depends on real estate — whether directly or indirectly — for its operations. That has raised some serious questions for property owners. Retail and hospitality property owners have taken a direct hit from COVID-19, with delinquencies and watchlists for CMBS loans secured by these properties expected to be 20 percent to 40 percent or more. A less immediate effect is on office spaces: Will employees be comfortable returning to them?
While the answers remain up in the air, understanding what is known now and what is knowable are keys to identifying real estate investment opportunities. Office space density has been on the decline for decades and now sits at less than 200 square feet per employee as estimated by Cushman & Wakefield.
In the wake of the pandemic, office users most assuredly will be looking to increase the space between their colleagues ultimately reducing the productivity of and hence, value of, urban office space at a given rent level. With the appeal (and health conditions) of cities more in question, relatively less-expensive suburban office space may become more attractive. Also, with the accelerated adaptation of technology by telecommuters, data centers — and last-mile industrial settings — will become more coveted.
What’s going on with REITs? Many are already trading below their net asset value (NAV) and the cost to maintain public status may do more harm than good. Now may be the time for REITs to privatize and exit the public domain, which in prior downturns often was a viable restructuring strategy. For PE investors, this presents a prime opportunity to snap up depressed assets at deep discounts.
We may be seeing more vacancy signs ahead, but with the right insights and timing, investors can add promising properties to their portfolios.
Read the full introduction to the series "Creative Destruction vs. Created Destruction." To learn more about specific distressed M&A opportunities in real estate, visit our Distressed M&A Outlook Series.