On the real estate horizon

Over the past 12 months, everything changed, for everyone. “Business as usual” no longer applied, and as the shock began to subside last summer, the question started seeping into conversations. At awkwardly distanced gatherings, muffled through two-layer masks, or from the person perched in a “Hollywood Square” on our laptop in the day’s fifth Zoom meeting, we all heard it: “So how’s your business making it through this mess?”

Real estate professionals get more than our share of such cocktail party questions simply because people are interested in what they see, and they constantly see real estate. Fortunately, our pandemic era answer to “the question” has been an honest “surprisingly well.”

But what about all the empty parking lots, the failing malls, the restaurants begging us to buy another curbside, foam-packed meal that’s cold before we can eat it? How can real estate be doing just fine when the businesses renting buildings are completely disrupted?

First, a qualifier: The full response should be a more tempered “surprisingly well, for now.” We don’t know what lies ahead, and there is reason for caution. Some paradigm shifts, which were in infancy pre-pandemic but grew to adolescence virtually overnight in 2020, are undeniably taking hold. More people are working from home and shopping at their computers. Especially as exacerbated by the virus, the potential impact of these two trends alone on demand for office and retail space is obvious. Ignoring it would be a serious mistake.

On the brighter side, several factors contribute to the surprising relative health I see in commercial real estate. First, this is Arkansas. Every location or state has strengths and weaknesses, and I believe Arkansas is less threatened by changing office space usage than are major metropolitan areas. An important trend to watch is the increasing discomfort with densely populated towers with crowded elevators and parking structures. As tenants seek buildings that are more accessible and have fewer forced interactions with strangers, Arkansas will benefit over time. We have fewer “tower” properties to worry about, and we have the available land and development patterns most conducive to building more accessible structures. Watch for an accelerated migration of corporate users to low-rise solutions in states like Arkansas.

Second, efficient work is collaborative, and collaboration is enhanced by physical proximity. For every announcement about how wonderful teleworking has been for a company, there is a corresponding executive comment about a recommitment to non-residential, group work environments. Our experience has been that office space users, whether a mid-sized law firm relocating from the city core to a suburban building or a major financial service company renewing a large lease, aren’t currently interested in giving up their space. Even if they have uncertainty about when or how extensively they’ll use the space, they want it available, and they can afford it. The balanced reality is that teleworking has increased and isn’t going away, but neither is traditional office space – the only question is the mix. Judging by the deals and discussions in the trenches, I am confident in office space as a solid asset class.

We also see interesting trends in other kinds of buildings. Multi-family has been sizzling for years. While values may be cooling slightly, new apartment construction continues at a strong pace, and quality projects easily attract investment capital. The market for industrial warehouse space is very healthy. All those goodies you buy from Amazon must get sorted and loaded somewhere. The need for quality medical space of all types is constantly growing as the healthcare industry innovates. Healthcare delivery will always be a predominantly physical interaction, translating to demand for buildings.

Hospitality has suffered mightily with the slowdown in travel, but it appears to be recovering. In the second week of March, U.S. hotel revenue per room reached its highest level since the pandemic began. The worst sore spot is retail, which took a hard hit from the coronavirus. Restaurant restrictions triggered a tug-of-war between eateries and their landlords, both sides trying to do the right thing without going broke. And with the already fragile in-person shopping experience further challenged by COVID concerns, large chains and mom-and-pop stores alike have struggled. Even in retail, though, not all news is bad.

One bright spot is the discount store category, where Dollar General has performed extremely well throughout the pandemic. And sometimes quality simply prevails. Our firm represents a large, Class A lifestyle center in Little Rock, where vacancy remains very low despite the challenges facing retailers.

From March 2020 through March 2021, the commercial real estate industry first felt shock, then settled into survival and stability. But what will we experience going forward? I predict the next few years will be marked by caution and innovation. Developers, owners and lenders will naturally be conservative in committing capital to real estate ventures as a landscape of changing building usage takes shape. Will corporate office users continue their commitments to the same amount of space? Will there be a surplus of vacant restaurant and shop spaces as many brave entrepreneurs decide the risk is just not worth it? Will sufficient alternative uses emerge to absorb the sea of available space in regional malls and department stores?

The answers will be influenced by the innovation that has always been a hallmark of American business. One trend will be creative re-purposing of buildings, as malls become fulfillment/distribution centers or are converted to mixed-use destinations combining living space, shopping, office, entertainment and lodging in ways not previously attempted. Similarly, more vacant retail spaces will emerge with unexpected uses, such as the impressive Premier Medical Plaza on Little Rock’s Rodney Parham Road, a beautifully reimagined former Kmart store. Another trend will be “well buildings,” in which new or refurbished office spaces deploy features like foot-activated elevators, touchless bathroom fixtures and temperature scanners – good ideas spurred to reality by a health crisis.

Our company and our clients are still buying real estate. Although it is more important than ever to be selective and strategic in choosing opportunities and structuring deals, a crucial fact remains: whether at work or home, everybody has to occupy a spot on the planet, and the planet isn’t getting any bigger.

Editor’s note: Jeff Hathaway is President of Hathaway Group, an independent commercial real estate company based in Little Rock. The opinions expressed are those of the author.