COVID Causing One Sector of Commercial Market to Diverge From Others
UBS says the industrial sector's performance is "relatively healthy, if softening", setting it apart from apartments, offices and retail during a challenging second quarter.
By not losing, the industrial property sector was the big Q2 winner in the U.S. commercial real estate market.
That’s the takeaway from UBS Asset Management’s quarterly Real Estate Outlook.
Data showed total returns hovering around zero for apartments and office space, and negative returns for hotels and retail. But industrial properties, while trending down, still returned about 5 percent on an annual basis at the end of June.
“Divergent sector return performance became exaggerated over the quarter,” Tiffany Gherlone, UBS’ head of real estate research and strategy wrote in the report. “Retail and hotel returns sharpened their declines as travel and in-person interactions remain restricted. June saw apartment and office appreciation returns slip into negative territory. This exaggerated the relatively healthy, if softening, performance of the industrial sector.”
Apartment vacancy is up a modest 60 basis points from a year ago, while average asking rents are down 0.6% year over year. That indicates “that landlords are letting rents slip as they struggle to sign tenants,” Gherlone wrote.
Total office vacancy ballooned 13 percent in the second quarter, with 7 million square feet of new supply coming on line. Tenants, meanwhile, are trying to decide whether to reduce space while maintaining work-from-home or creating more socially distant workplaces. “For the most part, capital improvement projects are on hold until these decisions are sorted,” Gherlone writes.
Retail also faces a time of transition, as restrictions have extended longer than initially expected and legislation to sustain small businesses has been drying up. “Motivated business able to shift towards online ordering with home or curbside delivery are more likely to succeed. Agile retailers with low levels of debt are best positioned,” she wrote.
That leaves industrial as the lone bright spot. “With many brick and mortar stores shuttered, fulfilling online orders and restocking grocers keeps the warehouse and transportation industry moving,” she wrote. Industrial properties represent a third of real estate transactions year to date and is the only sector to see rising price per square foot, according to Gherlone.
Going forward, she wrote, “There is a lot of uncertainty around two key inputs to private real estate pricing: future cash flows and current transaction metrics.” As more data becomes available, investors can be expected to adjust their underwriting.
“The downturn cut deep in the second quarter, but investors and teams are adapting,” she wrote. “We expect more adaptations and some clarity to emerge in the third quarter.”