Getting Back to Business in US Real Estate

Abundant capital, shifting behaviors, and a growing focus on ESG are shaping the post-pandemic future for US real estate

It is broadly understood in real estate that each property, building, and investment is unique. This principle drove the performance of the asset class throughout the COVID-19 pandemic, with each property impacted in its own way. The disruption was temporary for most sectors, but for those experiencing pre-pandemic issues, performance will likely worsen over time.

With this baseline established, there is still significant real estate capital as we emerge from the pandemic. However, this capital must be deployed selectively in a post-pandemic cycle. Investors must reassess their risk-adjusted return projections for each market and sector, considering the recent economic volatility, evolving demographics, and changing patterns of space demand.

Property Sectors and Market Performance
Disruption brings opportunities, and there is no shortage in this market. Warehouse distribution facilities and self-storage centers were the big winners during the pandemic, and investment plays remain in these sectors to improve technology and aggregate portfolios. However, a large amount of capital rushed in when there was nowhere else to go, and we are already seeing overbuilding and a rise in vacancies in several markets.  

Two other sectors that have shown positive, yet tempered, signs of recovery as we emerge from the pandemic are multi-family residential and hospitality. The multi-family market has performed well overall, but risks remain in the collection of past due rents and the evictions that will likely occur as moratoria are lifted. For hospitality, the recent boom in leisure demand has put it on the road to recovery, but this uptick in activity will not outweigh the longer-haul return of lucrative business and large-group travel.  

There are also higher-risk areas, however. Retail struggled pre-pandemic and will continue to suffer through the painful process of reducing inventory until supply and demand are finally balanced. Office is a new and unfolding story – perhaps the only one shaped irrevocably by the pandemic. In most cities and suburbs, employees are returning to work. But in the gateway cities, which are reliant on mass transit, the return will be slow: many companies across the nation will likely employ a hybrid approach combining working in the office with working from home. As such, we expect office leases to require more flexibility to proactively manage the square footage and configuration of their space going forward – the much-disparaged coworking companies may finally have their day, if traditional landlords don’t take the business from them.  

The recovery of property markets in major US cities is being impacted by the accelerated migration to warmer, lower-tax markets. While the magnitude of sudden population movements is likely overstated, investors must carefully watch shifts in corporate and consumer behavior. Urbanism is certainly not dead, but cities are increasingly unaffordable. As millennials are getting older and having families, they are starting to leave the cities for suburbs where they can rent homes, which is driving a boon for the single-family rental sector. Generation Z should also be watched closely: early studies are revealing trending preferences including a desire to stay in the suburbs and invest in home ownership.  

Capital Formation
As mentioned, there is still plenty of capital available for real estate investment. Unlike during the Global Financial Crisis (GFC), the debt markets reopened after only a brief pause, but with tougher underwriting standards and an aversion to retail and hospitality. Private bridge lenders notably played a bigger role in providing liquidity than they did in the GFC, helping owners get through short-term illiquidity as bank and commercial mortgage-backed securities lending receded.  

Property sales volume, however, remains low, as wide bid-ask spreads are providing fewer benchmarks for post-pandemic property valuation. As a result, most sellers appear willing to wait until stability returns to properly assess property values. Nonetheless, private equity funds continue to raise more capital, seeking the relative returns that only real estate can provide.  

Not to be outdone by broader market innovations, leading real estate investors quickly got onboard with special purpose acquisition companies (SPACs). While enthusiasm for SPACs has recently waned, the vehicle could add to the arsenal of capital-raising tools for real estate investments. To date, most real estate SPACs have focused on property-related technology investments, but some have been formed to invest in properties.  

Recent price volatility of SPACs in general may scare away institutional investors; but, if that stabilizes, SPACs may prove to be the next wave in aggregating capital for real estate. If not, the private equity firms will swoop in to pick up the pieces.

ESG Demand beyond Box-Ticking
Institutional investors are increasingly prioritizing environmental, social, and governance (ESG) criteria, and that focus is becoming more sophisticated. Early qualifiers such as green walls, solar panels, or LEED Gold Certificates are no longer enough for managers to attract capital. Investors are now asking managers to not only reduce their portfolios’ carbon footprint, but their companies’ as well.  

The issue is also moving beyond the ‘E’ component. It’s no longer just about fuel and water usage; the ‘S’ and the ‘G’ are equally important. Social factors mean understanding all of your constituencies –investors, employers, vendors, tenants, and the broader community – and providing equal opportunities for diverse talent. Drilling down further, this encompasses recognizing achievement, providing appropriate compensation, and developing careers.  

Governance factors being scrutinized involve setting principles, policies, metrics, and accountability for a company’s environmental and social initiatives and following through with ongoing communication to all stakeholders. Neighborhood involvement, vendor selection practices, tenant safety measures, and building design are all components of a broader ESG strategy to attract new capital.

A New Landscape Ahead
The pandemic has shifted the risks and rewards of real estate investing, and has changed demand patterns. The deal underwriting process is more complex: cash flows and valuations are harder to predict because the near-term risk is inherently higher. As such, we should expect demand for higher yield from investors.  

As we look out at the year, we expect transaction volume will recover, and real estate debt and equity capital flows will return to pre-pandemic levels. But investors should be mindful of recent tax proposals, particularly higher capital gains taxes and limitations on like-kind exchanges. One area we expect to be attractive under a high-tax regime is Qualified Opportunity Zones, or areas deemed to be distressed communities.  

Ideally, a year from now we hope to look back and see the pandemic behind us; the resilient real estate industry will have returned to the business of building and improving communities.  

About EisnerAmper
EisnerAmper LLP’s dedicated Real Estate Fund practice supports real estate private equity, Qualified Opportunity Funds, private REITs and property-level JV funds. Our advisors address complex matters, such as navigating operating agreements, waterfall provisions, and specific investor-ownership issues.  

EisnerAmper LLP, one of the largest professional services firms in the world, is a premier accounting and business advisory services firm with 200 partners and principals, and over 2,000 professionals. The firm provides audit, accounting, and tax services; valuation, due diligence, internal audit and risk management, litigation consulting and forensic accounting; as well as technology, compliance and regulatory, operational consulting, and other professional services to a broad range of clients.