For the next few weeks we will share some thoughts from four industry leaders as we try and navigate through these challenging times. ULI Chicago will do as we have always done…look to our members to bring clarity for a moment in time each week.  Stay with us and pause every Monday morning as we prepare for the week ahead.

If you have questions or want to share your thoughts, email us at [email protected].  Looking forward to an ongoing conversation.

All the Best,
Cindy McSherry
Executive Director | ULI Chicago
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KEITH LARGAY
Senior Managing Director, Chicago Office Co-Lead | JLL Capital Markets
District Council Chair | ULI Chicago

We are living in unprecedented times.  The world is very quickly shutting down as a result of wide spread quarantine as a means to stop the spread of COVID-19.  The world, our economy, and our political system were designed for growth, not globalized retrenchment.  The real estate world  has always been the physical space that houses the economy: the buildings in which people live, shop, work, and play.  That physical world is dealing with the same issues as the broader economy.

As we think about the real estate capital markets, the environment is changing daily.  As it relates to transactions, what we are seeing is the following:

• Deals in Closing – Most capital markets transactions far along in the closing process are moving forward. Capital is generally honoring their commitments and hoping to close transactions over the next couple weeks.
• Deals in the Market – Super-core transactions with sustainable cash flow are generally pricing well. Investors (equity and debt) are struggling with how to price transactions that have near-term cash flow risk.

The real estate investment market must figure out how private real estate transactions should be priced given that the stock market has fallen 35% from its January high, corporate bond spreads have widened significantly, corporations are quickly drawing down their credit facilities from banks, and near-term cash flows of assets are difficult to predict.  How do you price a hotel if no one is staying there and people are generally prohibited from moving, but you know there is long term intrinsic value?

Right now, there are a lot more questions than answers.  What we do know, is that going into this crisis the economy was fundamentally healthy and banks were flush with liquidity.  Fortunately, when things normalize, we expect normal economic activity to resume.  People will want to travel, eat out, and work together again.  These trends are starting to be apparent in China, as they begin to recover from the impact of COVID-19.  Hopefully we get through this quickly!   More updates next week as we have additional data points.

MARY LUDGIN
Senior Managing Director & Director Global Investment Research | Heitman LLC

REM’s classic song, It’s the End of the World as We Know It has been playing in my mind for several weeks. The pandemic has caused an economic rarity – a simultaneous shock to supply and demand. Economies around the globe have come to a virtual standstill, put into pause mode by their governments in an effort to limit transmission of the virus and save lives. The US, though relatively well-positioned economically when the outbreak started, now faces the prospect of a multi-quarter recession. This recession will trigger changes in property cash flows, market fundamentals, investor sentiment, and property valuations.

How deep the recession will be and how long it lasts are unknown today. The trajectory of the economy depends on the course of the virus and how effective actions like shelter-in-place are in limiting transmission. It also depends on the policy response to the economic shock. After an initial phase of denial, most governments are preparing stimulus plans to help us bridge to the future. Central Banks have cut rates, using a tool helpful in prior recessions but one ill-equipped to halt a supply-side shock. Stimulus needs to address liquidity and the threat to solvency for the hardest-hit individuals and businesses. The final element that will affect the depth and duration of the recession is behavioral. This relates to how we – individuals and businesses – respond during this period of workplace shutdowns, working from home, and sheltering in place. It also involves what people and businesses do once such restrictions are loosened.

From a capital market perspective, equity capital is largely on hold. Pension plans and other institutional investors know that recessions represent buying opportunities but they need more clarity about the recession’s path first. Further, many of these investors are at or over their real estate allocations now give the stock market sell off. Debt providers remain open but have instituted floors and widened spreads. Property types that will fare best in this environment are the defensive sectors. First among them is medical office, because of its recession-resistant demand-side characteristics and because it is not prone to speculative construction. Apartments are generally well positioned, with caveats given how much supply has recently delivered in some locations and how many units are under construction today. Storage has defensive characteristics but the starting point for a storage property makes a difference. The storage assets that will best weather this storm are stabilized properties in locations where the competitive inventory is also stabilized. Student housing has been among the sectors investors consider defensive. But student housing assets face unique challenges now, as universities close with months of the school year yet to go and uncertainty about when they will reopen clouding the leasing season for fall. Adding to the lack of clarity are travel bans and closed borders. This sector usually benefits from enrollment growth as a recession sends people back to school to freshen up/expand skill sets. Whether that dynamic bolsters tenant demand once universities reopen remains to be seen. Industrial assets serving Amazon and other beneficiaries of work from home will fare well; those related to manufacturing and stocking stores selling discretionary goods will struggle, as will the retail and office sectors.

MOLLY McSHANE
Chief Operating Officer | The McShane Companies

The current market conditions are impacting construction and development in different ways. The construction industry’s environment is inherently different from the office environment in that it is frequently open air, or individuals are widely dispersed indoors. This setting makes it much easier to proceed with work under current social distancing & CDC guidelines, and we are pushing forward with work on all of our projects with intense focus. The impacts we anticipate on our jobsites will likely be driven by the municipalities in which we are working. Different cities and states are issuing new regulations every day which may impact our ability to continue work.   One of the current issues on our active jobsites are challenges getting permits and inspections promptly due to shortages in manpower or remote working environments. In all of our regions, we are proactively preparing for the possibility of a jobsite shut down by ensuring we have a safe and secure project with protected perimeters and roofing in place where possible. Our most significant opportunity and priority right now is to continue to serve our clients as a reliable partner.  Hand-in-hand with this is our focus on providing the much-needed income for all of the hourly employees on our jobsites.

In the development world, projects in their early phases are most impacted by the current environment. As referenced above, getting timely entitlement approvals, construction permits and prompt inspections is becoming a challenge. For built projects in lease-up mode, we anticipate things could start to take a bit longer as building tours become trickier and companies pause to understand the impacts on their businesses . That said, at the time I write this, we are still actively negotiating leases for tenants who need space to occupy as soon as possible. Stabilized properties have a bit more breathing room to wait out the storm. Given the uncertainty in capital markets, with the denominator effect likely to play a role, many are predicting short to medium term upward cap rate movement. As a merchant developer heavily weighted toward Class A industrial, this could impact us less severely, but sales that we initially anticipated happening later this calendar year may see a delay. An opportunity we are keeping an eye on is previously controlled sites becoming available again, as some groups may choose to unload. Additionally, we expect that the current surge in e-commerce will have some permanency in the elevated demand – and that bodes well for distribution buildings.

JON TALTY
Chairman & CEO | OKW Architects, Inc.

A term I never heard before the start of this month – social distancing – flies completely in the face of our profession. Architects are collaborators. Our work, more often than not, focuses on bringing people together, not distancing them from one another. It’s about space and place making, whether it be a public square or a room for family to gather. Today, that thesis of connectivity is being challenged and reconsidered.

OKW practices architecture through a broad range of disciplines; from healthcare and retail, to housing, hospitality, and workplace. If there is a single thread connecting nearly every client and opportunity, it is the want for an experience. We are constantly in search of something to entertain, surprise, and engage us.  Our healthcare work is changing the paradigm by viewing its spaces through hospitality and retail lenses. Our senior housing and workplace arguably push hospitality to the forefront of design considerations.

With the sudden onset of Covid-19, we are being told to distance ourselves from one another. The idea of “benching” in a workplace has given all of us reasons to reflect on the modern workplace and how we gather on a daily basis. Furthermore, the notion of a storefront retailer or healthcare provider serving as both a provider of goods or services as well as a community center (think Starbucks and NorthShore University HealthSystems) is now a questionable premise.

These fears will not and cannot be sustainable. We are social animals. We are simply learning a lesson to be smarter than we were before. Lessons are often learned the hard way, but in the end, we need one another and we learn from one another. It cannot be replicated through a screen and syllabus provided by some remote individual.

Perhaps the result will be better technology in the surfaces that make up our workstations, or the hardware on our doors. It might be more sophisticated air filtration systems weaving through our offices or improvements in the treatment of water thorough our infrastructure. Perhaps it is as fundamental as the way we greet one another, especially the aged or medically compromised. We are learning new lessons daily. We are resilient. From this tragic development will come better and best practices that we have not yet considered, and we will all be better off for adopting them.

Opportunity
The healthcare industry will lead the way following this Covid-19 experience. We must foster and implement a new way of thinking to better respond to cataclysmic events, resulting in better preparedness for the next pandemic. Our hospitals and care facilities will have more flexibility to accommodate patient demand. Assessment of mass triage will evolve. It has already embraced the implementation of temporary structures and modified vehicular circulation to its problem-solving arsenal. Buildings that today sit empty or underutilized can be repositioned for flex space in cases of emergency.

At home and at the office, our technological infrastructure will continue to accommodate remote connectivity. Telecommunication companies and providers of remote communication services (Skype, Zoom, Google) will no doubt take the opportunity to upgrade and scale their infrastructure to account for future surges in demand. But none of this will happen without the insight, determination, and creative thinking of design and technical professionals, the drivers of the built environment.

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If you have questions or want to share your thoughts, email us at [email protected].