USRT - Commercial Real Estate Faces Short-Term Challenges But Could Have Long-Term Opportunities
2023-04-18 03:35:00 ET
Summary
- Why workers in North America are falling behind the 'back to the office' drive.
- Commercial real estate has challenges but also opportunities for investors.
- The importance of a diversified portfolio when holding real estate.
The post-pandemic return to office may have gotten off to a slow start in parts of North America. But Colin Lynch, Head of Global Real Estate Investments at TD Asset Management, says the current climate shouldn’t be seen as the new normal and may provide investment opportunities.
Transcript
Kim Parlee: Many desks sit empty or underused, as workers embrace a more hybrid alternative, and that's raising concerns about the overall outlook for commercial real estate. For more, we're joined by Colin Lynch. He is Head of Global Real Estate Investments at TD Asset Management. It's so great to have you here.
Colin Lynch: Well, thanks for having me. Good to be here.
Kim Parlee: It's a pleasure. Let's talk about commercial real estate, and I feel like on one hand, there's some issues. People are talking about what's happening. On the other hand, I'm sure there's some great opportunities. But let's just talk about what's happening. When you survey, what are the things that people are watching right now?
Colin Lynch: Well, it's an interesting time for sure. There's a lot of difference across the world. There's a lot of difference by property types. There's a lot of difference by risk strategy, as well. What do I mean by that? I mean income-producing properties versus things in development.
Kim Parlee: Got it.
Colin Lynch: So geographically, we are seeing difference between North America and Europe and Asia. Let's look at office, return to the work in the physical workplace is something that is different. Here in North America, it's a little bit slower. In Asia-Pacific, there's a lot more folks in the office.
Kim Parlee: Hmm. Why is that?
Colin Lynch: Well, a couple of reasons. One, people live in much smaller accommodations. So if you're in a 200 to 300 square foot apartment, in Tokyo, it is a lot less attractive to be working at home all day long. So that's one thing.
The other part is expectations, cultural norms. There is a much stronger face time environment in places like Japan, South Korea, Hong Kong, Singapore, than there is traditionally in North America. So combine both together, and you see a lot more individuals in the office five days a week.
Kim Parlee: So the office real estate is looking better in Asia than it is in North America.
Colin Lynch: That's correct.
Kim Parlee: Europe, you were saying?
Colin Lynch: Europe is actually closer to Asia than it is North America. So in France, in Germany, you see higher office utilization, particularly in centers like Paris. London is a little bit of a mixed bag, certainly higher office utilization than what we see here in North America, but a little bit lower than what we see in Paris, too. I think there, there is also that correlation between size of accommodation, a little bit smaller in a center like Paris than we typically see here in North America.
Kim Parlee: Do you see anything shifting in the North American office market? On one hand, if we are-- it's all these weird contradictory forces happening, but if we do hit into more of a slowdown, and there is more people back to office, those are counter-trends. So how does that net out?
Colin Lynch: Yeah. It's very interesting, and we've never gone through this before. So we've got a couple cycles. Let's start with real estate serves the economy, and so if the economy is slowing down, then the implication is tenants and occupiers, physical occupiers of real estate need less space. And we've seen that all the time.
Now, within that trend we see a flight to quality. So if you're a tenant, and all of a sudden there is space available in a better location, in a nicer building, generally put, tenants will use that opportunity to upgrade. And you might pay the same price as what you were paying in your original space, but you might get a better location, better quality. So that's one thing.
You also have another thing, which is working from home. And we started in 2020 fully in office, then we went fully at home, and now we've been gradually progressing back to the office. We're in hybrid, but hybrid was one day a week, two days a week, and now we're approaching three days a week. The question is, where do we end up?
Kim Parlee: And what do you think, based on your analysis?
Colin Lynch: Well, it's really hard to say, but my guess is we'll eventually, over the next three to five years, end up in an environment of three to four days a week, probably closer to four.
Kim Parlee: Yeah.
Colin Lynch: Hard to say that five days a week will come back fully, but generally, a Monday through Thursday in the office environment, three to five years in the future, is what I would almost guesstimate that we might end up.
Kim Parlee: I feel like we're just scratching the surface. There's so many interesting trends. I've only got a couple of minutes, but we talked about office, but what about retail and industrial? Again, I know by geography it matters too.
Colin Lynch: Yeah. You know what's interesting on retail? We have seen a real return to the physical environment of retail. So when we had the lifting of restrictions, we saw a bit of pent up enthusiasm, and the question was how long will this pent up enthusiasm last? We're still seeing pent up enthusiasm.
Kim Parlee: Interesting.
Colin Lynch: So we're--
Kim Parlee: And that means spending, I'm assuming.
Colin Lynch: Spending, right. So initially, the volumes were down in terms of foot traffic in enclosed shopping centers, even other types of retail formats. But what we were seeing was people spending more per trip. Now, people are still spending more per trip. Part of that's inflation, but part of that's additional goods being bought, and we're seeing the foot traffic increase. And so for the first time in a long time, in certain parts of retail, we're actually seeing some optimism.
Kim Parlee: Is that sustainable, though, just given the trajectory that people are worried about?
Colin Lynch: Well, let's go back to the economy. And ultimately, real estate serves the economy. And so I think here, if you think long term, you've got to look at the different types of retail. You have a central retail, like grocery and pharmacy. You have tenants like banks, and then you have tenants that serve more fashion and luxury and electronics.
Certain subsectors are more immune from e-commerce or more affected by e-commerce. And so if you look over the long term, the essential part of the retail landscape, the grocers, the pharmacies, are going to be a bit more immune to the effects of e-commerce, and that is a very relevant trend over the long term.
If you look at industrial, that has-- and what do we mean by industrial? Well, we used to mean manufacturing facilities. Now we really mean warehouses, the mechanisms through which we flow those goods through the system. That has truly increased over the last three to four years. And we've seen that increase begin to level off, but at higher levels than where we were in 2020. So ultimately, the rents have grown dramatically pretty much across the industrial world. But particularly in North America is where we've seen the fastest rental growth in industrial. And that might continue, but certainly not at those levels.
Kim Parlee: I've only got about 15 seconds here. This is fascinating. I wish I had two more hours, actually. But I would just think for you-- and we talked about this too when you were walking in. But you talked about generational opportunities. Some people, when things are hard, there's some real opportunities. So just what kinds of opportunities are you seeing?
Colin Lynch: Well, so first off, we've seen significant change in values in places like the United Kingdom. And there you've seen declines in property. The declines have been significant, and when you look over the long term, capital has flown into places like London from multiple parts of the world. And so if you have a decline of 20% to 25%, and you believe in the real estate and the location, the dirt is relevant, then that is an opportunity that rarely comes along, to acquire incredibly well-located property at a significant discount to what it was trading two to three years ago. Just using that as one example, there are few others, but that's where there's an opportunity in today's environment.
Kim Parlee: It's fascinating talking to you, Colin. Come back, please, and talk more about this.
Colin Lynch: I'd love to.
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Commercial Real Estate Faces Short-Term Challenges But Could Have Long-Term Opportunities