How COVID Is Making Some Developers Adjust Their Projects
As the conversations around long-term decisions start to percolate again after a six-month pause, some of the ways the coronavirus pandemic has adjusted new and upcoming developments are coming into focus.
Developers and landlords are scrambling to respond to shifts in the way people live and work and shop in future developments, from increasing apartment sizes to accommodate home offices, to pouring more money into technology and infrastructure to combat future pandemics.
“We are all sort of navigating our way through this and hope we come out on the other side," Integral Group Chairman Egbert Perry said. "During the Great Recession, really at the tail end of it, we all sort of exhaled and said, 'We won't see anything like this anytime soon, thank God.' Now here we are. To state the obvious, we're once again in a period of severe dislocation.”
The dismal data points in some commercial real estate sectors are hard to ignore. Twenty-nine retail chains filed for bankruptcy in the first six months of this year, including Pier 1, Stein Mart, JCPenney, GNC and Tailored Brands, which owns Men's Wearhouse and Jos. A Bank, according to a recent BDO report.
Retail chain bankruptcies have outpaced the numbers seen during the same six-month period in 2010, during the Great Financial Crisis, and that is nothing compared to the number of independent restaurants and hotels that are at risk of closure.
Office demand has already taken a hit as sublease space skyrockets in many of the major cities, especially as many companies continue to allow employees to work from home, with some already declaring that will last well into 2021.
The persistence of that trend could soon have an impact on apartments. Perry, a pioneer developer of mixed-income communities in Atlanta, said during his keynote during last week's Bisnow Atlanta State of the Market webinar that apartment developers will need to take into consideration the size of units, possibly incorporating home office space in the future.
“[We can anticipate] a space in the home where you can do work. [It] is something, I think, that will be here for a while,” Perry said.
Perry told Bisnow following the event that Integral is looking to create extra space in future apartment units that can be used as home offices as he expects more companies will rely on this work model moving forward.
“I think [we will need] some additional space, not much, but functional for working from home will start becoming critical,” he said. “We're tactfully seeing how we can incorporate that.”
Developers also will need to increase budgets to incorporate new technologies in projects. Jim Irwin, whose firm, Atlanta-based New City, is about to break ground on a project in Midtown Atlanta that will be home to the newsletter-marketing firm Mailchimp, said developers will have to add more money to budgets to account for rapid changes in building technologies spurred on by the coronavirus pandemic.
“We literally put a line item in the budget for future technology that will be added in a couple of years ... for our HVAC system,” Irwin said.
The pandemic has also forced builders of recent projects to adjust in light of the coronavirus's negative effects.
Carter Executive Vice President David Nelson said that the occupancy at its new student housing project catering to Morehouse and Spelman college students has dropped, even though it was fully leased prior to the start of the new school year. Due to Spelman going to virtual classes, occupancy has fallen to 60%, Nelson said.
Carter's entrepreneurial office hub in Downtown Atlanta, known as MET, also saw leasing velocity hit a brick wall, even after leasing 150K SF in the past year.
“We've been hit by several very large leases that just didn't transpire because of COVID,” Nelson said.
It's examples like these prompting banks and other lenders to become more stringent in underwriting standards, panelists said, as well as spurring corporate executives to rethink how they use the office space they have.
“Densification is dead. It is absolutely dead. Densification was way overdone and it was the theme over the last 10 years,” Glenfield Capital CEO James Cate said. “Right now, remote working is institutionalized. It has become normal. It has become expected. Your employer expects you to work from home or elsewhere."
Mixed-use projects, the darling of developers and local governments over the past decade, responding to the tastes of millennials while combating suburban sprawl and the reliance on cars, are now on the outs as well, Perry said, especially as many question the viability of retail and hotels.
The delinquency rate for mixed-use CMBS loans was on the rise. As of September, 4.7% of mixed-use project loans tied into CMBS's were delinquent, up from 1% a year ago, according to Trepp. Mixed-use properties are going delinquent at higher rates than office and multifamily.
Critical pieces of many mixed-use projects — hotel and retail — fared even worse in the CMBS market, with 26% of all lodging loans and 18.3% of retail loans in special servicing as of September, according to Trepp.
That has developers taking another look at ambitious mixed-use projects moving forward.
“Mixed-use developments, for the most part, are now going to go through a little bit of a rethinking,” Perry said.
Perry told Bisnow developers can no longer rely on a critical mass of retail to whet the appetites of consumers to want to take up residence in a mixed-use project. The reverse is becoming true. Developers are building lots of rooftops to attract retail, office and hotel.
“We're going back to the way it used to be, where retail follows rooftops,” he said.
Not everyone is convinced these trends are permanent shifts, and the strongest performing asset classes in the pandemic may not be the ones that remain so in the future.
"I think it's too early to call a winner," Jamestown CEO Matt Bronfman said. “At this point, multifamily is OK, office, retail is challenged, and industrial is better than ever."
He said Zoom meetings are only a tenuous substitute for actual in-person meetings. and in the long run, the employees who show up to the office, and in eyeshot of their bosses, will be the ones to advance through the ranks.
“I think this is work-from-home on a temporary basis because, candidly, people were worried about getting fired,” he said. “What I think you'll find is the people who are out of the office will get marginalized."
Cate said the collaboration will still be critical, and it is something that cannot be replaced by online meetings.
“I think it's very, very difficult to predict behavior now then getting beyond the pandemic,” he said. “I think the statements that we will never get back to our office … are overblown and overdone.”
RADCO Cos. CEO Norman Radow also questioned whether apartment residents, especially those who were laid off or furloughed because of the pandemic, will be willing to shell out for a space with a home office. For its new developments, the evidence of the movement just isn't there yet.
“We're seeing that the smaller units are leasing first,” Radow said in an interview. “I think it makes sense that people want that space, but I think also time will tell, because right now, value seems to be more important than space.”