Insights

Real Estate Asset Classes in the Commercial Space

Despite the initial shockwaves felt at the onset of COVID-19 in early 2020, certain sectors of the real estate market have proven to weather the storm with resounding resilience, and some asset classes have barely missed a beat. Soaring e-commerce sales have accelerated the demand for industrial properties, and multifamily properties have seen rising rent prices coupled with low inventory, making this asset class an attractive choice for investors in top markets.

While some asset classes rebounded quickly, others may have changed for the long term. The pandemic helped transform the idea of a traditional office and reshaped the way we interact, as remote work has become a steady option for many, and certain businesses fundamentally shifted their reliance on brick and mortar to digital operations. What does this mean for office spaces and living spaces? Is a reset anticipated in the near term?

Other asset classes have had to reimagine their operations and long-term vision to stay competitive in the market. Seniors housing and healthcare real estate experienced several challenges that placed pressure on facilities, including decreased occupancy, recruiting and retention, and rising operational costs. As a result, owners and operators are exploring ways to both increase revenue and control costs while growing occupancy, especially as the tide begins to rise with the baby boomer generation.

With so many unusual, unpredicted trends stemming from COVID-19, last year’s broader macroeconomic recovery presented an overall solid rebound. Bloomberg reported a record 6.4 million jobs created in the U.S. in 2021; leisure travel made a strong comeback in 2021, with the U.S. Travel Association predicting that domestic leisure travel will exceed pre-pandemic levels in 2022. However, even with widespread vaccine availability, the passage of an historic bipartisan infrastructure bill, kids back in school, and a healthy real estate market, experts remain optimistic but mixed on the shape of the recovery in 2022. The World Economic Update from the International Monetary Fund headlines “Rising Caseloads, A Disrupted Recovery, and Higher Inflation.” New mobility restrictions resulting from COVID-19 variants, rising energy prices, and supply chain bottlenecks resulted in higher inflation than originally anticipated and changing predictions for more moderate growth in 2022.

As seen in past market shifts, while the appetite of traditional lenders moderates, bridge lenders continue to demonstrate their viability during economic setbacks and will play a key role during and in the post-pandemic recovery period in the real estate market. Now, as opposed to being considered an esoteric financial product, bridge lending has cemented itself into the mainstream financial ecosystem. Many property owners and operators will enter 2022 with the need for capital to reposition, renovate, or acquire value-add properties as a result of the ongoing changes, effects, and opportunities resulting from the pandemic. Here’s what investors should anticipate among the asset classes in 2022.

Seniors Housing Experiences Favorable Tailwinds

Both real and perceived issues related to widespread, devastating outbreaks in seniors housing facilities caused serious operating and economic challenges for owners and operators. In addition, the increase in cost of protecting the residents, including the cost of personal protective equipment, testing and quarantine procedures, occupancy hurdles, and isolation and depression among residents became very large challenges. While most facilities already had procedures in place to address outbreaks (i.e. influenza), many were still faced with incidents of infection but fortunately were saved from more severe outbreaks.

Well-operated seniors housing properties saw an uptick in new resident activity in the fourth quarter of 2020 and the first quarter of 2021, as vaccinations for seniors were rolled out and virus containment grew. While the Omicron variant had a general impact on facilities, it was not as severe as the original outbreak, and because many facilities were experienced in handling the various surges, well-managed facilities may offer residents a more protected environment versus being exposed to the general population.

Although some of the financial, regulatory, and procedural impacts will continue to linger, the long-term prospects in this sector remain favorably strong due to its unique resiliency combined with demographic tailwinds. Because of the increasing age of baby boomers, the seniors housing sector has started to prepare for the demand with a focus on attracting residents by aligning with their interests, needs, and expectations. These include health and wellness programs, new amenities (such as salons, aquatic centers, and spas), recreation options, and technology-enabled services.

Because of the sector’s market strength and impending demographic apex, Wilshire believes that increasing its lending focus in this asset class will provide the most attractive risk-adjusted returns to its investors. Wilshire’s lower loan-to-value investments provides a significant protective equity cushion for investors, providing a conservative investment strategy for investors looking for a non-correlated asset to the stock and bond market that provides stable income and principal protection.

Movement in Multifamily

Occupancy and rents in multifamily properties have been on the rise for nearly a decade. Even during COVID-19, the multifamily market remained positive and remained largely untouched by the effects of the pandemic. This strong demand for apartment living may attribute to the housing market’s low inventory and steep sale prices, which has priced many out of the single-family home market.

Younger renters are also shaping new trends among the multifamily asset class with a focus on health and wellness and work-from-home amenities. Since remote and hybrid work has now become the norm, renters are now expecting more out of their living space and seeking out features like dedicated co-working spaces, built-in high-speed internet connectivity, and soundproof units. Owners and operators will be encouraged to update building layouts to accommodate for these new demands to stay competitive in the marketplace.

Wilshire’s experience in multifamily lending will continue to focus on infusing short-term bridge loans into value-add properties and strategic acquisitions as owners and operators look to make property improvements to attract and retain renters.

Industrial Leads the Way

Industrial and warehouse properties didn’t skip a step during the pandemic in response to the flood of e-commerce sales, especially those properties in well located areas near ports and transportation corridors. Further, due to the online retailer’s need to reach the “last mile” of distribution, smaller warehouse and industrial properties either saw a direct lift through sales or leases to online retailers or an indirect lift from the resulting demand and lack of available inventory.

Although the surge in and growth of online retailers during the pandemic will not continue at the prior breakneck pace, strong demand is expected to continue in this sector for the foreseeable future.

The Rebirth of Mixed Use

Mixed use, whether residential over office space or residential over retail space, is taking steps to rebound from the various issues impacting each segment of the property, including business closures and moratoriums on tenant evictions. The residential component of mixed-use properties will rebound faster than the office or retail components, as the demand for apartment leasing continues an upward trajectory underscored by the continued housing market frenzy. For lenders, this means a heavier reliance on the residential component when underwriting these property types.

While not a new trend, mixed-use properties experienced a rebirth during the pandemic when consumer shopping behavior transitioned from malls and big box retail to mixed use and strip centers. As such, some investors, owners, and operators have their eyes set on mixed-use zoning and adaptive reuse projects to be a value-added investment to address changing needs in the post-pandemic era.

Office Space in Limbo

Office utilization rates remain low due to concerns of COVID-19 transmission, but for the first time since the start of the pandemic, the U.S. office market showed positive net absorption during the fourth quarter of 2021. The National Association of Realtors, however, calls it “the tale of two bifurcated office markets,” noting that primary markets, such as New York City, San Francisco, Washington D.C., Los Angeles, and Chicago, show weak growth compared to secondary markets, primarily in the Sunbelt states, which show steady growth in the office space sector. So, while vacancies in core markets remain elevated, and there’s an increase in sublease listings as tenants continue to downsize, Class A buildings in ideal locations with smaller footprints (i.e., at or below 2,500 sq. ft.) are showing some signs of demand.

With consideration to the lopsided landscape of the real estate market right now, landlords are now reimaging and repurposing existing spaces to respond to market demands. In addition, they are also proactively seeking tenants through various concessions and offering more favorable economics for tenants, i.e., free rent periods, lower escalation provisions, move-in allowances, etc.

Looking down the pipeline, lease brokers are anticipating that office spaces will start to rebound in late 2022 or early 2023.

In Conclusion

The market trends in various asset classes suggests an optimistic outlook for bridge lenders in 2022, with seniors housing, multifamily, and industrial leading the way. Wilshire will continue its conservative approach to investing, while keeping pace with market shifts and elevating its focus in the seniors housing and healthcare real estate sector.