CRE investors should understand “headline risk” — and avoid falling prey to ‘headline panic’
Key takeaways:
- Headline risk is when media coverage creates negative effects on businesses or industries.
- During the pandemic, headlines speculated on the demise of some commercial real estate sectors, such as office space and brick-and-mortar retail.
- The pandemic has certainly changed CRE, but many of these doomsday scenarios haven’t played out.
- Investors should be flexible and innovative but always assess a specific property’s actual value via thorough due diligence.
In the spring of 2020, as COVID spread around the world, retailers closed their doors, restaurants shut down or switched to delivery only, and businesses sent workers home to work remotely. And news headlines soon claimed that some commercial real estate sectors would never be the same.
If restaurants didn’t need dining rooms, shoppers could make purchases from their homes, and employees didn’t have to go into an office, there was far less need for many types of commercial buildings. As the pandemic raged, sentiments like “the end of the office” and “the end of retail” were heralded by headlines and echoed by some investors.
But was this accurate? Was commercial real estate as we knew it — in certain sectors — dead or in for serious trouble? Fast forward to today, and CRE around the world is thriving. And some of the property classes that took the most heat may have changed but fared better than many analysts thought they would.
Let’s examine the phenomenon of headline risk, assesses how it may have affected the commercial real estate market, and explain what investors should keep in mind when considering trends gleaned from the news.
What is headline risk?
Headline risk refers to the negative impact of news coverage of a company or industry. In the old days, there was a delay in the effects of headline risk. Newspapers had to be printed and delivered before investors could respond. But today’s internet dominance means that businesses and industries suffer the consequences far faster.
True or not, contextual or not, a negative headline about a company or an industry can quickly tarnish its reputation and cause values to plummet. For instance, in late October 2020, a headline reported that Twitter was experiencing slower than expected growth. Almost immediately, in a single day of trading on October 29, 2020, the company’s stocks fell by 20%.
The office (and brick-and-mortar), while different, is here to stay
Some headlines heralded the demise of in-person work and the office space sector as companies went to remote work models.
Morris SE Group’s own blog took a more cautious view, noting that hybrid and remote models may change demand for office space — potentially less overall square footage, fewer custom upgrades due to shorter-term leases, and more safety features. This reasonably conservative take contrasted with speculation about “The end of the office.”
And about a year after the pandemic’s onset, a survey by the commercial real estate firm CBRE found an interesting change (emphasis added):
At the height of the COVID-19 pandemic in September 2020, CBRE’s semiannual Office Occupier Sentiment Survey found that 39% of large companies planned to significantly reduce their commercial real estate footprint. But in our latest Spring 2021 survey as the world began to emerge from the pandemic, that number was down to only 9%.
Emotions and uncertainty drove shifts in thinking and plans. When stay-at-home orders forced businesses to change operations, leaders felt like there was no end in sight. Many planned to close down some brick-and-mortar shops, reduce office space, and move further into the digital space. But even if that shift played out to the extreme — and to some extent, it happened — demand for space has recovered significantly.
And commercial real estate and its investors always have opportunities to thrive in different sectors.
Looking past the headlines in commercial real estate
The CRE sector grew in 2021. For example, during Q2, the commercial property price index increased 4.8% over the same quarter the previous year. Deal volume also grew by 81% to $243.5 billion.
And for investors who take a due-diligence-based approach, commercial real estate looks promising in 2022. A Deloitte Center for Financial Services Global Outlook Survey 2021 of 400 senior commercial real estate executives reveals they anticipate higher revenues in 2022 than 2021. Roughly a quarter or less of respondents expect stagnancy in rental growth, vacancy levels, availability of capital, cost of capital, and leasing activity.
The majority of the surveyed CRE executives (65 to 75%) anticipate growth of one to 20% across all of these operating fundamentals. And depending on the fundamental, five to 11% of optimistic respondents expect improvements over 20%.
Commercial real estate challenges
When making any decision, investors need to look at the whole picture — and commercial real estate is a large and complicated one. For example, some landlords in the residential and retail sectors face challenges collecting back rent, as many governments issued temporary moratoriums on evictions due to rent nonpayment. Thus, a proportion of these commercial real estate owners struggle to manage their existing debt.
Additionally, possible tax policy changes could affect this sector. For example, US investors closely watched the status of proposed limitations on or the removal of 1031 exchanges. This Biden administration proposal seems dead, and the “1031 Tax Deferred Exchange [is] Safe for Now.” But any future reexamination of this tax benefit —and other possible changes to tax law — could have a significant impact on CRE.
Making smart CRE moves
Investors can adopt some new approaches to succeed in a changing environment, but they must never lose sight of the fundamentals.
For example, the pandemic put a renewed focus on connecting with tenants to create stronger, longer-lasting, and mutually beneficial relationships. Some landlords even explored innovations like flexible leasing models — for instance, rents based on revenue shares.
And shifts in how people work, where they spend their money, and how they spend their time do call for innovative strategies that capitalize on new opportunities. Flexibility, such as considering retrofitting properties and repurposing spaces for alternative uses, can maximize ROI. And many property owners should keep in mind that businesses and people are going to continue to change. As a result, it’s not a bad idea to consider dynamic building designs with reconfigurable spaces to meet future needs.
Investors may also want to position themselves to take advantage of the increased corporate interest in sustainability and Environmental, Social, and Governance (ESG) concerns. These initiatives may spur greater demand for smart, energy-efficient properties designed to withstand natural disasters.
Nevertheless, while new developments can impact CRE investment and development strategies, some things always remain the same …
Due diligence beyond the headlines is timeless
When making decisions about commercial real estate or any other investments, we must consider but look beyond the headlines. The news alone can drive emotional choices. And while instincts have a role in business, numbers-driven due diligence remains the key to successful CRE investments.
Every property and decision must be assessed on its objective merits in the context of your goals, resources, and local factors. And investors must separate the perceived ‘smoke and mirrors’ value of a potential investment from its true value and predictable ROI.
At the Morris Southeast, we provide strategic guidance to CRE investors to help them achieve desired outcomes. To learn more and get assistance that goes beyond the headlines, contact us today.
