Early last year, once the pandemic took hold and work-from-home became the new normal, many “experts” were quick to predict our recovery. We learned about V-shaped recovery, U-shaped recovery, K-shaped recovery, and even the Nike Swoosh recovery, among others. Here we are, nearly one year later, with a K-shaped recovery prevailing. Some sectors of the economy are recovering nicely, yet many are still struggling. As we continue to talk with professionals inside and outside of the commercial real estate, we’ve captured perceptions of the real estate market and thought it was time to address these five prevailing myths that have emerged in recent conversations.
Myth #1: “Commercial property values have taken a big hit this year.”
This myth is only partially true. While some commercial real estate has been devastated by the effects of shutdowns, work-from-home trends, eviction moratoriums, and business closures, not all real estate classes have been equally impacted. Hence, the K-shaped recovery.
Sure, hotel occupancies are well below norms, WeWork is closing locations, and many entertainment and restaurants have been forced to close.
However, in the Denver/Boulder market, industrial real estate and owner-user demand remains strong, multi-family remains in demand by investors, and the lack of quality commercial properties for sale is keeping prices resilient for industrial, quality office, medical office, multi-family, and yes, some grocery-anchored or single-tenant net-leased retail.
There is capital on the sidelines with a HUGE appetite for well-leased properties, and with little product on the market available for sale, now is a great time to consider selling.
It is simple supply and demand. When we measure the supply of the limited inventory available for sale compared to the investor and user demand for hard assets such as real estate, property values for many asset classes remain unchanged, with some sectors showing increased pricing despite the pandemic.
Myth #2: “The office is dead.”
While we have witnessed the work-from-home trend explode last year, the appeal has worn off, and many companies and employees are eager to return to the office. While the office might look different in a post-COVID world, there is still a need for collaborative spaces, flexible work options, employee interaction, mentorship for younger talent, and a truly enhanced culture with in-person experiences. That is not to say that companies are not considering downsizing their office footprint – many are. But the office is not dead. Our work is simply evolving, and office usage is a critical consideration for companies moving forward. The good news is that this past year has forced companies to put office use under the microscope, and many will come out with a new vision, and we expect to see a healthy amount of activity as leases expire in the coming year. Some companies are even decentralizing and looking to suburban locations in favor of urban centers. In Colorado, technology companies make headlines with announcements to open locations or headquarters in Denver, and tech firms have been among the most active in new leasing activity. While sublease listings are on the rise, a shift in how we work will bring the office alive again, just not in the way we left it behind in early 2020.
Myth #3: “The 1031 exchange is at risk, and there is nothing to buy.”
With the new administration now in place, many are concerned about the uncertainty involving a 1031 exchange, and many are also worried about raising capital gains taxes. With the few quality options available for sale in the market, some owners are concerned there is a limited pool of properties to trade into.
Full disclosure: I am not a tax advisor. Only you and your accountant and advisor can navigate your tax implications. That being said, no one has a crystal ball on this issue. The fact is, even if the 1031 exchange were to go away or be modified under the new administration, tax reform takes time and does not happen overnight. Suppose you are considering a trade, upgrading to another property type, or alternative investment such as a DST to take advantage of a 1031 exchange. In that case, this may be the year to initiate dialogue with your accountant, exchange intermediary, and trusted broker. Some owners who believe capital gains taxes will rise are considering taking proceeds now to hedge against higher capital gains taxes in later years.
Myth #4: “With the commercial real estate market in the tank, my property tax bill will be lower.”
Not so fast. See Myth #1. Also, if your property is located in Colorado, you likely received your tax bill recently, and chances are you saw an increase. That is because property taxes are paid in arrears. Under Colorado law, real estate is re-appraised every two years by your local Assessor. This occurs in each odd-numbered year (2019, 2021, etc.). The Assessor analyzes the prices of comparable properties sold during the 18 months ending on June 30 of the year before the reappraisal. This means that your current tax bill reflects property values BEFORE the pandemic, lockdowns, and economic impacts rippled through the market. Sorry to be the bearer of bad news, but do not expect a break on your tax bill this year. You will have to wait for the 2021 re-assessment to determine if your local Assessor factored in the impacts of the pandemic on real estate values – which will show up on your 2022 tax bill.
If you don’t own a commercial property but you lease commercial space for your business, this will impact your bottom line if property taxes are passed through to you as the tenant. Be prepared. Have a broker evaluate your current lease for any triple net lease charges and property tax pass-throughs so you can prepare for these costs.
Myth #5: “This is a great time to lease – there must be huge discounts for office space right now.”
I won’t pretend to be a leasing broker. However, I thought I would include this myth since I’ve heard it in multiple conversations recently. This comes as a surprise to many office users that landlords haven’t significantly dropped their lease rates in the current leasing environment. Since my background as an appraiser leads me into the thought process of property owners, I thought I could shed some light here. Owners are trying to preserve value as much as possible. While it may be a great time for a tenant to pick up incentives, such as rent concessions (free rent), generous tenant improvement packages, and pandemic-friendly lease terms that were previously overlooked, owners still want to preserve the value of their investment. After all, the value of their real estate is tied to long-term, predictable cash flow. While landlords may be willing to entice new tenants in the short run in the form of free-rent or tenant finish allowances, owners want to maintain their face rents, and many views this past year as a short blip in a longer-term hold strategy. Overall, they do not want to set a precedence for lower rents over five-, seven-, or ten-year terms. Short-term incentives are easier to negotiate rather than lower long-term lease rates. If you are a prospective tenant searching for space, put yourself in the landlord’s shoes, and you’ll see why many are hesitant to drop their face lease rates right now. If you’re still looking for a deal, then check out the growing number of sublease options. There has been an uptick of office sublease options in the market, and many turn-key options include furniture, which can result in cost savings.
Ready to talk real estate?
As you contemplate your commercial real estate market perceptions currently, I invite you to a conversation. I challenge you to define your shaped recovery and consider how commercial real estate impacts your business or your investments. Contact Jaimee Keene at Jaimee@crebenchmark.com to learn about navigating through the commercial real estate market in Denver.