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March 17, 2020
As coronavirus grips the region, signs of an economic slowdown are everywhere: Traffic is scant on empty streets, vacant restaurants are suspending operations, conventions and hotel bookings are being canceled, and brick-and-mortar retail is suffering. There's even talk of global supply chains being disrupted, especially from China, which impact the local ports and logistics market.
Meanwhile, big new developments are underway all over Seattle and the Eastside. Property owners and contractors haven't paused or suspended those projects — as happened in some cases 12 years ago with the Great Recession. Construction loans have been taken out, and foundations are being dug.
But with no end to the pandemic in sight, what effects are being felt in commercial real estate?
The first concern is simply tenant safety, says Rod Kauffman, president of the Building Owners and Mangers Association Seattle King County.
Proper cleaning, health and hygiene, janitorial services, HVAC systems, etc., are the top issues to address, says Kauffman, who says he's been so inundated with member requests for information that he's slept at the office.
“Safety and preparedness” is his mantra. Each time an office worker tests positive or shows symptoms, extra cleaning and precautions are required.
Kauffman is busy putting together a webinar for members, also open to the public, set for today. He thinks weekly updates may be necessary, given the fluid and unpredictable situation.
3 WAVES OF DISRUPTION
Kauffman foresees three waves of economic disruption. First are the ground-floor retail and restaurants. Many of those had already closed — including the Tom Douglas and Ethan Stowell chains — even before Gov. Jay Inslee's emergency declaration yesterday closing all bars and restaurants.
“It's heartbreaking,” says Kauffman of the hourly wage- and tip-earning staff being laid off for the indeterminate future. Those are friendly, familiar faces to office workers and building owners.
“We're starting to be concerned about retail tenants that may not be able to come back,” he says. If a shop or restaurant is deprived of cash flow now, how can they afford to reopen later? Laid-off employees may seek opportunities elsewhere — perhaps where housing is cheaper for service-industry workers.
Anecdotally, he says, some of his members' buildings' retail and restaurant business has fallen by 80% to 85%. The bleeding, says Kauffman, has to stop. But “everyone is wondering if this is a one-month thing, a two-month thing. But four months?” He lets that dismal thought trail off.
Ground-floor retail and restaurants were already a troubled sector in Seattle real estate, with many storefronts empty. (That's why many have become meeting spaces for the offices above.) “There were pressures on retail before,” says Kauffman. “It's not a high-margin business.” Shopping patterns have changed, and probably permanently.
Kauffman points to BOMA's own home base at US Bank Centre, where new owner EQ Office was already planning a major upgrade of its lobby and retail levels — and will end up with less retail overall. (SkB Architects is working on that 150,000-square-foot makeover.) Kauffman foresees “a new paradigm as we come out of this thing. It was headed that way anyway.”
But if a building owner/operator wants to keep open that favorite locally owned pastry shop (as opposed to a bank or chain pharmacy), rent concessions and discounts will inevitably be discussed. Some tenants may even ask landlords for loans. Or some may declare bankruptcy to get out of their leases.
The second wave of disruption will be offices. With so many big firms sending workers home to telecommute, Kauffman says that, anecdotally, some members' buildings are only 20% to 35% occupied right now.
The hope is that's only temporary, but who knows when the coronavirus outbreak might be contained? Companies that had been thinking about leasing more space may reconsider those high downtown rents.
Telecommuting from your kitchen counter is free desk space, so far as employers are concerned. And your lunch is in the fridge — which presents a problem for downtown delis in the future, if their faithful lunchtime customers disappear.
“We're already seeing some delays in signing leases,” says Kauffman. For over a decade, he notes, the Seattle office market has been “a screaming, incredible machine.” Many, before coronavirus, expected it to cool. But, he says, “If any market can recover, it's here.”
At the end of the fourth quarter last year, Broderick Group estimated that about 6.3 million square feet of offices would be delivered by 2022. On the Eastside: about 2.7 million square feet by the same date. That's all being developed — though not all pre-leased — on the presumption of a strong future market.
The third wave of disruption could be logistics and industrial, which move in concert with the global supply chain. That takes many months to course-correct.
Logistics has been perhaps the hottest area in local real estate. But Kauffman thinks effects from the coronavirus “will get there eventually. I don't think quite as fast.”
He notes how Prologis and others are committed to big new logistics centers from Sodo down to Pierce County. Commercial Cafe estimates that the Puget Sound region will see the arrival of 5.7 million square feet in 22 buildings this year. That compares with its estimate of 3.6 million square feet in 2019. And most of that space is filled by global supply chains.
Says Kauffman, “Everything in our life is coronavirus-related right now. Things seem to be escalating fairly fast.”
A CHANCE OF RECESSION
That's at the local level, where Amazon and others have fueled an unprecedented, uninterrupted long boom since the Great Recession.
At a national level, real estate analysts emphasize the flight to safety in uncertain times. Bond yields are way down, at historic lows, because everyone wants that safe asset. By comparison, real estate is generally considered safer still, though far less liquid.
Thus, in Marcus & Millichap's just-issued coronavirus note to investors, it writes, “Real estate is a long-term investment offering significantly less volatility than most other investment options.
“In the ensuing flight to safety, long-term Treasury rates dropped to a record low, offering real estate investors an exceptionally low cost of capital and some of the highest levered returns in 30 years.”
In a more regional analysis, Colliers reiterates one of Kauffman's concerns — that some already distressed tenants may never return. It cites “force majeure reviews to include or exclude epidemics.”
Colliers thinks the logistics market will trail retail and office disruption by some three to six months. And with that disruption could come a shortage of cheap Chinese steel needed to build all those new Amazon offices in Bellevue. Those costs would be borne by Vulcan Real Estate, Wright Runstad, Hines, Skanska and others now building on the Eastside.
Right now, there's no indication that such projects could be suspended. And all were planned and financed with the knowledge that the long boom would eventually cool — if not quite to the point of a recession and bear market. The good times couldn't last forever.
Matthew Gardner, chief economist for Windermere Real Estate, has long been predicting a coming economic slowdown, but not another financial crisis.
He says of Wall Street's sudden slump, after a decade of low interest rates and cheap stocks, “Whether the ensuing drop in the equity markets is guaranteed to lead us into a recession is still uncertain, but I put the chances at about 65%.”
But he still thinks a recession, if one comes, will be “relatively mild.” That would, however, lessen demand for commercial space in all sectors.
And, echoing other observers, Gardner says, “I am watching retail very closely. Restaurants and general retail are already hurting, and it will be interesting to watch how the effects of the coronavirus play out in those spaces.”
Even if, post-coronavirus, office workers return, their favorite shops and cafes may not.
Brian Miller can be reached by email at firstname.lastname@example.org or by phone at (206) 219-6517.