Unpacking the investment opportunities in U.S Commercial Real Estate
John Murray, the head of PIMCO’s global private commercial real estate investment team, discusses the current state of CRE and provides a sector-by-sector look at where PIMCO sees both opportunity and risk.
Sara Benwellposted on Friday, June 25, 2021
Sara Benwell: Could you briefly describe the current state of the U.S. commercial real estate (CRE) market?
John Murray: The CRE market is in a period of heightened volatility as owners, lenders, and renters continue to navigate the impact of COVID-19. While public CRE markets have recovered from pandemic lows, uncertainty persists.
This is reflected in private transaction volumes, which are down 49% since January 2020[with wide bid/ask spreads. We estimate overall CRE values are down on average 5% from pre-COVID levels (March 2020) with substantial divergence across asset types.
Retail and lodging have been the clear losers since the start of the pandemic. Retail has faced headwinds from e-commerce for years, and the fundamental pressures are particularly challenging in the U.S., which has five or six times the retail space on a per capita basis compared to other developed countries like the U.K., Japan, and France.
"Retail and lodging have been the clear losers since the start of the pandemic."
The pandemic has accelerated this downward trend. In contrast, we expect hotels to eventually recover, with some market segments, such as drive-to-leisure, recovering sooner than others.
The winners since March 2020 have been multi-family and industrial. Industrial has benefited from the same e-commerce trend that’s decimated retail, and we continue to see strong tenant and investor demand for warehouse assets.
Multi-family has held up relatively well benefiting from government stimulus programs and reduced consumer spending overall.
"Office performance is likely to experience significant dispersion based on markets and the quality of asset"
The office sector is the wild card. Current office-using job growth varies widely around the country. In the Sun Belt, office-using jobs have fully recovered from pre-COVID levels, while in denser markets, like San Francisco and New York, job growth is still down over 2-4%.
How does that translate longer term after we return to office? Most agree working remotely will persist to a degree, but that will be somewhat offset by tenants requiring more space per employee.
Office performance is likely to experience significant dispersion based on markets and the quality of asset; but generally speaking, buildings that cater to smaller tenants will likely face more significant headwinds as smaller tenants tend to be more sensitive to rental expenses, and thus more prone to re-evaluate their space needs
Sara: What are some things that investors should be mindful of as they are thinking about investing based on property type?
John: It’s important not to paint with too broad of a brush when we talk about individual sector outlooks. Although a sector may be performing poorly, it may still present attractive investment opportunities.
The lodging sector has arguably been more disrupted by the pandemic than any other property sector, with most hotels experiencing revenue per available room (RevPAR) declines of over 50% as of March 2021]; however, we’re starting to see recharged demand alongside economic improvement.
Overall, we anticipate a return to 2019 RevPAR in the 2023/2024 time frame. With the price declines that have occurred, hospitality can offer compelling debt and equity investment opportunities.
"The lodging sector has arguably been more disrupted by the pandemic than any other property sector,"
Industrial is the other side of the coin. While it has been the darling of CRE, there are a couple things to be aware of.
First, not all industrial is created equal. Certainly, the big-box, long-term Amazon-leased assets are in high demand, but a lot of industrial, including so-called last-mile industrial, are smaller footprint, older buildings.
Smaller buildings imply smaller tenants, which can be of lower credit quality or more vulnerable, like restaurants or hotel suppliers.
Second, industrial is not immune from shadow supply. In 2020, as many corporations looked to raise capital, we often saw them pledge their owned real estate, including a surprisingly large amount of warehouse space.
This type of space does not appear in broker vacancy reports because it has been owned and housed, essentially, from some of the distressed corporates, including retailers.
Sara: Any final thoughts on how to think about the risk versus opportunities?
John: While we’re seeing the broad swath of sectors in various stages of distress and recovery – we are still applying the same level of cautious optimism to the long road to recovery.
Across property types, we are focused on resilient assets and locations and our team spends significant time underwriting a wide range of probabilities and outcomes.
"Our philosophy is buy at a conservative basis and have optionality"
In hospitality, for example, we identify a baseline by utilizing 2018-2019 RevPAR and then baking in conservative recovery estimates in the 2023-2024 time frame.
Our philosophy is buy at a conservative basis and have optionality through rent growth, lease-up, cap rate compression, etc. which is all additive to returns. This is ingrained in how we evaluate risk across cycles at PIMCO – and it’s definitely amplified today.
 Source: RCA, as of 31 March 2021
 Source: Green Street, as of 31 May 2021
 Source: Costar, as of 31 March 2021