The new Real Estate 2021 guide features 51 jurisdictions. The guide provides the latest legal information on the impact of disruptive technologies, proposals for reform, sale and purchase, real estate finance, planning and zoning, investment vehicles, commercial leases, construction and tax.
Last Updated: April 13, 2021
COVID-19 Presents Challenges for All Real Estate Asset Classes
Real estate sits at the intersection of supply, demand, liquidity and capital markets, and reflects the dynamics and trends of the broader global economy. As the third largest investment type (following fixed income and publicly traded equities), commercial real estate (CRE) has firmly established itself as a major global asset class. In that regard, CRE in 2021 reflects the unprecedented challenges of the global pandemic that dominated every aspect of life throughout most of 2020. As the world struggled with more than 135 million cases of COVID-19 and 2.9 million deaths (as of 12 April 2021) and the global economy vacillated between shutdowns and recoveries, each real estate asset class experienced its own set of challenges.
The global pandemic caused the end of the 11-year bull run following the Global Financial Crisis. The International Monetary Fund predicts that the global economy will lose over USD22 trillion between 2020 and 2025. Last year, global CRE transactional volume fell 29% according to the 2020 Capital Trends Report published by Real Capital Analytics. While a few asset classes – most notably logistics, data centres and life sciences properties – held up well or even improved, most other property types, including hospitality, retail and office, were severely impacted by the lockdowns and the work-from-home regime that became the norm during the second quarter of 2020. Government intervention, particularly in the US where stimulus legislation pumped USD4.4 trillion into the economy in 2020, plus strong underpinnings in the global financial markets enabled capital liquidity to be sustained; without these factors, CRE results likely would have been much worse.
The rollout of the COVID-19 vaccines around the world provides hope that 2021 will be a much better year. There will be many adjustments for CRE, particularly in the hardest hit sectors. Recovery in the retail sector will depend on multiple factors, including the willingness of consumers to return to physical retail locations and the ability of retailers to continue omni-channel strategies, which appear more important than ever. Owners of office buildings in cities with a heavy dependence on mass transit face the physical challenges of transporting people from home to office to individual work locations, together with the question of how office workers will shift from the comforts of work-from-home to return to the office. In the end, the CRE winners in 2021 and beyond are likely to be those that are the most creative and adaptable to the new paradigms.
Unlike 2008–09, when the underlying structural problems in the capital markets essentially froze capital liquidity, the combination of reformed banking rules and historically low interest rates meant that capital remained available in 2020. However, the challenges of underwriting asset values when the global economy was in freefall translated to a massive reduction in CRE lending. One year ago, prior to the COVID-19 pandemic, the expectations were that 2020 loan originations would increase modestly from the prior year. In fact, as reported by Commercial Mortgage Alert, worldwide commercial mortgage-backed securities volume dropped 39.4% last year. However, the same experts are predicting a 28.4% increase in 2021 in light of the vaccine rollout and a hoped-for return to robust commercial business levels.
Another factor that could affect CRE lending is the scheduled cessation of the London Inter-Bank Offered Rate (LIBOR) as the global reference rate, on 31 December 2021. Almost four years ago, the Alternative Reference Rates Committee, a group of market participants assembled by the US Federal Reserve Board, announced that the Secured Overnight Financing Rate (SOFR) was the consensus best practice to end the long run of LIBOR. SOFR is a secured, risk-free, overnight rate, rather than a forward term, unsecured structure with a bank (counterparty) credit risk component that defines LIBOR. The US Fed has reiterated that, given the potential systemic risks involved, market participants – regardless of their size or the size of their portfolios or the magnitude of their LIBOR exposure – should stop making LIBOR loans before 31 December 2021 and work toward a transition of their legacy loans away from LIBOR. While some serious tax and accounting challenges to the transition away from LIBOR have been addressed by the US Internal Revenue Service and Financial Accounting Standards Board safe harbour proposals, significant challenges still persist in the cash financial markets.
Although the original cessation date was based on the belief that at least 80% of USD200 trillion in outstanding legacy cash and derivative LIBOR-based contracts would expire by their own terms by 31 December 2021, in fact the US cash and derivatives markets have continued to enter LIBOR-based contracts, and the outstanding legacy contracts outstanding at the end of the first quarter of 2021 have increased to USD223 trillion, of which only 60% would mature by mid-2023. Faced with this significant increase in outstanding LIBOR-based legacy contracts, the US regulators decided that an extension of the cessation date was necessary to mitigate the economic consequences of the risks to individual participants of the legacy LIBOR-based contracts having inadequate or no replacement rate language in the face of the hard stop on 31 December 2021. After consultation with market stakeholders, the ICE Benchmark Administration (the UK LIBOR Administrator) announced that it will continue publishing LIBOR’s most frequently used tenors (one-, three-, six- and 12-month) until 30 June 2023. Because one-month LIBOR is the most frequently used tenor in real estate transactions and three-month LIBOR is the most widely used tenor in all other cash markets, the 18-month extension should allow most legacy LIBOR contracts (those executed before 1 January 2022) to mature by their own terms before publication of LIBOR ceases on 30 June 2023.
In the context of the discussions regarding the extension of the original cessation date, the US federal regulators have made the following clear:
It is important to note that the 18-month extension of the LIBOR cessation date, as approved by US regulators, will not affect the international financing markets that will officially transition away from LIBOR-based loans to new replacement benchmark rates at the end of 2021. For an in-depth analysis of the LIBOR/SOFR debate, see "Reports of the Imminent End of LIBOR May Be Premature", 29 December 2020, and "Libor’s Endgame: A Brief Pause, Not A Reprieve; A Safe Harbor But New Penalties", 29 March 2021, both written by Joseph Forte, General Counsel of AmTrust Financial Services.
While annual sales volumes in every asset class dropped significantly from 2019 levels, in most cases capitalisation rates remained at low levels, with predictions that the trend will continue in 2021 driven in large part by record low interest rates. In addition, the continuation of low cap rates is a function of classic supply/demand theory – ie, limited supply of investment grade properties matched with strong demand fuelled by abundant capital available for real estate assets. But the continuation of low cap rates does not overshadow many uncertainties in the CRE markets. As the US turns the page under the new administration, many challenges remain, including international trade policy, global instability from hotspots such as North Korea and Iran, implementation of the BREXIT agreements completed at the end of 2020 and, of course, the unknown and unpredictable path of the COVID-19 virus and its variants.
While history suggests that liquidity in markets is affected by both uncertainty and the prospect of substantial market changes, the strong performance of the financial and CRE markets during the second half of 2020 demonstrated that geopolitical unrest and other uncertainties can lead to demand for investment in countries that have sophisticated and relatively transparent markets, such as the US. In fact, Real Estate Alert reported on 17 March 2021 that the high-yield real estate fund universe hit record highs in 2020, undeterred by the pandemic, the US presidential election or uncertainty about property values. However, while funds are poised to be active investors, 2021 appears to be off to a slower start than anticipated, with Real Capital Analytics reporting a 58% decrease in year-over-year transaction volume in January.
In the face of the greatest global pandemic in 100 years, governments around the world have focused on controlling the virus and supporting economies. The US enacted five major stimulus packages that pumped USD4.4 trillion into the economy during 2020, and added yet another USD1.9 trillion when President Biden signed the American Rescue Plan on 11 March 2021. Among the most important aspects of the 2020 legislation were the Paycheck Protection Program (PPP) and the Main Street Lending Program. While not focused directly on CRE, these programmes enabled many small businesses to work their way through the numerous lockdowns and other COVID-19 related restrictions. The hallmark of the PPP was that loans were 100% forgivable if the proceeds were used to fund payroll, rent and other qualifying expenses. As a result, many tenants were able to continue to meet obligations to landlords when revenue streams were greatly reduced.
The US federal legislation imposed restrictions on residential evictions for most of 2020. Initially extended until 31 March 2021 by an Executive Order issued by President Biden, the US Centers for Disease Control announced on 29 March 2021 a further extension of the ban until 30 June 2021. In addition, many states and some major cities adopted legislation that prohibited evictions of residential, retail and, in some cases, small office tenants. In some jurisdictions, the legislation prohibited landlords from raising rent pursuant to pre-negotiated lease provisions. As the virus continued to spread during the fourth quarter of 2020 and into early 2021, the eviction moratoria and other tenant protections in most states and municipalities remained in place. However, on 25 February, a US District Court ruled that the federal eviction moratorium was unconstitutional, but that ruling does not affect individual state eviction moratoria (and the ruling is expected to be appealed).
The final US stimulus package of 2020 included USD25 billion in emergency rental assistance for residential tenants, allocated on a per capita basis to state and certain local governmental authorities (provided funding was applied for by 12 January 2021). The state and local jurisdictions are responsible for making the aid available to eligible residential tenants (ie, low/moderate income families), mostly in the form of relief on rent, rental arrears, utilities, utility arrears or “other housing expenses” resulting from the pandemic. These amounts can be utilised for up to 12 months (with a possible three additional months under certain extraordinary circumstances).
The legislation also included USD15 billion to fund grants to operators of live venues and movie theatres. In another effort to help small businesses, the American Rescue Plan of 2021 included a Restaurant Revitalization Fund, which allocated USD28.6 billion in grants for restaurants, food trucks, bars and other businesses in the food and beverage space. The grants are intended to reimburse “pandemic-related revenue loss”, but such losses are reduced by any amounts received from PPP loans. The aggregate amount of grants to any eligible entity is capped at USD10 million (and USD5 million per physical location).
2021 is likely to be a year in which many legislative proposals could directly or indirectly affect CRE. At her confirmation hearings, Treasury Secretary Janet Yellen endorsed raising the corporate income tax rate, increasing the tax rate on capital gains, and increasing the minimum wage to USD15 per hour, once the economic devastation of the pandemic has been reined in. The Real Estate Roundtable continues to focus on efforts to adopt a Federal Pandemic Risk Insurance Program similar to the TRIA programme that was extended through 2027 at the end of last year. In addition, a growing number of states and municipalities have adopted some form of rent control legislation, raising serious concerns for CRE investors and owners. While one justification for these programmes is to create more affordable housing, CRE experts believe that the expanding regulatory regime could chill future investment into multi-family assets and have the opposite effect on the important goal of increasing affordable housing.
Cross-Border Capital Flows
The COVID-19 pandemic impacted CRE markets across the globe. Of the 15 most active global CRE markets, only one (Seoul) saw an increase in sales volume from 2019 to 2020. The five most active CRE markets in 2020 (measured by sales volume) were New York, Los Angeles, Paris, London and San Francisco. Although total cross-border investment into the US CRE market declined by 33% from 2019 to 2020, investment activity started to pick up toward year end, and fourth quarter cross-border capital entering the US CRE reverted back to 2019 levels. The top source for global capital in 2020 was the US, followed by Singapore, Canada, South Korea, Germany, the UK and China. Despite the COVID-19 challenges, many experts predict that cross-border CRE investment into the major global markets will rebound in 2021.
Evolution of CRE
Over the years, real estate has been affected by a wide range of events that often begin with issues that have little or nothing to do with CRE. While some of those events that affected the capital markets were more closely related to CRE (eg, the interest rate crises of the 1970s and the US savings and loan crisis of the 1980s), others like the bursting of the tech bubble in 2001 had little to do with the real estate community. And, of course, while the COVID-19 pandemic had no direct connections to real estate, the impact on hospitality, retail, office and even multi-family assets in the past year may be as severe as any global event in history. However, unlike the crash of the financial markets in 2008–09 (where underwriting of residential mortgages did play a major role), the financial markets have been stable in the post-pandemic world, interest rates are at record low levels and CRE assets are generally not over-leveraged as in the past. As a result, while the challenges of 2020 cannot be ignored, the recovery looks much more promising than the last time the CRE markets began to reset in 2010.
As most developed countries went through various lockdowns in an effort to control the spread of COVID-19, both business and leisure travel ground to a halt. The effect on the hospitality industry cannot be overstated. As reported in Real Estate Alert, total hotel property sales in 2020 (with a minimum sale price of USD25 million) was only USD5.8 billion, a drop of 70% from the previous year. Overall occupancy and revenue per available room (RevPAR) also were at record lows.
The retail sector was also severely impacted by the pandemic. The combination of the lockdown orders that forced people to remain at home and the mandatory shutdowns of large gathering places like shopping malls and restaurants meant that the revenue stream for most retailers and restaurant operators disappeared overnight. The number of store closings in 2020 far exceeded even the most dire pre-pandemic predictions of early 2020. By December 2020, more than 110,000 restaurants in the US – one of every six – had permanently closed, and the National Restaurant Association estimated that another 37% of restaurant operators said they were unlikely to still be in business by mid-2021. On the other hand, retailers with strong omni-channel platforms in place that could capitalise and expand on their e-commerce offerings combined with rapid delivery and pick-up options have been able to weather the pandemic storm better than expected.
In the office sector, work-from-home and Zoom/WebEx/Teams meetings were the dominant theme in 2020. As the vaccine rollout advances, workers will begin to return to their offices to be part of a collaborative, more productive environment. In the near term, building owners and employers will continue to be focused on social distancing, contact tracing, indoor air quality and UV light installations. In the longer term, companies will re-evaluate office space requirements in light of any permanent shifts resulting from the COVID-19 pandemic and the fear of future pandemics.
In one recent study commissioned by the Building Owners and Managers Association (BOMA) International, 74% of office decision-makers viewed their workplaces as being vital to business operations, though 61% indicated they are likely to reassess how they use such space. Will suburban office buildings prosper because some businesses will abandon their historic city centre locations or convert to hub-and-spoke locations? Will the "hotelling" trend in professional offices accelerate? And, if so, what will the impact be on long-term space requirements? How will co-working businesses adapt to the new paradigm of social distancing? These and many other questions are on the horizon for 2021... and beyond.
The bright spot in CRE during 2020 was the logistics sector. While almost every other real estate asset class suffered major drop-offs in aggregate sales for the year, Real Estate Alert reported that total sales of industrial/logistics properties last year (with a minimum sale price of USD25 million) were down only 2.5% from 2019, and that 50% of the 2020 sales (USD22 billion) occurred during Q4. With the continued growth of e-commerce sales and same-day – and even same-hour – deliveries, the requirements for last mile and last meter logistics spaces will continue to rise.
Proptech continues to play a major role in the evolution of the CRE industry. While capital raised in 2020 fell from the prior two blockbuster years, apps supporting contact tracing, scheduling building entries and elevator use for social distancing, and monitoring air quality were just a few of the areas where the innovative minds in the proptech world were critical to the recovery of the office sector. To kick off the new year, Latch (a maker of smart locks and building management software) announced plans to go public by merging with a special-purpose acquisition company (SPAC) backed by Tishman Speyer. Other major real estate companies, including CBRE Group and Starwood Capital, have also raised SPAC funds for investments into real estate start-ups, hoping to profit from rising valuations and modernise their own buildings.
While the real estate industry has historically been technology-resistant, it appears that the pandemic has accelerated demand for real estate technology products. The disruption driven by proptech entrepreneurs is creating both new products that are needed in the post-pandemic world and opportunities for the most innovative property companies. There can be no doubt that proptech applications and programs will continue to impact construction, property management, development, leasing, hospitality and virtually every aspect of CRE.
Like all other industries, CRE was profoundly impacted by the COVID-19 pandemic. As in past years, CRE was also impacted by changes in technology, the economy, regulations, political uncertainty and other external factors. But 2020 was a year unlike any other, and the far-reaching consequences of the pandemic remain to be seen. In the CRE world, some of those consequences were accelerations of prior trends, most obvious among them being the challenges in the retail sector. In the end, CRE held its own as owners, investors, tenants and the general population demonstrated their resilience in adapting to continuous challenges. The future of CRE remains bright, as large segments of the workforce return to urban centres and drive the restoration of retail, entertainment, residential and general business activities. The underlying financial markets remain on solid ground and the political uncertainties that affected many aspects of life have begun to recede. Therefore, while some uncertainties and apprehension will remain regarding the length of the market cycles for different asset classes and the uncharted, long-term impacts of the COVID-19 pandemic, CRE will generally continue to perform well and is likely to remain an attractive asset class for most global investors. As a global asset class, it will almost always face local issues and nuances that can materially affect an investment in CRE. Therefore, investors are strongly advised to consult with local counsel and other expert advisers in each jurisdiction where an investment will be made.