Global Commentary on COVID-19 and Infrastructure Trends

While businesses are beginning to reopen, it will likely be two to four years before prior demand peaks are reached in the more severely affected sectors, according to Russell Devlin of AEW Capital Management.
Russell Devlin

While the COVID-19 downturn hit more quickly and with more severity than prior downturns, the impact varies greatly by sector, as sectors such as industrial, apartment, and storage have seen more muted declines, while sectors such as retail, lodging and, to some degree, office have been more severely affected.

Some smaller sectors that have been uniquely hard-hit by the COVID-19 outbreak have strong underlying drivers that should support demand once the pandemic passes.  Student housing, for example, should rebound as colleges resume normal activities. Additionally, while occupancies in senior housing have been meaningfully impacted in the near term, with some state and local regulations preventing move-ins, there are already signs of demand for available units. Industry surveys have highlighted the desire for new residents to move in, as restrictions ease and the demographic wave of Baby Boomers is very much still a tailwind for long-term demand.  

While businesses are beginning to reopen, it will likely be two to four years before prior demand peaks are reached in the more severely affected sectors, but we still view these disruptions largely as cyclical declines.  They should wane and reverse course at some point, but the economy will track the virus and the property markets will track the economy, so that point is difficult to pinpoint at this time. 

There are indeed structural impacts that will result from the COVID-19 outbreak that are wide-ranging and in most cases will accelerate trends that were already evident.

Data center is one of the primary sectors that has seen an increase in demand in recent months. On Verizon’s network, use of collaboration tools alone saw peak usage levels reach 1,200 percent of a typical pre-COVID-19 day over the March to May period, and gaming (up 257 percent), streaming (up 47 percent) and VPN use (up 83 percent) also rose sharply. More e-commerce, more remote work, more streaming, and just the general digitization of society in this era has all supported data center demand, which was already growing fast before COVID-19. Some of that excess demand may temporarily drop off as people return to the office, but network access has become even more integrated into everyday life under COVID-19, and the underlying structural demand trend toward more data usage has clearly shifted higher.

Housing is expected to see a structural shift, and single-family rentals have also held up well of late.  Millennials who were considering a move to a less-dense housing situation seem more inclined in today’s environment to consider a suburban lifestyle. A recent Citi survey of 5,000 adults suggested that 15 percent were considering a move to the suburbs in the next three years, compared to 7 percent pre-COVID-19. Among Millennials, 19 percent were considering that move, compared to 10 percent pre-COVID-19. These figures were higher yet among wealthier demographics and those with children. This change was probably going to happen eventually as Millennials aged, but it has likely been accelerated by the pandemic; single-family rents have actually increased in many markets.

Many types of retail were in distress before the pandemic hit due to the ongoing shift toward e-commerce, and that trend has only accelerated. Some retailers will not survive this downturn in their current form, and this poses challenges for already hard-hit retail property sectors like malls and power centers.  However, there will be retail winners, as some retailers have learned to operate in a more flexible manner, which will help their long-term survival.  Models where people order food and goods online and pick up at the store or curbside are still operating, and there has been an opportunity for these same retailers to grab some of the shop-from-home demand. 

Retailers have been talking about building omnichannel capabilities for some time—they can sell to a customer online but ship from store, or buy online and pick up in-store, or use the store as a showroom but make the sale online and ship to the customer’s home from a warehouse, or simply make a traditional in-store sale. Those who have succeeded in building the capability to make a sale over every channel are well-positioned both during the downturn and coming out of it. 

Whether from newly relevant omnichannel retailers or traditional powerhouses like Amazon, it is very likely that e-commerce will gain share and that this trend has been accelerated by COVID-19. In the U.S., e-commerce may top 30 percent of sales this year, up from less than 20 percent last year.  That share should come down as stores reopen, but it is unlikely to retreat below 20 percent again. Beyond supporting retailers, this should boost industrial and data center demand, particularly as the broader economy begins to rebound. Industrial will still see a cyclical reduction in demand while the outbreak lasts. Retailers are a big part of the industrial tenant base, so their troubles aren’t a clear win for warehouses, but e-commerce will provide some support to overall industrial demand and shift some space usage from traditional retail to industrial, over time.

Other sectors are also seeing a structural impact from COVID-19.  For some time, it has been possible to effectively work remotely, but few companies have allowed employees to do so regularly.  By necessity, COVID-19 changed that, and in office-using sectors most employees have proven that they can be productive working remotely.  This could reduce office demand post-pandemic if employers decide they need less space as more employees work from home.

However at the same time, COVID-19 will also likely increase space-per-person requirements to ensure proper social distancing, required either by local regulations or by employees who no longer feel comfortable in a dense floor plan.  While it is very unlikely that we would go back to an era of everyone having an office with a door, more physical separation will likely be desirable to employees.  Prior to COVID-19, space per employee had been declining for decades, and to the extent this trend halts or even reverses the decline, it should offset some of the effect of remote work on office space demand.

Less clear is whether the pandemic will result in a long-term boost in demand for suburban offices.  Some analysts have suggested that it will, as companies seek to decentralize and move employees out of high-density, high-cost areas.  While this seems plausible, it is not clear how much traction these efforts will get if employees can simply work from home.  We will be monitoring leasing trends to see whether this theory stands up to scrutiny.

Russell Devlin is an economist in AEW Research, the firm’s in-house research group. He devotes the majority of his time to providing research support to the firm’s public market activities. His role is (i) to interpret the results of AEW Research forecasts with respect to factors affecting real estate securities investing; (ii) to conduct additional research (both directly and using third-party resources) into areas of particular interest or concern to the REIT team, and (iii) to develop and maintain specific tools that provide useful insights on portfolio construction and ongoing management.