Briefly…on Real Estate in the Post-COVID World
Above (L to R): Nora Creedon of Goldman Sachs and Jamie LeFrak of LeFrak
The pandemic is accelerating underlying trends in the real estate market, such as a decline in office space in major cities like New York and a move to the suburbs, according to Jamie LeFrak, Vice Chairman of LeFrak, a multi-generational real estate investment firm with one of the largest privately held portfolios in the US. Speaking at a recent Goldman Sachs Asset Management (GSAM) Forum event, LeFrak shared his thoughts on real estate in a post-COVID landscape with GSAM portfolio manager Nora Creedon.
Nora Creedon: One of the big surprises from the pandemic has been the desire for people to continue to work from home—and employers’ willingness to allow it given high productivity levels. As a result, the shutdown has created a work-from-home revolution which has big implications for the future of work. What are your thoughts on how remote working might affect the office business?
Jamie LeFrak: While many are predicting the “death” of office space, I don’t see this as a forever secular change. Once the pandemic is under control, people will want to be near each other again, and those face-to-face interactions will be important, especially in certain sectors such as finance. We’re all going to need to interact more efficiently and frequently. New York City, however, as a place to do those things is in trouble and will continue to be.
Nora Creedon: Can you expand on that? Given the fact that you have major portfolio holdings in New York and New Jersey, what is your assessment for commercial office space in New York?
Jamie LeFrak: In New York City, the need for commercial office space has been steadily declining since 2007 and the operating side of the office business—faced with ongoing margin erosion amid higher real estate taxes and higher costs of tenant acquisitions—has been especially difficult. The pandemic has only accelerated the number of people leaving big cities which has, in effect, made it easier for employers to move their workers to lower-cost cities.
Nora Creedon: But what about the requirements to maintain social distancing? Is it possible that companies will want to invest in more office space as a result?
Jamie LeFrak: I don’t expect that companies will be making significant capital investments to reconfigure their offices. Just a year ago, for example, we were talking how the Green New Deal obligations in New York office buildings would require the air to circulate in a way it didn’t before. But to date, we haven’t seen the large-scale investments materialize. My sense is that the discussions to de-densify office space is a fad, like the styles of office that come and go.
Nora Creedon: So in a market like New York, if office demand slowly erodes, one of the obvious impacts will be on the residential market. What do you think will happen there?
Jamie LeFrak: The problem with New York is that the population has been in decline and COVID has only accelerated that trend. New York City had been losing about 30,000 people each year over the previous two years. That’s a trend that we haven’t seen since the 1970s, when the city lost about 800,000 people, creating dire consequences. We’re undergoing the same circumstances today and we’re likely to see higher real estate and city and state income taxes, as a result. There’s a larger trend whereby most states’ fiscal resources are being directed to pension payments and the like, so there’s a lack of reinvestment in the municipalities which will continue to inhibit growth and depress interest rates.
New York City residential rents, for their part, are down about 15% on average since the start of COVID, with higher pre-existing rents experiencing a steeper drop. Meanwhile, landlords are having collection issues since tenants cannot be evicted, even when they can pay. While tenants in higher-end properties are continuing to make payments, tenants in cheaper properties aren’t as consistent because they can’t be evicted any longer. So landlords are in this strange situation where they can have high-end properties where they’re collecting say, 97% of rent but the rents have dropped by about 30%. Or, they may have cheaper properties with rents of $1,500 a month that haven’t changed, but are only collecting about 85% of those rents.
Nora Creedon: How are those trends affecting residential sales?
Jamie LeFrak: We haven’t yet found a floor for sales of residential properties. We expect, for example, sale prices to drop by about half in high-end properties from current levels. In fact, we haven’t been bullish on New York since 2007 primarily because of the shrinking population. All real estate relies on people to use it. Many millennials, who are now in their 30s and 40s, have been fleeing the city for the suburbs, so COVID is accelerating trends that were already in place. Longer-term, many cities will stay resilient but there will be a demographic shift to an even younger population. In many ways, the virus has continued to exacerbate income inequalities—those who can afford to leave, have already left the city.
Nora Creedon: So where are people going if they’re leaving New York and where are you looking to invest in places outside of the tri-state area?
Jamie LeFrak: We started building major projects in south Florida in 2012 and in other sunshine states where there’s been strong population growth before COVID. As soon as the virus is under control, we believe those states will be among the first places people will go. Those states’ fiscal positions are also stronger, which invites the opportunity for growth. We’ve also been happy with our investments in Seattle, which has been very attractive for businesses and we continue to have substantial real estate holdings in Los Angeles.