2021 Is the Year to Think Local, Real Estate Investment Experts Say

For many commercial real estate investors, 2020 was likely the most uncertain year they’ve ever experienced. But although the pandemic continues, the industry remains largely bullish about seeing a slow but certain rebound in 2021. Among those professionals who are optimistic about making deals in the new year, a universal theme reshaping their approach to CRE investments is the importance of nuance and localization.

Portfolio diversification remains key, but if there’s any one takeaway to glean from a series of year-end webcasts conducted by commercial real estate advisory firm Marcus & Millichap, it may be that the coming year will not be won by blunt force and big, sweeping spends across many sectors on a national scale — but by zeroing in on asset and market specifics, all the way down to the community and property level.

Hyperlocalization will be the name of the game like never before, according to several webinar panelists from the investing world – especially as it pertains to personalizing relationships with tenants and their neighborhoods. This kind of ground-level focus could favor smaller, regional and noninstitutional business owners and investors, some concurred, with one expert even proclaiming that 2021 will be the “year of the local entrepreneur.”

In early 2020, Beth Azor, the founder and owner of Azor Advisory Services, was preparing for a very active year full of large deals. Then seemingly overnight, in the early days of pandemic-related shutdowns, she found herself both negotiating with large national retailers over rent collections and helping fill out paperwork extended through her personal banking connections in attempt to keep her “mom-and-pop” tenants afloat.

“I had to separate my days,” Azor explained during a Dec. 8 webcast on retail trends. “One day I would talk to national retailers — of whom, some were sending nasty letters, having rough conversations with landlords and making bold demands about not paying rent. On other days, I would talk to the mom-and-pops, whose livelihoods were on the line, and they were saying, ‘I’m going to do anything I can to try to pay rent.’ I was pleading with local city officials to let some of our smaller food and beverage tenants serve food out in their parking lots to keep their businesses alive. It was a whole different psyche for dealing with those two types of tenants.”

Fast-forward to the end of the year, and Azor said she’s signed eight leases in four weeks with local-market-based tenants, while deals with national chains are in the works but not closing due mostly to travel bans, leading in part to her claim that 2021 will be the “year of the locals.”

What good is a credit tenant, she posited, “if they don’t want to pay rent?” As such, she hopes that investors everywhere will continue to “embrace the local tenant.” Community-focused retailers bring a “unique quality,” she said, “and I don’t know about other [portfolio managers and landlords], but in my experience throughout the crisis, at all costs, they wanted to pay their rent.”

Blackstone Managing Director Andrea Drasites agreed, noting that the economic crisis will likely lead to portfolio and asset managers narrowing some of their focus from broad, national credit-based tenants to local mom-and-pop retailers. This follows an intense process of providing services to the latter group that Drasites compared to those of a counselor, and “figuring out how to help make their business viable during a difficult time.”

In contrast, she said, “the nationals – usually the ones that were the ballast of our business, whom we’d cite as the reason our retail centers were institutionally attractive in conversations with lenders in credit committees – were the ones with whom we experienced a flurry of standoffs. Some of the fallout in retail relationships on the credit side is going to create a bit of tension and frankly, put even more of a microscope on credit as we’re assessing new investments going forward and we’re assessing whether or not to dispose of assets.”

Collection issues with large national retailers is not the only reason investors might redirect their focus from the large and unwieldy to the small and nimble. Consumers are having their say, too.

“There’s a renewed focus on community,” Drasites said. “People are flocking to small businesses, and landlords and the communities they are in are thinking about how to support them, and that’s fundamentally a really positive change in attitudes. You could say it started pre-pandemic, but it’s something that’s going to stick.”

In retail, the consumer will continue to drive retailers’ decisions, explained Jami Passer, chief investment officer of investment firm Edens. “Until a vaccine is fully effective, the consumer will want to stay near home – and statistically, people will not travel more than about 17 minutes for essential goods. And that means that owning centers that are embedded in your communities and reflective of your communities is critical.”

Agility, flexibility, essentials and value are all absolutely in demand, she asserted. “Convenience is queen.”

That’s why convenience-oriented retail is not just one of the best-performing retail subcategories, but one of the strongest niche segments across all of commercial real estate, noted Marcus & Millichap CEO and President Hessam Nadji. “We’ve seen plenty of strength in the single tenant net-lease, fast food, necessities, [dollar store] discount and value retailing side of the equation, proving in part that retail is a broad spectrum that does not warrant generalization.”

The same focus on convenience is, of course, fueling the e-commerce catalyst, and has accelerated that trend by an amount of at least three years, the retail experts agreed. But, as Passer noted, BOPUS, or buy-online-and-pick-up-at-store, is the highest growth segment of all e-commerce variants in 2020.

“BOPUS highlights the value and relevance of the brick and mortar location,” she said, and the importance of the community-focused anchor that the physical asset provides. Because, as all presenters echoed, though COVID-19 rapidly accelerated the inevitable trend toward e-commerce for not just big box retailers like Amazon but for even small, local businesses – smart investors in the brick and mortar real estate space will not ignore e-commerce, but embrace it.

It’s e-commerce, in large part, that has many investors’ eyes fixated on industrial through the pandemic and beyond. In fact, some Marcus & Millichap investor clients view the asset class as “borderline perfect,” according to Alan Pontius, senior vice president of office and industrial for the firm, during its Dec. 10 webinar on industrial investment outlook.

Here again, though, e-commerce and retail convenience tighten the focus on localization. “One of my favorite phrases in the space is that we went from ‘just-in-time’ delivery fundamentals to ‘just-in-case’ delivery, and our inventories have increased because of that,” said Celeste Tanner, chief development officer of Confluent Development. “The way people were shopping was already trending in this direction and it’s only accelerated. But that’s a core fundamental that’s not going to go away in the short term.”

Just like any other asset class, Tanner continued, industrial is market-specific and smart investors don’t make a big, blind play.

That’s backed up by the idea that while industrial is hot, a national view shows that the bulk of development activity in recent years has occurred in five major markets — Dallas, Chicago, Phoenix, the Inland Empire in California and Atlanta. Over half of that is for giants like Amazon requiring spaces that are 500,000 square feet or more, noted John Chang, Marcus & Millichap’s senior vice president of research services. As a result, those regions are a bit overcooked with construction and are thus actually softening a bit, he noted. “You get this interesting vacancy dynamic across the country, and it becomes a very localized business.”

Further supporting the importance of location was a strategy offered during the webcast by Steve McKnight, president of Ozinus Realty. “The problem with hotspots is often that the smart money was already made as the area became hot, and so what you’re doing as an investor is empowering the area and disempowering yourself. The smartest investors I know aren’t the ones that buy into hot areas, they are people who buy into emerging areas before they’ve gotten hot.”

While not everyone can do this, McKnight conceded, “all you actually need is a relationship with a good real estate broker to tap into their expertise about what they are seeing in any specific market at the moment to ask what’s hot, what’s cold, and why that is the case. What is it that made Phoenix hot that’s going to make the ‘next Phoenix’ hot?”

If you’re looking for the next Phoenix, there are plenty of opportunities to be found in the self-storage market, several speakers noted.

Cap rates for Class C self-storage properties, for example, were as high as 10% in tertiary markets, Chang’s team found, compared to an average of around 4.5% for Class A assets in primary markets.

That’s not to suggest that inexperienced or risk-adverse investors should rush blindly into secondary or tertiary markets, however. But noninstitutional investors that are keyed in on a local community have some leverage that large capital firms do not, some said, as self-storage thrives on business in a 3-to-5 mile radius of the user.

“If you’re in a local market and you really own the market and you’re really on top of your stores you can actually continue to do really well,” said Founder and CEO of Merit Hill Capital, Liz Raun Schlesinger. “I think a mistake a lot of investors make when they get into storage is not checking their ego when assuming they can do better than a mom-and-pop who knows the market.”

While advances in technology systems and management platforms have favored economies of scale, which are fueled by the bigger investors in the self-storage class, a nimbler regional investor can likely manage expenses better in some cases, admitted Rick Schontz, president and CEO of City Line Capital. “Anytime we’re going into a smaller market, our expense loads are most likely going to be much higher, so I think if you’re looking at net income, there’s a gap. You can’t put a 5-cap on a deal in a tertiary market with an expense load that’s 15% of your revenue.” But, he said, “if you are focusing 100% of your time on one or two small properties, you can set yourself apart by the amount of time you have to spend on it.”

Despite the increased institutional interest self-storage has drawn due to its strong fundamentals, that type of nimbleness and nuance will continue to play a role in the niche’s investment opportunities, which will likely abound next year, Schlesinger said.

“We’ve had multiple groups in the past six or seven years trying to put $100 million or even $400 million of equity to work [in self-storage], but it’s tricky,” she concluded. “It’s tough to find really great opportunity at that scale in our asset class.”