Don’t bet against the Big Apple (or the Bay Area either, for that matter). A report just released from KKR’s Global Macro and Asset Allocation Team says that historical precedent from past epidemics and traumatic events, as well as secular trends underway prior to covid-19, point to long-term resilience for major U.S. cities that can effectively manage fiscal constraints and harness innovation into the service of recovery.
This, in turn, bodes well for a swift rebound of commercial real estate markets in urban hubs like New York, San Francisco, and Washington D.C., as well in fast-growing, medium-sized cities in the SunBelt region.
“Historically, what has determined the path of return and recovery has been the will to act—driven by who is impacted, the ability to contain the crisis, new regulations as well as infrastructure, all of which are tied to capital availability,” writes Paula Campbell Roberts, Director of KKR’s Global Macro and Asset Allocation team in the new report, “The New Normal: The Long-Term Impact of COVID on Cities and Consumers.”
“The case for the long-term recovery of high-density cities like New York, San Francisco and Washington, D.C. relies upon historical precedent and recent commercial real estate investments,” she adds.
Back and better, baby
Despite the heavy human toll during times of mass illness, Campbell Roberts and her team at KKR found multiple examples of pandemics serving as growth catalysts, from which cities not only survived, but thrived.
New York City has been a platform for just this kind of regenerative innovation many times over the past 200 years. Outbreaks of yellow fever and cholera in the early and mid-19th century led to widespread innovations in city sanitation and hygiene, the development of water infrastructure like the Old Croton Aqueduct, and the establishment of the Metropolitan Board of Health. In the 20th century, New York’s effective citywide response to the 1918 flu pandemic attracted new residents, leading to a surge in the Greater New York population, which rose from 4.8 million to 6.9 million between 1910 and 1930.
Moreover, KKR writes, these beneficial, post-pandemic outcomes frequently occurred despite a backdrop of social unrest, in which early infection waves disproportionately affected poor people, minorities and immigrants, and were unfortunately, often blamed upon these same vulnerable populations. In the post-covid environment, KKR writes, racial inequalities laid bare by the pandemic must to be addressed in order to move forward.
WFH: Not a real estate dealbreaker
KKR’s research suggests that partial remote work patterns—employees working remotely 1-2 days per week—are likely to continue post-covid.
But, they find, office spaces and the urban environments that host them will remain vital, as these physical spaces are a centerpiece for recruiting talent, expressing company culture, and collaborating in teams.
Tech companies—which were likelier to have embraced flexible policies on remote work before covid—are an instructive example of this tendency. Per KKR, major tech firms including Amazon, Facebook, TikTok and Apple have leased almost 1.9 million square feet of new office space in New York City this year alone—1.4 million of this amount just since early March.
Nor is the flex-versus-physical workspace an either/or proposition. KKR notes that Facebook, which has publicly indicated that it does not expect employees to return to in-person work until mid-2021 and projects as much as half of its staff may work remotely over the next decade, has continued to expand its physical real estate footprint in major urban areas like New York, Los Angeles and Seattle.
Instead, KKR sees post-covid U.S. urban recovery occurring along three thematic lines.
First among these is dispersion. KKR reaffirms its bullish conviction around Sunbelt migration, as well as above-average growth for medium-sized cities, both views which predate covid. Within real estate, KKR says will benefit multifamily housing, industrial and innovation office space. Gateway cities could struggle in the near term, but could benefit from long-term municipal budget reconciliation measures.
“COVID has only accelerated the growth of medium-sized cities, as well as exurbs and suburbs near gateway cities. Amid growth in southern and medium-sized cities nationally, the locus of economic activity should disperse among multiple metropolitan nodes beyond gateway cities,” KKR writes. “We are long-term bullish on these secular trends, which create cross-asset class investment opportunities across real estate – industrial, multifamily, and office, infrastructure, as well as consumer private equity – both online and brick and mortar.
Second is the thematic trend of “Essentialism,” whereby in-person meetings, events and appointments are held only when “safe, necessary, or highly valued.” This theme will impact multiple industries in different ways, with single-family housing, industrial real estate, and properties retrofitted with HVAC and air filtration systems all poised to benefit.
Thirdly, KKR sees consumer spending consolidating among very large, omnichannel retailers and very small, differentiated ones, a thematic trend it calls “Bifurcation.” Under this scenario, larger, cost-competitive brands with solid delivery capabilities will continue to attract price-conscious consumers, even while cutting back on overall SKUs. This in turn could present new opportunities for smaller, niche retailers not available in large retail stores. Mid-sized retailers or those without a differentiated product offering stand to lose market share.
Finally, KKR’s research team expects a second wave of job losses to materialize over the next few quarters as companies cut costs and accelerate digitization, with covid-related structural underemployment expected to last until 2024.