2021 Market Outlook

2021

COMMERCIAL REAL ESTATE MARKET UPDATE

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MARKET OUTLOOK 435 S Broadway St | Wichita, KS 67202 | 316.262.0000 | www.NAIMartens.com

ECONOMIC OVERVIEW

COVID-19 is taking an historic toll on the U.S. economy. Wichita, like most of the country, went into lock-down in midMarch resulting in a shrinking economy. Unfortunately, Wichita was feeling the effects of Spirit AeroSystems 737 Max production woes well before the pandemic, which exacerbated already depressed manufacturing employment. Wichita’s aerospace industry, led by Spirit AeroSystems and Textron, has suffered several thousand layoffs and furloughs. Even though aerospace firms are diversifying, any job-related improvement is not expected until late 2021 or well into 2022.

Many non-manufacturing layoffs are temporary rather than permanent separations. Businesses seem to be reopening and rehiring faster than expected, following jobless claims that were estimated at quarter of the labor force. The Paycheck Protection Program served to stabilize professional services employment and other government stimulus programs, including the unemployment supplement, helped ease the impact on the service and blue-collar worker segment. To continue the recovery, a second round of relief seems obligatory.

Unfortunately, some segments of the economy will not come back right away, especially in businesses like travel, hospitality or anything involved with social interactions; some businesses will never come back. The Wichita and regional economy are driven by manufacturing, oil and gas and agriculture and all are experiencing a downturn in one form or another. As mainstays of the economy, each must look to diversification and innovation to sustain any type of turnaround. This has been a theme coming out of every previous recession, now it is mandatory.

Office OFFICE OVERVIEW Because many office jobs are well-suited to be performed at home, layoffs were less severe than in sectors that require face-to-face contact such as leisure, hospitality, retail and restaurants. Led by tech and financial services, the office sector benefited from the adoption of work-from-home policies, which preserved jobs for many companies.

The current pandemic created two new and compelling trends. The first is social distancing, which should lead to at least a temporary decrease in office density and increased worker space requirements.

The second is the work-from-home policies implemented by nearly all professional services companies.

Neither of these two trends should lead to drastic changes in space demand but will influence leasing and deal flow as owners and tenants evaluate their space needs.

There will be a renewed focus on health, wellness and safety.

Companies are similarly evaluating the cost of their physical office space alongside the technology cost of supporting a remote workforce.

While many office personnel are still working from home, it is too early to tell the extent this trend will persist but it is safe to say it will increase substantially over pre-COVID percentages. A home environment is a positive for some workers while others miss the idea creation, socialization, problem solving and person-to-person collaboration of the office.

In lieu of larger centrally located offices, some firms will rely on smaller remote locations dedicated to engagement and collaboration. Tenants will demand the right mix of flexible environments and lease terms where employees can continue to work remotely at least some portion of the time. Landlords can expect requests for tenant improvements and, if not available, tenants will look at alternatives.

The office sector most likely will not be able to go through the current crisis unharmed. Vacancy will likely rise and rents are expected to decline somewhat. A rebound of economic activity in the second half of 2020 and during 2021, should result in a recovery and increasing leasing activity.

Investor Outlook Investor attitudes are brightening. There may be a small decline in pricing. Strong demand for value-add properties that may be reconfigured at a reasonable cost and smaller owner-occupied properties where control of environment will be paramount.

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Market Trends Medical office is performing well with a few vacancies in quality properties and rental rates holding steady. Owneroccupied buildings will be in demand with activity focused northeast and to a lesser extent northwest.

There have been a few casualties of the pandemic as users and developers canceled plans. Traditional office buildings will see tenants looking at space alternatives unless owners can provide options that satisfy their requirements.

Developers still have new and renovation projects under consideration. They will focus marketing efforts on prospects willing to consider higher rents in return for flexibility and more efficient environments.

Following the completion of Cargill Protein’s headquarters last year, activity has been brisk with no less than 10 significant firms moving into or expanding in the core area while work continues on the Kansas Health Science Center.

Vacancy Rate • Overall • Class A • Class B Asking Rent (FS) • Overall • Class A • Class B Construction Activity Leasing Activity • Core Area • Suburban

Trends 19.91% 11.8% 19.7% $11.69 $17.25 $9.77

Retail RETAIL OVERVIEW Early in the pandemic, consumer spending was experiencing record lows. With shelter-in-place and non-essential retail closed, there were very limited or even no sales. Retail sales are signaling a consumer spending recovery that has been inflated to some extent by stimulus checks and increased unemployment benefits. It will be important to monitor retail sales numbers in the following months to understand the strength of pent-up demand in light of looming cutbacks and delays in new stimulus checks.

Many consumers went online to shop during stay-at-home orders and store closures, which accelerated increased e-commerce sales. The assumption is that it will become second nature and more convenient, and thus they will remain online shoppers.

Market Trends Development activity has essentially come to a standstill.

A few smaller projects are proposed or under construction and tenant churn will likely continue at lifestyle and power centers. As they adjust to the new normal, there will be continuing interest from retailers looking to enter the market and backfilling available space.

Regional malls Towne East Square and especially Towne West Square are reinventing themselves. The former Sears space at Towne East remains vacant while the Round One entertainment center has opened. Towne West continues to repurpose space with non-traditional uses and a focus on diversifying its retail mix.

New locations are being added by fast casual restaurants with drive thru lanes. Those who have perfected the system are enjoying increased sales. Torchy’s Tacos, Schlotzskys and others are entering the market or expanding locations.

Like other market segments, retailers will reconsider their approach to locations, square footage and configurations as they adapt to the impact of changing requirements of the customer.

Vacancy Rate • Overall Asking Rent (NNN) • Newer/New A Rent Construction Activity Leasing Activity

Trends 10.8% $10.35 $16-25

In addition to national chains who filed bankruptcy and or closed stores, local small businesses are heavily affected by the pandemic including certain segments of general retailers, restaurants and personal services. Most have reopened to varying degrees of success under local mandates on wearing masks and social distancing.

Long before COVID, consumers were already favoring quick service restaurants and off-premises dining. Many of those with a quality product and drive-thru lanes have flourished and are adding locations throughout the market. In fact, many national chains will not open a new location without a drive thru. Full-service restaurants have ramped up delivery programs, streamlined their menus, and established interior social distancing guidelines. A new ordinance, Open Air ICT, allows for expanded outdoor dining on sidewalks, on-site parking lots, grassy areas and city rights-of-way which is an excellent accommodation. Additionally, more recent policies allowing restaurants and some bars to reopen with reduced capacity and hours will be beneficial.

The majority of retail categories are showing promising signs of customers returning with people wanting to come back to physical stores once the pandemic is over. However, with retailers operating at limited capacity, having to adhere to safety guidelines and some consumers fearing public places, the recovery will likely be slow.

Investor Outlook Retail remains a pessimistic place with investors expecting a decline in prices and looking at an increase in returns to enter the market. Net lease properties are a bright spot.

Industrial INDUSTRIAL OVERVIEW The industrial property market has performed relatively well and is one of investors' preferred asset classes. It remains the strongest sector despite the pandemics disruption of the supply chain. Going forward, manufacturers and retailers will adjust by holding additional inventory relative to their sales. This reverses the post 2008 financial crisis trend toward leaner inventories particularly in retail, and will stimulate demand for industrial space over the long term.

The pandemic has fundamentally changed the ways that people work, shop and live. The number of people shopping online continues to rise and this shift to e-commerce will be permanent. The timing of recovery will vary, but these changes in the economy will drive increased demand locally as e-commerce typically requires more warehousing space than traditional retail outlets.

Despite being one of the strongest asset classes throughout the coronavirus pandemic, the industrial job market continues its downward trend. Nationally, transportation and warehousing employment has fallen and local manufacturing employment has decreased to levels not seen since 2009, in the middle of the Great Recession.

Wichita is primarily a manufacturing market, dominated by aircraft and aerospace. Given the forecasted demand for commercial aircraft, production may take years to get back to “normal”. Private and corporate aircraft demand is slightly better but will still see a similar recovery timeline. Companies are looking to diversify their product lines, such as Spirit AeroSystems looking at military production opportunities. Their suppliers and vendors are doing much the same.

The availability of manufacturing buildings and warehouse space remains challenged. There has been limited new development and construction in the recent past and the pandemic will keep inventories low in the short term. Wichita’s incentivized development program provided much need inventory and additional projects can be expected. Out of market companies continue to look to enter the market and demand should be steady. New development will progress slowly as rental rates continue to be depressed and don’t yet support significant development.

Investor Outlook E-commerce continues to propel the industrial sector.

Investors are more bullish with a strong appetite for multitenant properties and quality single tenant assets.

Market Trends The city’s speculative building program has been successful. It has provided much needed availability for expanding local companies and new firms entering the market, such as Amazon’s recent lease of 138,000 square feet in Comotara.

Major leasing activity, resulting in the absorption of several buildings from 100,000 to 400,000 square feet, has set the stage for future development. Smaller single user and flex buildings are seeing slightly higher vacancy rates but should realize a turnaround. Availabilities in the general warehouse sector are primarily in older, less desirable buildings and locations.

Even though demand may be hampered in the short term, the inventory of small to mid-sized, well located buildings remains short supply. Land is increasingly available and a newly announced 120 acre (+-) development at 21st and I-135 will provide a highly accessible alternative to suburban industrial land.

Vacancy Rate • Overall • General Industrial • R&D/Flex Space Asking Rent • General Industrial • R&D/Flex Space Construction Activity Leasing Activity

Trends 12.2% 11.9% 15.7% $4.27 IG $9.11 3N

Investment INVESTMENT OVERVIEW Investors appear to be optimistic and expect to remain in a low interest rate environment in the near-term. This should set a sound backdrop for a resumption of sales activity. Patience and safety are paramount today.

There is tremendous capital on the sidelines with investors wanting to get back in the market. Under the assumption that the pandemic is under control by year end, a return to normal transaction volume can be expected next year with prices returning to previous peaks over the next couple of years.

Multifamily: Multifamily investors are more optimistic in general. There appears to be strong investor demand for middle market assets. It is expected that the local market will see another strong year in 2020 with transaction totals similar to last year. Multifamily fundamentals will follow the economy as the market should bottom in the fourth quarter and commence its recovery path the first of 2021. Through fourth quarter 2020, any increase in the vacancy rate will be minor. Rental rates are projected to slightly decrease in 2020 and then begin to fully recover.

Leasing has been a little slower but steady in the Wichita market.

The CARES act has helped tenants support rent payments as owners indicated that less than 10% of residents asked for relief. Class C properties have felt the most impact as residents were less stable financially and whose jobs were more susceptible to furlough and layoff. Stimulus measures, along with eviction moratoriums and rent deferment plans, have helped hold vacancy rates steady. Absorption should slow as residents wait out employment uncertainty and then to spring back in 2021 when that pent-up demand is released. There are approximately 700 units planned for 2022 following the 450 units to be completed this year. View the NAI Martens MultiFamily Report: https://naimartens.com/q2-2020-multifamily-update/.

Hotel: At mid-year, U.S. hotel occupancy was up significantly from its low point of just over 20% in mid-April as strict local lockdown measures brought travel to a standstill. Given the expected rebound in economic growth and historic resiliency of travel demand, a strong hotel recovery in 2021 and 2022 can be expected and RevPAR could recover to pre-recession levels by late 2022. Many hotels continue to operate unprofitably, and cap rates will rise toward the end of the year as limited trading resumes, which has been down as much as 90% year over year. Cap rates will peak in early-to-mid 2021.

With COVID-19 numbers not declining, slower growth is ahead. Hotels have been one of the hardest hit sectors by the coronavirus pandemic given the widespread reduction in corporate, group, and leisure travel. The convention and visitor numbers have been severely curtailed locally and nationally. Until such time as the pandemic shows sign of abating meetings will continue to be held remotely. There will be limited new development in the foreseeable future. A couple of properties were under construction during the pandemic. Home2Suites at 21st and K-96 opened this summer and the Hyatt Place on the WSU Innovation Campus is nearing completion.

Net Lease Investments: Despite market volatility and uncertainty created by the pandemic, investor activity continues to remain relatively strong, albeit at levels lower than pre-COVID. Net lease assets are a strong investment option as single-tenant properties have lower price points compared to large, multi-tenant property. Most net lease buyers and owners consist of small private investors or groups seeking yield and are attracted to owning a tangible asset.

Several sectors that are proving their resilience include Grocery, Pharmacy, C-Store/Gas Stations and Land Leases. Areas of concern include the Big Box sector and Casual Dining. The fundamental characteristics of net lease and investment real estate in general, are based on a long-term investment approach, particularly the fundamentals of an investor’s basis, tenant credit and location.

Investment (Continued) Mobile Homes/Manufactured Housing: During these times of economic uncertainty, mobile home communities are proving to be the desirable COMPREHENSIVE RESEARCH ON MARKETS AND SUBMARKETS investment that many THROUGHOUT THE WICHITA MSA hoped they would be. Rent collections exceeded The Martenshave Companies provide trends and forecasts of rent, expectations and housing vacancy and inventory for Apartment, Office, Medical Office, demand has been strong Retail, Warehouse/Distribution, Flex/R&D, General Industrial, and since the onset of COVID-19.

NAI Martens is the brokerage and investment services division of The Martens Companies, the largest full-service commercial real estate firm in Kansas. Providing third party representation in all facets of the industry, the firm was founded in 1948 and serves clients throughout the state of Kansas and increasingly throughout the country. The company focuses the major Aircraft Campuses. Because overall metro averages on being different from our competitors in often conceal significant variations from neighborhood to The story of 2020 has ways that client value. We do that by (1) been financing.

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In-depth trends and statistics can be found in our quarterly reports.

In-depth trends and statistics can be found in our quarterly reports.

435 S Broadway St | Wichita, KS 67202 | 316.262.0000 | www.NAIMartens.com © Copyright 2019 NAI Martens. Reproduction in whole or part is permitted only with the written consent of NAI Martens. Some of the information REAL contained herein has been gathered from sources deemed reliable. However, NAI Martens makes no warranties or 28 | COMMERCIAL ESTATE MARKET UPDATE