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Commercial property – Post Pandemic

Commercial Property – Post Pandemic

Written by Ivan Fletcher – Senior Adviser

As one financial year closes and another starts it can be a good time for rebalancing investment allocations. One sector that requires some deep consideration is that of Listed Property trusts. In the last decade, this has been a relatively strong performing sector, supported to a large extent by high population and employment growth, significant infrastructure spending by governments and a lag in supply. Traditionally this sector traditionally favours income overgrowth however suffered more acutely than more traditional equity markets in the downturns during the GFC and more recently the COVID 19 spill in early 2020. The recovery over the last 12 months or so has mirrored that of the traditional markets rebounding strongly. It continues to hold an important place in a diversified portfolio, however, COVID 19 has introduced a dynamic shift to this sector and its outlook in the years ahead.

One of the most noted impacts of the COVID 19 Virus is the movement of population. With lockdowns around the globe being a regular feature in the last 18 months developed nations have had to rethink how we work and how we shop. Necessity is often the mother of invention. Prior to the pandemic, very few employers were prepared to allow employees to work from home away from the observing eyes of management.

Now after multiple lockdowns we all know too well that working from home has become an overnight reality for many industries. It is becoming the preference for many employees to work from home at least for part of the week, so much so that the real estate market is boasting strong gains for residential property in outer suburban areas and even regional areas claiming more flexible hours as the primary shift in sentiment with the need to remain within reasonable commutable distances of the metropolitan CBD’s waning.

Similarly, we have catapulted into the age of digitisation of everything from the streaming of entertainment and education and adapted to shopping online in greater proportions than pre-pandemic, especially if you wanted to avoid the football like a scrum in the essential supermarket isles of toilet paper or rice and pasta. These changes in the movement of the broader population have had an impact on Commercial property (in both office and retail shopping space).

Short Term Impact

As reported in an article by Lonsec 8/6/21, “..In Australia, the immediate impact has seen CBD office vacancy levels rise in Sydney and Melbourne from 3-4% to around 8-9% over the year to January 2021. Net absorption for Australia overall has reduced from +50,000sqm in the six months to January 2020 to -90,000sqm in the latest six months to January 2021. Sub-leasing has spiked as tenants with longer leases look to offload spare capacity. While face rents have remained largely unchanged, incentives have risen to over 35% compared to around 25% pre-pandemic, dampening net effective rents. Businesses are taking longer to commit to new leases and when they do, there is a trend towards shorter terms.

Longer Term Impact

The debate in Australian and global property markets is now focused on how the pandemic may have changed the demand for office space on a permanent basis.

On the global scale, we have started to see restrictions ease as the vaccination rates climb and workers begin returning to their offices with encouragement from businesses and the government. Whilst it is well documented that Australia is well behind the curve in vaccination rates it seems logical we will follow the same path eventually, so what does that mean for the “movement of the population”?

My thoughts are that this will be the greatest demographic shift of our time, but how it plays out and to what extent and impact it has on Commercial property will be something that will be well scrutinised by the investment community. There are many aspects to consider.

  • Greater flexibility to work-from-home is both possible and more desirable (now that we have had a taste of it).   The broader consensus view is that ‘hybrid’ working model is the most likely outcome – two or three days working from home with the remaining days spent in the office. While some firms experienced increased worker productivity during the lockdowns, intangible aspects such as corporate culture, team morale, creativity and innovation rely on human interaction to a large extent.
  • As long term lease renewals come around, there is likely to be a shift in the format of contracts.  Large corporations will continue to need core space plus but will need more flexibility with amount of floor space they commit to as well as the terms (duration)  of the lease.  Focus will shift from quantity to quality,  with tenants seeking higher environmental ratings and lower floor densification with more floor space per person in line with social distancing requirements (future pandemics are now likely to remain a long term consideration).
  • There is also some debate on whether suburban offices, which are usually in less preferential locations compared to the CBD and accordingly charge lower rent per square metre, will benefit from the working-from-home trend.

In summary,  there is a degree of uncertainty in the Commercial Property space as we navigate the ‘new normal”.  The CBD population looks set to have a permanent reduction with the end of the 9-5 working era as we know it. I have no doubt there will be new innovations and inner-city properties become re-purposed on some scale. 

For portfolios, the commercial property sector remains an important component.  Whilst uncertainty remains it is however appropriate to consider the level of exposure held.  For many, this has been a sector with long term overweight exposures due to the love of income or simply good compounding returns.   It may be time to reconsider the level of exposure.

Source: Lonsec 8/6/21

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