Al-anwar Newspaper English news in Australia
By Mohamad Mourad
The onset of COVID-19 in 2020 has produced a number of interesting effects on dynamics in the traditional real estate sectors and real estate markets across Australia in terms of leasing activity and investment activity. This paper is designed to be a summary of the key events and themes surrounding the commercial real estate sector over 2020. The high-level themes include 1) people, as workers and consumers, doing more from home, 2) a rethink by business of their real estate space requirements and 3) landlords rethinking their provision of space to secure rental cash flow in more uncertain times.
Leasing Market – Demand and Supply.
Where Did the Demand for Office Space Go?
Demand for office space over 2020 was transformed into demand for residential space primarily because of the stay-at-home and work-at-home push by the Federal Government. Interestingly, the increase in demand for residential space has been predominately concentrated in the housing sub-sector rather than in the apartments sub-sector. Housing and the renting of houses provides workers with much more flexibility because there is more room to structure a home office setting, combined with having a backyard for children and pets. Furthermore, unlike apartments, houses do not have lifts in them, hence negating the fear of people needing to be in close contact with others unnecessarily.
In some cases, leasing agents in suburban Sydney have relayed information that white-collar workers have combined to lease a house from which to work in and split the cost of rent. These factors have contributed to the decline in housing vacancy rates on the one hand, and maintaining, if not increasing rental rates on the other hand. There are not many housing options currently on the market for rent. Over the short-run period, this shortage will contribute to sustained rental rates given that there is not enough construction activity to keep up with the transformed demand.
Sub-lease vacancy across the CBD office markets has increased – although not all has been related to the pandemic according to JLL Research. Businesses begun to re-evaluate their existing footprints in office buildings across Australia’s office CBD markets. Business tenants with at least 5,000 sqm of office space are likely keep their head offices (usually within the CBD) yet reduce their footprint, and simultaneously embark on a hub-and-spoke model for their staff. The hub-and-spoke model is where smaller satellite offices in surrounding suburban markets are leased to allow workers to commute to work closer to home and also with lower staff numbers in any one area. These are the spokes, while the hub is the head office.
Demand for apartments and studio apartments has been negatively impacted by the government regulations put in place from COVID-19. International travel bans have translated into reduced demand for these types of housing, a large proportion of which are primarily leased by tourists and international students. Landlords have been offering prospective tenants with rent-free periods of up to 6 months and shopping gift cards to secure rental cash flow over the short term. Unsurprisingly, apartment rents have reduced significantly, and a lot of vacancy exists for people wanting to exploit the abundance of rental apartments for lease.
Co-working Spaces – A Long-term Revival?
Flexible office space providers are likely to be slight beneficiaries of the health and safety settings pushed through by the COVID-19 pandemic. Start-up businesses and other small-to- medium enterprises may indeed elect to lease office space from WeWork, Servcorp, Regus among others to maximise the benefit of flexibility of space offerings along with lease terms and conditions in comparatively uncertain times. This particular fact may bring forth some challenges to the landlords that provide traditional office space.
The Retail Sector – Dealing with COVID-19 and Existing Structural Changes.
Shopping centres and specialty shop owners have faced huge challenges over the past 5-10 years. Most of these challenges have been structural with retailers still coming to terms with adapting to the online purchasing phenomena. Another challenge has been the quick rise of subscription-based streaming services and home delivery of meals and beverages. In 2020, the push to work from home and stay at home has naturally reduced foot traffic across the major regional and sub-regional centres across Australia. It has also reinforced the impetus to purchase goods online rather than in-person for a majority of consumers.
However, the major supermarkets (Woolworths, Coles and Aldi) have retained a degree of cash flow and foot traffic by virtue of selling essentials (food, drink and toiletries). Owners of Category killers such as Bunnings Warehouse, IKEA and Amart Furniture among others have also benefitted from the COVID-19 pandemic. White-collar workers have restructured their homes to create work desks and a general office environment within their homes.
National retail turnover rates rebounded when respective states began to ease physical distancing requirements. However, specialty shops vacancy rates across the key retail subsectors increased and are at levels not seen for over 10 years. Average year-ended rental growth rates ranged between -2% and -8% per annum over 2020.
In the lead up to Christmas, the anchor tenants of major shopping centres like Myer and David Jones began an advertising campaign to attract consumers back into stores. There was also a push towards window shopping as a way of reducing the compulsion to purchase goods online. The advertising campaign did have a positive effect however the recent spike in COVID-19 cases in Sydney has dampened the mood for Boxing Day shopping. The current official health settings by the State Governments will predominantly have an effect on the extent to which there is a smooth running of specialty shops, and hospitality providers across Australia. Shopping centre owners and retailers need to rethink how they can re-engage consumers to start dining out and shopping in-person. Landlords and developers will also be deferring major construction projects to focus on diversifying rental cash flows.
Industrial Markets – Ahead of the Rest.
The industrial sector has probably been the only sector of the 3 traditional commercial real estate sectors that has flourished over 2020 when considered from a leasing perspective. Demand has been high and has contributed towards sustaining rental rates across market in Australia. Industrial leasing agents have experienced burgeoning demand for warehouses, logistics centres and distribution centres. The move towards this trend has come from the push to work from home and combined with the strong preferences for purchasing online. Some of the major retailers have leased industrial space to accommodate these new societal trends. It is likely that these trends will continue into the foreseeable future. The strong demand, not just over 2020, but also in the recent past has pushed construction activity to increase.
Investment Markets –
Capital Inflows and Outflows
Investments and transaction volumes decreased over 2020 when compared with levels in the preceding 3 calendar years. The reduction in investment activity was not all induced by the COVID-19 pandemic. Prior to 2020, there has been quite a lot of investment transactions across the three traditional real estate sectors. As a result, there has been a small amount of investment grade assets left that could be sold. The high levels of investment activity contributed to general yield compression across markets and sectors. However, general investment activity in 2020 was underpinned by a number of institutional investors divesting holdings in key assets on the expectation of the yield compression cycle coming to an end.
Yields and Pricing – A likely Bifurcation of Yields in Key Markets
The typical effect of recessions on commercial property pricing is a general decompression of both the upper and lower end of the capitalisation rate range. The decompression reflects the incorporation of higher business risk inherent in the sector emanating from tenants reducing production levels. However, the COVID-19-induced recession has created a minor bifurcation in the capitalisation rate ranges in the office sector. There was mild decompression of the lower end of the capitalisation rate range in most suburban office markets over 2020. The upper end of the ranges across most markets remained unchanged. However, transaction activity has been concentrated towards prime-grade assets with long-term WALEs where security of rental cash flow remains high because of the presence of blue-chip tenants in these buildings. If competition between institutional investors picks up among the limited secure assets, there may be compression of the yield range at the upper end while decompression may continue at the lower end.
The strong leasing activity in the industrial sector over 2020 has contributed to moderate compression of yields in all markets except for Perth. The industrial property capitalisation rates range remained unchanged in Perth. It is likely that pricing may continue in this fashion across the industrial sector over the next 12 months.
Disclaimer: The views expressed in this paper are those of the author (Mohamad Mourad) and are not reflective of the views or position held by the University of New South Wales. This paper is the property of the author and he asserts his right over the distribution, dissemination, and reproduction of the paper in all ways, shapes, and manners for all time periods.
