The outlook for property: Implications of COVID-19

Overview: Economic Impact of COVID-19

  • The global health crisis caused by COVID-19 is rapidly leading to a potentially severe global economic downturn.
  • Unprecedented in nature, self-imposed lockdowns have resulted in an adverse economic impact.
  • The shape of the recovery (V, U or L) will likely depend on the timing and effectiveness of a vaccine.
  • The extent of the global economic impact will depend on how long the pandemic takes to be brought under control. At this stage, this is unknown.
  • The longer the recessionary period, the more impact on the real estate sector.

 

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The Office Sector: Medium Term Value Implications

  • Expect weak leasing activity, but increased renewal rates as tenants elect to ‘sit tight’ given the uncertainty of the economy going forward.
  • Tech markets should outperform, and we also expect increased demand from life sciences / biotech companies.
  • Co-working office operators are likely to be hit hard, with potential for a significant re-think of the sub-sector. Co-Working was a major driver of net absorption in office, especially major cities such as NYC, LA and London.
  • Public transport is an issue that may have no solution prior to an effective vaccine.
  • Potential for a permanent adoption of ‘working from home’ could lead to less demand for office space.

Quotes by CEOs of several major US companies point to the changing work culture:

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  • Will the densification trend be reversed if we require 2m between desks, will the need for lower densification offset the ‘working from home’ space reduction requirements?
  • If COVID-19 results in an extended recessionary period, there is potential for business to contract resulting in a reduced demand for office space, leading to excess supply. This will then start to impact on the office sector.
  • In this instance, office valuations could come under pressure if market rents decline and cap rates soften.

The Industrial Sector: Medium Term Value Implications

  • The global supply chain shock resulting from COVID-19 will likely lead to an increase in onshoring of manufacturing, higher inventory levels and more diversified supply chains.
  • Social distancing measures have seen a material increase in online retail, which is likely to have accelerated the shift to online, especially for groceries (currently ~2% market share in US and Australia).
  • Online retail will drive demand for infill locations & supply chain configurations.
  • This will see the Industrial/logistics sector be the likely ‘winner’ from the pandemic, with a potential increase in demand for warehouse space.

 

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  • Consequently, Industrial valuations have the potential to hold up more than the other property sectors, however an extended recessionary period could lead to business contraction which will then impact on industrial asset values similar to the office sector.

The Retail Sector: Medium Term Value Implications

  • COVID-19 has put even more pressure on retailers, with the forced closures of many retailers (including restaurants, cinemas and gyms) which could lead to retailer bankruptcies, which will ultimately lead to less demand for retail space.
  • Convenience centres anchored by supermarkets and essential retailers have fared better.
  • The recent increase in online retail as a result of COVID-19 social-distancing measures is likely to have accelerated the take up of online retail, especially for the grocery sector.
  • Pure online retail has low operating margins due to shipping and returns costs. Omni-channel retail that adopts ‘click and collect (and return)’ are more profitable. Coles and Woolworths are investing heavily in ‘click and collect’ including ‘drive by’ collection.
  • Retailer store footprints are likely to shrink, with a focus on flagship stores in the highly productive Super Regional centres to market the brand. While these centres are under pressure now due to social distancing measures, going forward, retailers will choose to be in these centres and close their stores in smaller centres.
  • All retail assets likely to see some valuation impact due to reduced market rents, however the supermarket anchored convenience centres and the Super Regional centres are likely to fare better over the medium to long term.

 

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The Residential Sector: Medium Term Value Implications

  • While the ‘Build to Rent’ sector is in its early stages of development in Australia, it’s very mature in the US and parts of Europe (defined as the ‘Multifamily’ or ‘Apartment’ sector in US).
  • Historically the most defensive, as demand-driven by demographics rather than economic cycle.
  • If ‘work from home’ philosophy gains momentum post-COVID, there is potential for increased demand for ‘Single Family Housing’ sector as tenants require more space to work from home.
  • Also increased ‘work from home’ adoption and need for affordability is likely to accelerate migration to states/countries with lower tax regimes (more applicable to the US and Europe).

 

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  • Sector attributes and medium term outlook are less likely to be affected in post-COVID world, notwithstanding the potential changes within the residential sector highlighted above.
  • Residential valuations are likely to hold up over the medium to longer term as rents can be increased more quickly relative to other sectors as employment growth comes back.

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JANA respectfully acknowledges the Traditional Custodians of the land where we work and live. We pay our respects to Elders past, present and emerging. We celebrate the stories, culture and traditions of Aboriginal and Torres Strait Islander Elders of all communities who also work and live on this land.