The effect of COVID-19 on the Commercial Real Estate Market
The Covid-19 pandemic has sent shockwaves through the economies of the world, ravaging lives and livelihoods, leaving us uncertain and bewildered about the future for our personal lives, businesses, industries and, indeed, global commerce. 2021 brings a potential fresh start with the rollout of vaccines, availability of better treatments and continuing huge scientific research efforts. The world’s scientists have collaborated as never before in the fight against disease, but the scientific community is also warning us of more challenges in the potential consequences of virus mutations, allowing new strains and variants to arise and spread across borders.
Many industries are facing a tough economic outlook. The growth of online retail at the expense of physical retail is one example which directly affects the commercial property industry. Consumers are estimated to have spent $839.02 billion online in the U.S. in 2020, up an incredible 40.3% jump compared with 2019. That’s the highest annual U.S. ecommerce growth in at least two decades.
In Europe, retail footfall is still far behind pre-Covid levels although it did show signs of recovery in the summer when restrictions were eased. As of August 2020, according to ShopperTrak, footfall was 25% lower in France and 30% lower in Germany than the previous year. Furthermore, as countries have re-imposed restrictions in order to control the virus in the autumn and winter months, this trend looks set to continue for the foreseeable future.
The Centre for Retail Research has estimated that in 2020 there have been 176,718 total job losses and 15,747 store closures in the UK as a result of administration, compulsory voluntary arrangements (CVAs) and rationalisation – the worst year for high street job losses in a quarter of a century. Major companies such as Boots, Oasis and Warehouse Group, River Island, Arcadia Group, John Lewis, WH Smith, M&S, The Edinburgh Woollen Mill Group, Pret A Manger, Upper Crust, and even Burberry all announced job losses. Other organisations have gone into administration either directly or indirectly as a result of Coronavirus. These include Debenhams, TM Lewin, Oliver Sweeney, Harveys Furniture, and Victoria’s Secret to name but a few examples. France has suffered similarly with more than 12,000 store closures in the retail sector, directly due to Covid-19.
In this environment, Aberdeen Standard have found retailers to be the most likely type of tenant to seek rent deferrals and believe most traditional brick and mortar retail outlets – aside from supermarkets – will struggle in the coming months and years. For asset managers it is important to be aware of these risks, have visibility over their assets and factor into their cashflow forecasts the possibility of void periods resulting from lockdowns, reduced footfall and store closures.
Another recent casualty for the commercial property industry has been office space as many employees have been directed to work from home in lockdown. Covid-19 has facilitated a shift to remote work with 46.6% of surveyed employees working from home, 86% of whom are doing so as a result of the pandemic. This has caused a global conversation about making permanent changes to the traditional office model.
Tech firms such as Facebook, Twitter, and Google have made decisions to shift to remote-working with the latter deciding not to proceed with a new office in Ireland. Pinterest made headlines for paying $89.5 million to terminate a San Francisco office lease. Barclays, Nationwide, and Morgan Stanley have also been reviewing their office requirements. Anticipating the second wave of Covid transmission in late 2020, and associated restrictions, banks such as Deutsche Bank, HSBC, and Citi have put plans on hold to bring employees back to the office.
The scale of transition to the “work from home” model and its relative success within organisations may indicate a direction of travel for the future. According to a survey by the Institute of Directors (IoD), over 50% of UK directors say they will reduce their long-term use of office space with 20% reporting their usage would be “significantly lower” and 75% stating that they would be keeping increased home-working beyond the fallout from Covid-19.
Savills notes that European office take-up in the first half of 2020 fell 32% against the same period in 2019, with significant drops coming from the Banking, Insurance, and Finance sectors. According to Capital Economics, five-year European office rental growth forecasts have fallen from an average of 1.9% to 1.4% pa as a result of Covid-19. Fitch also expects European office rents to weaken as a result of economic contraction and increasing unemployment. Moreover, Aberdeen Standard has revised down to a negative rate office growth forecasts in the short and medium term. Aggregate vacancy rates in office are set to rise from 6% to roughly 8% by 2022 and there is an expectation amongst analysts of continued downward pressure in the near-term. According to Savills, it is evident that occupiers are seeking more flexible lease terms in light of the current situation, and there is evidence of incentive use increasing throughout Q3 2020.
A market survey conducted by RICS revealed a view amongst those surveyed that the pandemic has facilitated a shift to remote-working that will have a lasting impact in the European office sector, as investors, landlords, and tenants seek to adapt to the “new normal”. France, for example, a key office market, now has one of the highest mix of employees working from home. In addition, countries such as Germany, which was one of the fastest regions to bring people back into the office environment, are now looking to enshrine legal homeworking rights. Similarly, Spain, Greece, and Ireland are all considering legislation to safeguard employee rights when working from home.
As organisations conclude that it is possible for large parts of the workforce to work remotely and consider moving to less office-based work models, this may impact commercial real estate owners and investors, and adjustments to business plans will need to be made, at least in the short to medium term.
However, in the longer term can we be sure these adjustments will prove to be of lasting effect? Is the office really dead? The work from home culture so many of us have had to adopt certainly has its advantages. The wasted time too often involved in the daily commute has largely become a thing of the past and improved working flexibility around appointments, household chores and childcare has been a great benefit for many. Technology has allowed distanced online meetings and the flexibility to get work done at any time of the night or day, as circumstances allow. But it has also deprived human beings of those bonding moments, at the water cooler or coffee machine, birthday cake get-togethers, leaving dos, chats and catch ups after work. These are known to be those aspects of working life which are apt to improve communication and understanding between colleagues, generate creative ideas, and induce a greater sense of wellbeing, belonging and purposeful, collective endeavour, from which companies undoubtedly benefit in terms of their productivity.
Equally there seems no need for pessimism for other commercial property sectors. While the high street retail, hospitality and leisure sectors have been particularly badly hit, human beings are sociable creatures who will want to re-engage with each other in leisure, shopping and hospitality settings as soon as lockdowns allow.
It is a truism that economic markets hate uncertainty and it is undoubtedly the case that the commercial property market is experiencing its fair share of uncertainty at the moment. But markets essentially reflect the behaviour of investors, entrepreneurs, buyers and sellers and, indeed, the public, who react to perceived threats and opportunities. Just as, over centuries, developments in technology have closed doors for some traditional industries, business processes and employment, such developments have undoubtedly created entrepreneurial activity leading to new business opportunities, processes and employment.
The same is likely to happen in our Covid-19 environment and beyond. The need for increased vaccine manufacture and short, secure supply lines for vaccine ingredients and vaccine distribution could mean, for example, that the real estate industry will see a demand for more commercial and industrial manufacturing buildings and infrastructure, and more specialised warehousing and storage facilities.
Covid-19 will change our global economic outlook, risk analysis, environmental decision making and, from all this, other opportunities will arise. For example, it already looks to be kickstarting other scientific endeavours in a bid to face up to other important risks facing humanity. There is nothing like seeing the effects of one crisis to wake people up to other impending threats. Ineos, one of the world’s largest manufacturing companies, has donated £100 million to Oxford University to research and produce new antibiotics to deal with the highly resistant bacteria which threaten to take us back to the pre-antibiotic age when any infection was potentially fatal. So, for the real estate industry, Covid-19 may provide an opportunity for investment in sectors hitherto untapped, born from the need to adapt traditional business models.