In a manner nobody could have predicted, people’s habits have changed, and lives have been flipped upside down due to the COVID-19 global crisis. These are unprecedented times causing fundamental shifts in the world’s habits and priorities, in turn shaping different responses in Australian real estate. Nonetheless as I go through various sectors below, it’s apparent that most of the movement arising from the crisis is simply an acceleration of the course we were already heading in.
Currently, new leasing activity is stagnant due to uncertainty combined with a focus on negotiating within established landlord-tenant relationships rather than seriously seeking alternative space. A lot of the negotiations involve rent deferral in return for extensions of leases.
For small commercial tenants, a federal government-mandated code of conduct has been introduced which involves a combination of rent relief and deferment. The deferment component is outlined to be amortised over a 24-month period (or remaining lease term if greater) following the government’s declaration of the end of the COVID-19 period and ‘reasonable recovery’. Therefore, we’re likely to see a disproportionate number of leases ending unanimously roughly 2-3 years after such government announcement. Whenever this may be, this will result in increased activity as tenants move out, seeking places better suited to their business’ adaptation to the new norms.
I should note that there are many other factors which deem this return ambiguous, including fears of the state of the economy, impacts to the supply pipeline due to social distancing measures and reduced spending. As much as we can go into the finer details of the supply and demand sides if the fear of an economic recession is realised, my focus here is to run through a few things I expect to happen in the office, retail, industrial and residential leasing sectors in response to the societal shifts post COVID-19.
Once existing agreements come to an end we may see a number of changes in office demand which reflects the push to flexible or working from home arrangements.
Flexible working will re-shape office leasing
Working from home and flexible working arrangements has been growing in popularity, with companies such as PWC and KPMG having flexible opportunities high on the agenda to cater to the modern workforce. COVID-19 has interrupted traditional office and only accelerated the movement to flexible work, which will re-shape office leasing.
As a result of recent social-distancing measures, more resources have been poured into remote working technology to perpetuate the movement to flexible working. For example, online conference platform Zoom has increased is security and support services in response to its usage doubling from 100 million to 200 million daily meetings between December 2019 and March 2020. With the expectation for staff to be stationed at an office 5 days a week becoming a thing of the past, large firms may opt for high quality, smaller spaces over traditional large spaces. In these types of flexible arrangements, there will be a demand for spaces that accommodate co-working type fitouts and amenities, however, there will be a period where ‘hot-desks’ are prohibited due to pandemic contagion concerns.
There will be a period of experimentation before revisiting more traditional leasing agreements.
Whilst some businesses have already been practicing flexible working, the break away from traditional office use is still new to most employers. Thus, it will be a learning curve and stage of experimentation for a lot of offices. One option that companies might take up is utilising co-working to test what space requirements work for their new flow without making a long-term commitment. The response to this demand might not necessarily look like a single co-working operator taking over, rather, due to the varying trials, we may see new innovative co-working facilitators offering niche services over a range of size, location and grades.
Once we get through this transition stage, and businesses are confident in their size and fitout requirements, we may then find a movement back to traditional leasing arrangements including longer leases and larger spaces direct to the end-user. It may be important for landlords and developers to keep a close eye on what shifts in demands in facilities and floor layouts arise so they can get on the front-foot when this time of commitment arises.
Experimentation doesn’t necessarily mean the disappearance of commitment.
It is not all doom and gloom for landlords seeking secure leases over large spaces. In the return to stability we may see sub-letting becoming a heavier consideration. Currently, tenants locked in long-term leases which don’t have the opportunity to downsize may look to sectioning their tenancy for subletting or managing co-working. If sub-leasing becomes increasingly popular, we can also expect some of the barriers to subleasing such as legal costs, advertising and low demand easing.
If sub-leasing becomes more common, businesses may be more comfortable committing to longer leases and larger spaces. This is because they could have a fall-back option to section off their space to sublet or manage co-working outside of their firm. Companies considering this option would require facilities which can be shared and flexibility of the floor areas to be separated. The flipside to this is that the market for smaller office space may become increasingly competitive with this ‘secondary market’ of leasing on the table.
The rapid increase in online shopping and changes to the workforce will increase demand for smaller spaces, with consulting services faring the best in the long-term.
Will online retail take over Brick & Mortar
Online shopping has disrupted brick and mortar retail for the past decade, and has been continuing to grow steady, up 17.2% YOY to 2019 according to Australia Post – even before the push of COVID-19. This threat has only been accelerated as consumers change their shopping habits and increase their confidence in online shopping.
I expect that online sales will jump this year, and the heightened popularity of this choice over brick and mortar will sustainably grow into the future. Australia Post found that one of the biggest deterrents for consumers buying online was fear and the low sense of security. Ironically, it is now the cautious people who are avoiding contact in the streets and switching to online shopping for even basic needs. This is evident as Colliers found that Coles’ online sales have grown 14% in the 13 weeks to 5th April, which is disproportionate to the increase in supermarket sales (up 10.3%). Woolworths had a similar trend, up 26.5% in online sales. New Woolworths stores expect that click-and-collect will account for up to 30% of sales.
Another big hurdle for online retail has been the inability for customers to touch and see the product in-person, however this aspect can be alleviated in gaining trust in retailers as well as improvement in return policies and systems. Such procedures are naturally improved upon in this race for online retailers to win the favour of the new wave of online shoppers, gradually becoming a more and more viable option for shoppers.
Consumers will be looking for experiences. Tenants will be looking for small spaces.
In isolation, a lot of people have realised the importance of being outside and amongst others. Soon, the necessity to leave home won’t be to buy goods but rather seek experiences. If brick and mortar retail cannot compete with the convenience of online shopping, it can certainly offer bespoke, luxurious experiences to quench this social and tactile thirst. The most obvious industries which come to mind fulfilling these needs are health & beauty and luxury goods retail.
This skew of the retail mix towards services and retail will thus push the size required per shop down. Firstly, health and beauty has traditionally only required small operating spaces. Plus we can expect to see a shrink in the need for floorspace for goods retail when we consider the factor of online shopping; with a focus on experiences and ability to trade online, retailers will find it more cost-effective to rent a small showroom and store their inventory offsite somewhere more affordable and convenient for shipping.
A significant portion of tenants will be young start-ups
There’s no doubt that this is an incredibly tough time for small businesses, however we may see a rise in start-ups once confidence in the economy picks up. This is because the recent increase in unemployment has been skewed towards hospitality and therefore to the younger population. It is this younger generation that happens to have a big appetite for starting their own businesses, particularly in health and beauty. One study found that millennials pursuing their own businesses did so following a lay-off and because ‘the opportunity presented itself’. Sound familiar? It seems all factors are at play to drive a surge in start-ups looking to meet the increased demand for consulting and online retailing. Such new businesses might be seeking out short-term leases, small spaces, innovative agreements and faith from their landlords.
Lo and behold, more co-working.
For landlords not wishing to take on the risk of a start-up, and tenants not ready to commit to a lease, we could see a surge in ‘co-working’ operations in the retail sector. Pre-COVID-19, the health and beauty industry already had similar ‘rent a chair’ arrangements, where for example an individual hair-dresser brings their own clients to a workstation hired off a hair-salon lessee. Therefore, the idea of a co-working operator stepping into this space seems a natural progression and could act as an intermediary for landlords wanting security and businesses wanting flexibility. After this wave of start-ups, the successful businesses would then be able to rent directly off the landlords, and co-working could maintain a presence, albeit on a smaller scale as the excitement softens.
This high pace in demand from online shopping is no doubt a positive for the industrial sector. There will be a constant need to adapt to the evolution of supply-chains and consumer demands.
There will be an increase in demand for all types of warehousing
Many online retailers would have witnessed the importance of maintaining an inventory in the panic buying event shipping delays and trade restrictions. As I touched on in Retail, the movement of additional inventory from in-store to warehousing has also heightened the need for storage. Since this shift towards shipping goods is impacting all strains of the retail industry, it will be a healthy time for all grades and sizes of warehousing.
Last mile delivery & local pick up locations could reshape physical and geographic needs
The industry is growing in the highly competitive online retail store, leaving consumers with high demands, and shifting priorities. For example, where previously the cost of shipping was the most important, the need for speedy and bespoke delivery may become the deciding factor for consumers.
It is unlikely that any online retailers have perfected their supply chains or solved the dilemma of last mile delivery. Even the largest company in e-commerce, Amazon, continues to funnel energy into perfecting supply chains. It is logical for Amazon to take this step and invest in the rare knowns about the future. As per CEO, Jeff Bezos’ words, “It’s impossible to imagine a future 10 years from now where a customer comes up and says… ‘I love Amazon; I just wish you’d deliver a little more slowly.’ Standards are being pushed higher and higher as delivery time benchmarks are calculated in hours rather than days.
As for exactly how the desire for faster deliveries translates into commercial property, it is unknown and likely differs with each business and city. Supply chains and warehouse systems are constantly in a process of refinement and responding to geographic and consumer changes. As always, the factor of proximity to logistical nodes will be important in industrial real estate, however, could also see a movement closer to suburbs or collection points to reflect experimentation with last-mile delivery strategies.
Industrial development will increase from investors and occupiers will continue to rent
In a time of uncertainty, I am confident in saying that online shopping will continue to rise, and low interest rates will stick around. I am not the only one who shares this sentiment, as we are seeing investors and developers increasing their interest in industrial real estate. In a survey conducted by Colliers, various capital investors stated an increased focus on the logistics and industrial asset class between April and May 2020. Colliers also forecasts a rapid increase in industrial investment volumes as soon as the second half of this year.
A similar drive has been seen in development. For instance, Mirvac is planning construction of an industrial estate in Sydney to commence next year. This, they announce, is specifically intended to cater to the growing demand in online shopping and last mile delivery.
With the attraction to industrial development, it is reasonable to question whether large online retailers will also look to purchase or purpose-build warehousing. However, it is still safe to say that online retailers are better to focus their resources on research and technology rather than real estate. Again, in the long stage of reaction to change, leasing also provides tenants the flexibility required in refining their strategy. Therefore, despite the increase in supply from developers, the rise in online shopping and its rapid nature will keep industrial real estate healthy for the long term.
The biggest factors to consider in the residential sector is international travel and tourism.
Air-Bnb fluctuations means a stronger correlation to the tourism industry
One of the immediate changes to consider in the residential market is the influx of supply of long term rentals from users of homestay platform Air-Bnb, as they struggle to find tourists to accommodate. Due to Air-Bnb being a relatively new player it is difficult to measure the correlation between the tourism and residential market. However, with tourism dying down, there is a suspected increase of long-term accommodation supply from Air-Bnb hosts seeking fixed leases for long-term residents rather than tourists.
People are strongly divided about the speed of recovery in demand for international tourism once the lockdown period is lifted. However, there is general consensus that domestic travel will pick up quite quickly once Australians are able to make up for their cabin-fever and cancelled Easter (and Christmas?) getaways. With this, we would see the new supply transition back to Air-Bnb with each lease end. This is likely to have a greater impact on areas of domestic tourism, where the original suburban Air-bnb-come-rentals will take longer to switch back.
Australian tertiary education will create changes in student’s accommodation priorities
One of the changes arising from the pandemic is that online learning is becoming increasingly accessible. As a result, students who are renting may seek accommodation where they can study at home. This may mean an increased importance of high-speed internet and private studies. It could also mean more students will flock to purpose-built student accommodation with shared break out areas, potentially with this factor of higher priority than location to campus.
… but does this make geographic location a redundant factor in education?
Due to the number of international students renting in Australia, we cannot take the influence of the higher education industry on rentals for granted. A significant portion of students are from overseas and live on campus or in inner-city accommodation. Realistically, it is probably a while off before online education becomes a serious competitor with tertiary education. Australia offers a wealth of experience in its lifestyle, environment and variety of culture. If anything, this global crisis is pulling the world together and also proving that government security is more valuable than appreciated.
As long as Australia can offer a lot to international students, there will still be a demand for student accommodation from them. There may be a longer recovery period and a wave of low enrolments due to travel restrictions, however, the fundamental attractiveness of Australia still exists. On top of this, studying abroad could largely be taken up by students killing the travel bug with the security of study being considered more ‘essential’ than discretionary travel. Thus, it’s likely that students, including those from overseas, are likely to continue their demand for rentals.
International travel and movement to online has a complex influence on the residential rental market. In all, it may take residential longer to recover due to its relationship with international trade and tourism, however, the long-term impact of COVID-19 isn’t enough to change the fundamentals of residential leasing in Australia.
COVID-19 has lined up many sides of commercial real estate to pick up a fast pace after this dormant period of reflection and stagnation. Commercial and industrial sectors will navigate experimentation with working from home and an increase in online shopping, respectively. As retail has been long warned of the threat of online shopping, focus has already shifted to experiences, which demand for may be heightened due to isolation. As for residential, there will be multiple waves in response to changes to travel and accessibility to online education, however, it’s unlikely this will have a significant lasting impact.