Five challenges facing the real estate sector

This article was originally published 12 May 2020.

Unprecedented times have created enormous challenges for the real estate sector in Australia.

COVID-19 is ‘the great disruptor’ and the sector faces a lengthy downturn, likely to stretch well into 2021.

But the real impacts will ripple through the industry for many more years to come with significant long term changes to the way we work and invest in real estate. Five key areas that will see much focus are:

Landlord and tenant relationships

The central business districts are silent and offices sit empty, shopping centres are quiet, with retailers hoping to re-open once social distancing measures have eased.

Landlords are working through the new commercial codes, legislation and regulations that have recently been put in place. Many tenants are in distress and are looking to manage their cash flow and receive rental abatements.

Landlords must recognise the stress and strain on tenants and show compassion, for, in the long term, tenant relationships will be key to the revitalisation of their business.
In the coming months as tenants and landlords work through the issues, a balanced approach combined with patience and teamwork will be needed to reach fair and reasonable outcomes.

Adapting to the ‘new normal’ for Office Space

The pandemic has proven that flexible working is not only possible on a large scale, but is an effective way of working. However, it doesn’t suit everyone. Many employees don’t have access to a suitable home work environment - shared housing, small apartments or carer responsibilities -make working from home a challenge.

The social distancing measures have emphasised just how important personal connectivity is to our lives. Remote working makes it difficult to read body language over video calls, on-board new people and maintain connections and cultures that are so valuable to organisations.

Before businesses rush to reduce their office space needs, they should pause to consider a new demand emerging for office space. Whilst flexibility in the workplace is important, it’s expected that there’ll be demand for less density in office spaces. The two elements will likely offset each other, with Gross Lettable Area maintained, but office space used in a different way.

Asset valuations

With an economic crisis, there is uncertainty and volatility around property valuations. This financial year, many difficult judgements will need to be applied in financial reporting with respect to asset valuations.

The fair value of an asset is determined with reference to many variables: yields, future rental cash inflows, rental incentives/abatements provided to tenants, future capital expenditure requirements, comparable market sales.

Special attention will be needed on the key inputs that are used in developing fair value conclusions. For financial reporting, disclosures around changes in fair value techniques, inputs to the fair value measurements and sensitivity to changes in the assumptions will also need to be considered.

Whilst there may be less volatility in the quality assets that will hold their value, to an extent, secondary asset valuations are expected to be impacted. As demand for secondary assets decreases due to uncertainty, there will be less comparability to determine fair value of these assets in this environment and this is where valuations become problematic.

Potential decreases in property valuations may impact banking covenant compliance and complex going concern considerations.

Sustainability cannot be forgotten

There is increasing pressure on organisations to consider their corporate social responsibilities and enhance reporting to various stakeholders. It’s expected that integrated reporting will become the new normal in Australia. Pre-COVID-19, global warming and other social and political issues were front of mind. The pandemic has now further thrust forward the thinking on sustainability in real estate, with future decisions on capital expenditure viewed through a COVID-19 lens.

Innovation and wellness will drive real estate decisions

Development activity will decline and new projects that do push forward will focus on innovation, technology and wellness.

Technology developed for commercial real estate in respect to air quality and filtration will be in high demand as a result of the pandemic. Current commercial properties will need to be cognisant to future capital spending in this area to remain competitive. Decisions around office fit-outs and commercial spaces will be considered in relation to the wellness of the people in those spaces and a new focus on people’s needs will be forefront of decision-makers’ minds.