Market Views: Has Covid-19 popped commercial property's appeal?

One major business impact of the Covid-19 pandemic has been enforced lockdowns and white collar employees having to work from home for extended periods. It has had a deleterious impact on the valuation of commercial real estate, in Asia and across the world.

Hong Kong, as one of the most expense proprerty markets in Asia, saw a 22% decline in gross leasing activities of offices in the second quarter this year, the lowest quarter since early 2014. And overall office vacancies rose to 8.8%, the highest level since the third quarter of 2009 a CBRE report shows. And many tenants continue to seek cost-saving options such as relocations, shorter terms or fully fitted premises.  

Office valuations have not been the only sole victim. Industrial and retail buildings have also faltered amid lower business activity and a collapse in tourism. Hotels have been especially hard hit as travel diminished this year.

Yet while the near-term outlook for commercial real estate is mixed, it is far from entirely negative.

“What is apparent is that the rents for prime offices dropped faster than secondary in the early days of Covid-19 but demand has now picked up as tenants who could not previously afford it are moving into better space,” David Faulkner, president of Urban Land Institute Asia Pacific told AsianInvestor.

Investment enquiries are gradually recovering across the region, particularly in Korea, Singapore and New Zealand, according to another separate CBRE report. In the regions, capitalisation rate ranges have narrowed since May as pricing is supported by low borrowing costs and return on investment demand. Across major Asian markets, Grade A office yields range from 2.5% (Taipei) to over 8% (Mumbai), with rents is expected to climb at 3% or more in Singapore, Bangkok and Bangalore, real estate services provider Colliers International said in its latest report.

AsianInvestor asked four experts on how a long-tail Covid-19 pandemic could reshape investors’ appetite on commercial real estate assets.

The following contributions have been edited for clarity and brevity.

Greg Hyland, head of capital markets, Asia Pacific
CBRE

Following a sharp decline in investment activity in the second quarter of 2020, during which Asia Pacific commercial real estate investment volume fell 48% year on year to $17 billion, market sentiment is now improving along with the gradual resumption of business activity.

We have seen an encouraging pick up in investment enquiries in recent months, including from several institutional groups. Recent stock market volatility will encourage institutional investors to invest in real estate for diversification. This year has seen several major institutional investors increase their exposure to logistics assets for long term investment.

Commercial real estate remains an attractive asset class for investors. Interest rates are expected to stay low for longer and the real estate yield spread will continue to encourage investors to include real assets in their portfolios.

Although remote working may impact future office demand to a certain extent, Asia’s small residential spaces along with other challenges mean the office is here to stay. Investors are advised to capitalise on the price correction to acquire good quality office assets for long term investment. Other opportunities include discounts on the listed market such as Reits, many of which are currently trading below their net asset value. Core/core-plus assets with high quality tenants are the main focus for investors at present.  

Sarah Lien, director, client portfolio manager
Eastspring Investments

Real estate-related stocks have not fared well in the Covid-19 environment. It’s been one of the worst pockets of performance in the market on a year-to-date return basis.

However, we think the market is pricing in too much downside and the negatives are well-known. Across Asia, the worst is behind us.It is highly unlikely we will see a repeat of the large-scale lockdowns experienced earlier in the year.

Many of the real estate stocks have recovered from the bottoms earlier this year, but some stocks in areas like retail and commercial are priced as if no one will ever shop in a mall or work in an office ever again – and therein lies the opportunity.

Investors need to be selective because there will of course be winners but also some losers in the fallout if the individual properties are unable to adapt to changing consumer preferences. 

For working from home trend, the jury is still out there. We do not know how this will look going forward. Suburban offices are fine and will face little disruption, particularly in countries where firms can employ a hub-and-spoke model like Australia and Singapore. Central business district properties may have lower occupancies in the future, and we are likely to see rents reset lower on the back of this. 

Leslie Chua, senior vice president and director of Asia Pacific investment research
Heitman

We believe the valuation of commercial real estate assets’ discount will likely be limited, in both quantum and time.

Partial remote work—or at least a flexible work week, with some time spent out of the office—appears to be emerging as a preference for office workers globally. It is likely this trend will exert some near-term downward pressure on office take-up, but the full extent of impact remains largely speculative.

In most Asia Pacific markets, we expect that figure to be much lower than in other parts of the world, due to a variety of factors including lower Covid-19 mortality, less IT infrastructure, smaller home size, and cultural preferences.

Over the short-term, we expect desk space per worker to increase slightly, which could shore-up demand as employers separate employees and attempt to limit infection. We anticipate that space-per-worker will return to its pre-pandemic level over the medium- to long-term. In the end, the more-pressing concerns of land cost and limited supply of developable land will determine the fate of high-rise buildings. This has been especially true across the ultra-dense megacities of Hong Kong, Singapore, Tokyo and Seoul.

Capital continues to chase large office buildings while transactional activity has been significantly lower than in recent years while the demand for prime, well-amenitised, and well-located office assets has weathered the recent volatility.

Niall McSweeney, senior director, Asia Pacific
Altus Group

According to our Altus Group Global Property Development Trends Report, 67% of development executives said that tenant/occupier expectations and preferences have a major influence on development planning.

The rise of e-commerce has long been making inroads into bricks and mortar retail, and Covid-19 has only accelerated this.  Activity in this area is unsurprisingly subdued, with the bolder players looking at new innovative retail formats for longer-term appeal. This has prompted investment into logistics, and with consumer preference becoming entrenched, this trajectory will be difficult to reverse.

According to the report, 68% said the risk of a cycle downturn has a big impact on their decisions regarding new construction investments, with distressed asset acquisitions (57%) and change in asset/portfolio mix (66%) viewed as more of a risk than opportunity. While some larger firms are looking to do “bargain hunting”, many are waiting for ‘the bottom’ to hit first.

So far, valuations have held relatively steady for most areas of commercial real estate, likely due to a lack of broad consensus on future demand. There has been the ‘flight to quality’ that occurs under difficult conditions, and the industry anticipates prime offices will remain attractive to investors.