Resilience needed in face of change

The Reserve Bank says the commercial property sector is vulnerable to the Covid-19 crisis. But PMG Funds' chief executive believes that while there’ll be short-term pain, the biggest long-term impact will be structural change.

Thursday, May 28th 2020

PMG Funds chief executive Scott McKenzie

In its latest Financial Stability Report (FSR), which was released Wednesday, the Reserve Bank says commercial property – especially accommodation, hospitality, retail, and some office properties – was immediately affected by Covid-19 prompted travel restrictions and the alert level four measures.

“Many property owners have proactively offered rent reductions to support tenants during the downturn, but a prolonged economic slump will put downward pressure on rents and lead to increases in vacancy rates.”

The report says current development pipelines also indicate that an above-average volume of retail and accommodation space is due to be delivered over the next year in the Auckland and Queenstown markets

“Demand may therefore struggle to keep pace with this increased supply, and the viability of some commercial property loans will be called into question.”

While the tightening of lending requirements for the sector mean the problems it faces are unlikely to threaten financial stability on their own, the report says that could exacerbate the downturn and weaken the financial system’s resilience.

However, PMG Funds chief executive Scott McKenzie says that while the Covid-19 crisis is unprecedented and has presented major challenges for commercial landlords and the businesses who are their tenants, long-term it is a bump on the road.

He thinks the industry has responded pretty well to the crisis, with most businesses and landlords managing to work together to find a solution to help them get through - despite confusion around the ‘no access’ clause in many leases.

“We have 250 tenants, made up of a combination of small, medium and large businesses, across our portfolio and we want them to stay long-term. We were willing to share the pain and so we came up with packages targeted for each of our tenants and we’ve now finalised discussions with 90% of them.

“Most landlords would have been done the same and negotiated agreements which are fair and reasonable for their situation. It hasn’t been easy though because it is not just a commercial discussion, it is also an ethical and moral discussion.”

They expected to see the loss of about one month of rent across their portfolio, yet the impact has been below that, McKenzie says.

“A lot of our tenants have proved to be resilient. But our portfolio is geared more towards office and industrial properties, so we have less than 8% exposure to tourism, hospitality and/or retail. That makes a difference as investors with heavy exposure to those areas are likely to be suffering.”

Going forward, he doesn’t see the Covid-19 crisis as dealing a king-hit to New Zealand’s commercial property sector.

One supportive factor is that there were some residual low vacancy rates going into the crisis, he says. For example, in the Auckland CBD office space, the vacancy rate pre-Covid was 6%, as compared to the pre-GFC rate of 14%. Likewise in Christchurch, the rate was 10% pre-GFC but 5% pre-Covid.

“This leaves the commercial sector in a reasonably strong place in terms of capacity to absorb the shock. It’s a better situation than during the GFC. Also, in the industrial/logistics sector, the capacity is even tighter as there was even less vacant supply around pre-Covid.”

Real estate – whether commercial or residential – goes in cycles and the commercial property sector’s journey to growth will continue, but there will be some major structural changes ahead, McKenzie says.

One big change will be with retail property as there will be much more interaction online. That means high-street retailers might need to rethink their business model, but it will good for industrial/logistics property.

Another big structural change is likely to come in the office space. McKenzie says lockdown was the biggest global remote working experiment the world has ever seen and it will have an impact on the office property sector.

“Some of the existing trends in that space have now sped up. In particular, flexible and remote working. There will be differences around health and safety protocols, especially short-term. We’ll see much less of things like hot-desking and there will be questions around the best, most effective use of space.”

But office property in central locations has been round for hundreds of years and that’s not going to change, he says.

“Offices exist to bring people together to facilitate interaction and collaboration. There’s still a need to for spaces to do that because they enable creativity, innovation and the transfer of know how. It’s harder to achieve these things in remote working environments, even with the help of technology.

“So I think offices are here to stay but the way people come together for work and how they work might change a bit. Office property and the way it is used will evolve. The spaces will be designed to be more efficient and to better enables the work and the culture.”

For investors, the way forward is all about cash flow, the resilience of their portfolio and their tenants, and also making the most of any opportunities to enhance their portfolio, in McKenzie’s view.

At PMG, they have been thinking hard about the future of real estate and the trends that they are seeing and they will continue to review their portfolio accordingly, he says.

“It is about anticipating changes. So that we are able to expand our real estate assets, and improve the quality of our portfolio, in a way that is right, not just in the current market but for the long-term. It is all about the value add – and resilience. That is our mandate.”

To that end, PMG has just announced its latest investment offer: its office fund is acquiring the Vodafone Innov8 office in the Christchurch CBD.*

McKenzie says the acquisition is not about trying to pick up deals at the bottom of the cycle. “It is all about the asset which is one that we think will add value to our portfolio long-term.”

*To find out more information about the offer it is possible to download a Product Disclosure Statement from the PMG website here


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