Australia’s commercial real estate sector was thrown a massive curve ball with the COVID-19 pandemic.  Suddenly many businesses had to close, all have had to accommodate social distancing requirements and at the same time they have had to provide reassurance for their teams that the work environment is a safe place to be.

Whilst these changes have provided opportunities in terms of offering flexible working from home conditions, it has greatly affected the relationship between landlords and tenants, put pressure on available office space, and asset valuations.

These challenges are likely to be long-term affecting how we view commercial real estate as an investment, how we structure our businesses and office space and how the tenant-landlord relationship is shaped into the future.

Landlord-Tenant Relationships

The landlord-tenant relationship has been a key area of focus as many tenants struggle to meet their rent commitments as they in-turn have watched revenue streams disappear.  It is a fine balancing act for landlords.  They need to act sympathetically towards their struggling tenants whilst still meeting their own financial commitments.  It is really a lose-lose situation.

That being said, for the economy to recover well, shops need to be open, offices need to be filled so it is imperative that relationships are handled with care.  Key in this are real estate agents, many of who are being left to navigate the murky waters between tenant and landlord.  They are expected to interpret legislation changes and make sure both sides of the equation are helped through these times.  As is to be expected, some are performing better than others.

Ultimately, this is a situation where legislation alone is not the answer.  Empathy is required by landlords and agents alike as they recognise the stress and strain facing businesses owners.  The long-term view needs to be taken – treat your tenant with compassion and they are more likely to renew their lease at the end of it’s term.  Assist your tenant through this period and you help a business stay afloat which will help the economy recover.

As a balance to this, tenants must understand the position of their landlord, and recognise they too have financial commitments which need to be met.

The most successful outcomes will arise from a balanced approach.  Understanding on both sides and a willingness to accept changes to leases and rents in order to facilitate the ongoing recovery of small business.  Now is not a time to be greedy.

The Office Space Conundrum

In a pre-COVID-19 world, it was suggested the optimal office space would be calculated on about 4 square metres per workstation.  With many offices working to less than this, especially as a business begins to outgrow it’s leased area.  With social distancing requirements set to be a fixture into the foreseeable future, this estimate should work quite well however, what about break-out areas?  Lunch rooms?  Bathrooms?  Lifts?  Then it becomes altogether more difficult, I can’t imagine anybody wants to have to queue for the toilet whilst at the office, and I have seen estimates of anything up to an hour for an employee to be able to sit at their desk as they wait to be able to use the lift.

The pandemic has demonstrated the implementation of flexible working conditions is possible, and has the ability to work-well for those in a position to utilise it.  Creativity will be needed to ensure a balance is achieved between providing employees with a safe working environment and utilisation of existing space and its amenities.

We are likely to see many changes in the office space environment as businesses trial new approaches to the work environment.

Asset Values

The commercial real estate sector has long been seen as an area of “safe” investment.  Tenancies are generally long-term, businesses are generally reliable when it comes to paying rent, rental yields tend to remain steady as do property valuations.  Overall there is little volatility.

This apparent certainty has been dealt a blow with the expected economic downturn as a result of the COVID-19 pandemic.  When economies are stressed, property valuations become uncertain which makes it difficult to make informed fair value judgements for financial reporting purposes.

Determining the fair value of an asset means considering many different variables including, yields, future rental cash flows, incentives, future capital expenditure and comparable market sales.

It’s this latter point that has the propensity to cause the most pain.  In a market subject to volatility it is difficult to compare accurately with other transactions due to both a lack of transactions and significant variations in price.  This becomes problematic for fair value reporting as all these variances need to be given due consideration and disclosures amended.

Not only this, falling property valuations impact upon borrowing capacity, banking covenants and may even present going concern issues.

So…

The dialogue between landlords and their tenants will be crucial to the success of any future relationship and associated recovery.  Now is not the time for either party to be greedy.  It is likely there will be greater demand for landlords to invest in capital expenditure, especially in relation to air quality and other safety amenities to ensure their buildings remain attractive and desirable.  Employers are facing a period of innovation in terms of how to manage the work environment.  It is clear the idea of the traditional office is being eroded and offices and businesses alike will have to adapt and be used in different ways to accommodate this “new normal”.

Tolerance, understanding and patience are required as we as individuals, managers, employers and businesses navigate our way through this period of change.

[gravityform id=”1″ title=”true” description=”true”]