This article is from the Australian Property Journal archive
THE coronavirus pandemic inflicted global recession, the worst since World War II, will hurt demand for office space with occupancy and rental rates to come under pressure, according to S&P Global Ratings.
S&P expects a global GDP will contract by 2.4% in 2020 before a rebound of 5.9% in 2021, which will spark job losses and lead to lower demand for office space. Its forecast is more optimistic than the World Bank’s predictions that the global economy will shrink by 5.2% in 2020, which is the deepest recession since World War II.
S&P said office real estate occupancy and rental rates are under pressure. In the United States, it will take several years to recover to pre-pandemic levels of unemployment of below 4%. Moreover, stagnant job growth will likely pause expansion plans for several corporations, limiting the appetite for additional office space.
In Europe, lockdown measures are eating into many companies’ capacity to pay rent. GDP in the eurozone will deteriorate by 7.3% in 2020, but will recover and grow 5.6% in 2021. S&P believes the unemployment rate will reach 8.6% in 2020, up from 7.6% in 2019. As a result, the pandemic and its aftermath will dampen companies’ growth plans in key European markets, while cost cutting and staff reductions will pressure office occupancy rates.
Furthermore S&P expects a sharp decline in economic growth in China with GDP up just 1.2% in 2020 versus 6.1% in 2019. Even prior to the COVID-19 outbreak, office rents in some tier-one cities, such as Beijing, Shanghai, and Shenzhen, were already suffering from oversupply, with vacancy rates as high as 12%-21% at the end of December 2019. Although Shenzhen’s vacancy rate has stabilized since then, Beijing and Shanghai’s vacancy rates remain on the rise. With weaker demand for office space combined with a significant amount of new supply over the next 12-24 months, S&P said spot rents in those cities will continue to be under pressure.
“We believe office landlords will share some of their corporate tenants’ pain despite the protection from their long-term leases. Rent collection for office properties within our rated office REIT portfolio has remained relatively high (average of 96% in U.S. in April 2020) despite many office buildings having sat virtually vacant (from government shelter-in-place orders) during the months of April and May.
“This is significantly higher compared to rent collection for retail properties (55% range in the U.S.) as retail store closures led to deferral of a large portion of rent. Although we expect tenant retention to stay high as companies avoid relocation expense during a recession, we believe the market has shifted to a renter’s market, with landlords facing increasing pressure for rent concessions and growing vacancies across all markets over the next year. As a result, we expect same-property cash net operating income (NOI) declines in the low- to mid-single-digit percentage range in 2020 for the rated office REIT sector in the U.S.”
Despite the challenges ahead, S&P said office REITs enter this recession in relatively good shape, with low vacancy rates and steady rent growth, and long-term leases and staggered lease maturity schedules, which should help mitigate the impact of the recession.
“Steady job growth and limited new supply supported healthy rent growth and steady occupancy levels for office REITs in 2019. In Tokyo, the vacancy rate stands at 2% and we expect a moderate rise in the vacancy rate and flattish rental growth over the next 12 months.
“In Australia, the two major office markets of Melbourne and Sydney enjoyed a vacancy rate of 3.4% and 5.8%, respectively, as of March 31, 2020. The Australian federal government’s provision of financial assistance to employees via the “JobKeeper” supplement should help the private sector retain the core of its workforce while the economy goes into hibernation.
“Commercial landlords are banned from evicting tenants unable to meet financial commitments over the six months from April 2020. They also must offer a mix of rent waivers and deferrals for qualifying SMEs whose revenue has fallen more than 30%. Australian state governments have progressively announced land tax relief measures to partly soften the blow to landlords.
“Likewise, the Singapore government announced various measures in response to the COVID-19 outbreak, including property tax rebates to landlords, which are mandatorily passed on to office tenants, as well as job support schemes to relieve employers of some operating burden. There was also a bill introduced to allow a rent moratorium of up to six months for commercial tenants that are suffering from the COVID-19 fallout. We expect the deferred rentals will be collected in fiscal 2021.
“In the US, occupancy rates for rated office REITs remained in the low-90% area and same-property NOI grew 4% in 2019. We expect the long-term nature of office leases (with an average of eight years) could mitigate downside risk amid a recession. However, while tenant retention rates will likely increase, the leasing up of any vacant space if tenants do move out will prove challenging, in our opinion,”
S&P said while only 5% of office REITs’ annualized base rent is set to expire in 2020, with 8% expiring in 2021, REITs could face modest declines in occupancy rates and lower rent growth given the fallout from the recession.
“We expect US office REITs to report cash same-property NOI declines in the low- to mid-single-digit percentage area. This compares to a decrease of 2.4% in NOI in the last recession in 2010 for the rated U.S. office REITs.”
In 2020 and 2021, after buoyant activity in 2019, most European office leasing markets should falter, mainly due to a weakening of long-term fundamentals.
“Consequently, our rated office landlords’ major markets, such as Paris, Madrid, Berlin, Frankfurt, and Warsaw, should experience a slowdown in leasing activity in 2020. This is despite a healthy take-up in 2019 and ongoing decreases in vacancy rates to very low levels.
“We believe the scarcity of prime-quality assets, high population density, and low vacancy rates should partly mitigate the impact of a fall in demand in the major office markets this year. We expect a slow recovery in office demand in 2021 on the back of an economic recovery,”
S&P also expects values to decline modestly.
“Following years of positive revaluations, they may reverse to negative 5% in 2020. This reflects potentially weaker cash flow expectations by real estate appraisers (owing to lower occupancy rates, lower rental uplift, or lower indexation than anticipated), a decline in market transactions in the second quarter of 2020, and a potential rise in the capitalization rate. While these factors could result in valuation losses, we have no visibility on what the appraisers’ independent decisions might be at this stage.”
