The Shifting Sands of Commercial Property Investment

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Covid 19 continues to have a huge global impact on both health and economics. In New Zealand we are fortunate that it seems (gripping as much wood as possible) that we are through the worst of it. The 8 weeks that we spent locked down however are likely to have some lasting impacts and I wanted to look at what might be happening with Commercial Property.

The general acceptance is that with a full economic lockdown of 8 weeks we are likely going to see some heightened unemployment, business failures and an economic downturn. There remains a lot of uncertainty to the extent of these as we see the government pumping as much cash into the economy as it can, people returning to work and interest rates at all time lows. No-one can really predict what the impact will be, but most accept there will be one.

In general it is expected that retail will struggle as peoples budgets become stretched and discretionary expenses are the first to be cut from the household budget when times are tight. There are other contributing factors to some locations too, take a look around next time you walk down Broadway in Newmarket, a number of businesses have vacated premises to move to the mall and lots of stores haven’t been filled.

Hospitality is another sector that will fare the same as retail. This is another form of discretionary expense that will be peeled back as people conserve their funds and limit their budgets. It will also be interesting to see how central city businesses go. I have been back in the office since lockdown was lifted but where previously my commute would be an hour minimum I am lucky (or rather unlucky) to have it stretch much more than 30 – 40 minutes. We are definitely seeing less people coming into town whether that is due to working from home or unemployment I am not quite sure yet (probably a good mix of both) and I expect that businesses reliant on working people to support them will be suffering.

The entire business sector however is likely to be affected and retail won’t be the only suffering parties. As wage subsidies run out, government loans are spent and loan holidays come due it is widely accepted things will start to slow down and we may start seeing redundancies and business closures. Interesting to note that it was 2011, 3 years after the GFC, that we saw the peak in liquidations and foreclosures. These things take time to pull through the system and we aren’t likely to feel the full affect immediately. Secondary office and industrial will suffer vacancies and it is likely that incentives to get tenants into properties will need to become more aggressive.

What does this all mean for Commercial Property though? Well let’s start with what we will see in values. Cap Rates will soften (get higher) which will mean that values will start to ease. Cap Rates are a reflection of the expected return on a property and as risk increases (see above) then we can expect that these rates will increase. The full impact of this will be somewhat lessened from the low interest rate environment however, referring to my previous blog, I don’t expect OCR cuts to flow fully through to commercial lending and this will only partially offset some softening of values.

Banks are also wary of the risks of property in the current market. ASB, BNZ, Westpac and ANZ have all chosen to ‘focus on existing customers’ essentially meaning no new to bank clients. That leaves KiwiBank as the only lender fully considering new to bank clients in the property space however even they have very limited risk appetite. It has never been so important as now to protect your existing banks relationship and ensure that they can and are there to support you if needed.

Secondary Commercial is more or less out of the question for a refinance at the moment without other supporting information. If you are looking at refinancing a loan it is especially important to present the transaction in the strongest possible manner with a good WALT, spread of tenants if possible, low gearing and good IEP. I have been dealing with a client at the moment and we have gone so far as to ask for the tenant of one of his properties to share their financial performance with the bank to support the application further underpinning their capacity to meet the lease obligations.

Big Box retail and large industrial still holds some appetite as do strong transactions (think low gearing, strong tenant and central location).

The commercial investment market is becoming increasingly difficult to access with liquidity limited (bank lending) which will see further pressure on prices in the future. This in itself will present opportunity to pick up good assets for cut rate prices as long as you aren’t overly reliant on leverage to acquire them (we are seeing some banks propose interest cover as high as 4x or LVR’s as low as 30%). Properties that were trading at yields below 5% I expect will start pushing 6%+.

If you own commercial property at present and have your loan term approaching expiry you want to be managing that conversation early with your bank, renew what leases you can and as above, put yourself in the strongest possible position to get your bank to roll the loan over. I don’t expect banks will look to tip clients up if they can avoid it but you may see some pressure come on or price increases. It also isn’t a matter of course that loans will be rolled over without question.

Overall it is really interesting times for Commercial Property out there and will be intriguing to watch what the effects are going to be over the next 6 – 12 months. Very much a ‘watch this space’.

As always, if you are looking for any advice on Commercial Property or lending in general please get in touch!

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