COVID-versary - The pros and cons of the pandemic’s impact on property

Monday 20 March marked the three-year anniversary of this black swan event, which has had a lasting effect on our commercial real estate sector… for better or worse.

Arguably, COVID has changed our habits and behaviours. More specifically, it’s generally altered our perspective on our work-life balance, how we shop, how we source our food/groceries and, most poignantly, it’s put into focus our personal healthcare needs. In turn, these changes have impacted investment in office, retail, industrial, agriculture and healthcare real estate.

Following is a summary of the pandemic’s pros and cons for each property sector.

Offices

For most, donning trackies and Ugg boots is a dwindling choice for work attire as office-based work has returned as a mainstay, or at least for some of the working week. According to the Property Council of Australia[1], physical occupancy across cross-capital cities has increased to between 46% and 81% with Perth and Adelaide leading the charge (81% and 80% respectively) as of February 2023.

Unsurprisingly, office capital values across this three-year period regressed but don’t tar all markets with the same brush. While Sydney and Melbourne CBD yields have softened 33 basis points (bps) and 37bps respectively, fringe and metropolitan markets have fared comparatively better, with Sydney Fringe yields softening 19bps and Melbourne Fringe holding steady[2].

In fact, 54% of office building transactions between 2020 and 2023 have been within non-CBD markets².

What drove this resilience? We believe it’s the affordability of office rent. We have seen a high volume of leasing in the fringe markets driving strong net absorption, particularly in the Melbourne Fringe, which recorded over 82,000 sqm in 2022, compared to Melbourne CBD’s negative net absorption of -13,000 sqm².

With the increase in demand for non-CBD office space, rents have also increased at a higher rate in the fringe – Sydney and Melbourne at 17% and 11%, respectively, compared to their corresponding CBD markets (10% and 4%)².

The flight to quality theme has gained significant traction. It generally means tenants can get better bang for their buck – larger floorplates, better amenities such as end-of-trip facilities, and better commutability than CBD offices. According to CBRE[3], the main gripe for workers returning to the office is the commute. Commercial buildings based in City fringe or metropolitan markets lend themselves to shorter worker commutes, which in turn, lends itself to a better work-life balance.

Sheds

Industrial property demand – from tenants and investors alike – has gone on a tear since the pandemic began. This is largely driven by 

1. an acceleration in e-commerce and 
2. onshoring supply chains. 

The corresponding behavioural change is that we are shopping online more than ever and we are buying locally sourced products to avoid delays/backlogs from international markets. These changes are driving demand for transport and logistics, warehousing and distribution centres and, therefore, driving demand for both existing and new industrial developments.

For example, if we look at the average industrial land values for a one-hectare site:

• In Sydney average values more than doubled (126%) to $1,703/sqm[4]
• In Melbourne average values jumped a whopping 143% to $939/sqm[5]

For existing prime industrial assets, average prime rents across Sydney jumped 35% and Melbourne by 31%[6]. While secondary industrial rents in Sydney expanded 33% and 40% in Melbourne[7]. In short, COVID has turbo-charged the industrial real estate market and supply cannot keep up with demand.

Shops

When I say we are shopping online more than ever, there are some non-discretionary items we still buy in the store. For example, we might do a big Woolworths grocery order online but during the week we still need our neighbourhood shopping centre to pick up that extra carton of milk or get a prescription filled or to drop off our dry cleaning. For this reason, Daily Needs Retail (DNR) has remained resilient.

Data from JLL suggests DNR shopping centres’ average capitalisation yields tightened by up to 100 bps between Q1 2020 and Q4 2022[8] while DNR rental values were up an average of 1.5% during the 12 months to December 2022[9].

On the opposite end of the spectrum, we have been renovating and refurbishing our homes intensely during this three-year period, rather than spending our disposable income on travel and hospitality. This has had a positive impact on Large Format Retail (LFR), such as homemaker centres. In fact, these assets benefitted from an average cap rate compression of 75-100bps[10] while LFR rental values were up by an average of 0.8% in the past 12 months to December 2022⁹. These have been the two darling sub-markets within the retail sector.

Agriculture

As mentioned, supply chain issues have impacted the goods we imported during COVID with shipping freight stalling due to quarantine and labour issues. Subsequently, businesses responded by sourcing local goods. This theme also applies to our produce. We want to eat locally grown food.

In fact, demand for Australian-grown fresh food and other quality agricultural products is forecast to increase materially over the next 10 years, driven by middle-class population and income growth in both local and offshore markets[11].

On the real estate front, median agriculture land prices have generally increased between 12.9%[12] and 20%[13] across the nation between 2020 and 2021 (data for 2022 isn’t available, yet). This increase is across all types of farming – from livestock stations to broadacre crops to precision farming within glasshouses or under protective cropping.

Healthcare

Last but not least, let’s take a look at the pandemic’s impact on healthcare real estate. Interestingly, since the onset of COVID there has been a 5.7% increase[14] in private healthcare insurance participation, that is, c.785,600 Australians have taken out private healthcare cover since the onset of COVID. Currently, 14.42 million Australians have private health insurance[15]. 

With delayed elective surgeries within the public system, it is assumed more Australians have taken up private health cover to have their healthcare needs expediated. This has had a positive impact on private healthcare real estate values.

According to the MSCI Real Estate Index, between the March 2020 quarter and the December 2022 quarter, the annualised total return for the healthcare real estate sector was 15.8%. We see this tailwind continuing with the estimated elective surgery waitlist growing to 99,300 patients in NSW alone, as at the December 2022 quarter, up 4.9% within 12 months and 12.8% in 24 months[16].

So, with a little perspective, we can see the pandemic’s effects on Australia’s real estate sector have been far and wide but largely, changes have generally been positive. Depending on the assets, asset location and asset class, many commercial real estate investments have shown resilience during the pandemic. Nonetheless, with crossed fingers, let’s hope the next black swan event is many moons away.

Never miss an insight

If you're not an existing Livewire subscriber you can sign up to get free access to investment ideas and strategies from Australia's leading investors.

You can follow my profile to stay up to date with other wires as they're published – don't forget to give them a “like”.