Posted on Apr 01, 2020
Trying to look past the present is difficult at the best of times. And in the current unprecedented environment no one really knows. But let’s give it a try!
At Expedio we will be using the lockdown period to plan as best we can for what the “new normal” is likely to be, and then how we adjust to it.
What is the “new normal” likely to be?
There will be businesses which don’t make it out the other side. That’s an unfortunate reality – especially in industries such as tourism which are not likely to recover any time soon. And for businesses that were already struggling with solvency, this crisis will end their struggle. The government is offering levels of support to business that we have never seen previously. Preserving jobs has become one of the major priorities. Because we all know that jobs are necessary for our circular economy. We don’t mean circular in a green, or recycling sense. We mean that people in jobs earn money which they spend, which supports other jobs, or they save, which gets invested into other jobs, or they pay tax, which supports even more jobs. And broke companies means no jobs which is a fast start to a downward spiral. But irrespective of the government support, there will be companies which don’t make it. Which means fewer jobs.
Because of the financial hit everyone is about to take, we forsee that there will be something of a reticence to spend on the part of both consumers and businesses. There will be pent up demand. The cabin fever element which will come from spending four weeks (or likely more – who knows at this time) in lockdown will see a splurge in some forms of spending. But over-riding that, for many, will be a sentiment that says “perhaps we need to put something aside for a rainy day in future”, which is likely to hit bigger ticket spending. There will be some industries and businesses which do well from this – and others that miss out.
A crisis of the type we are currently facing exposes those businesses who have not had the foresight to plan for the proverbial rainy day. And it is fascinating to see that often those businesses that have been pillaged by their owners are the first to cry poor, and expect to be subsidised or bailed out by others. Perhaps one good thing to come out of Covid19 would be a greater awareness of the need, and motivation for, prudent financial planning. On the individual level one of the unintended consequences of the massive government bailout (which we believe is necessary) is that those in our population who have taken the attitude that they have an entitlement to be looked after by the state, will have that belief reinforced.
One of the lessons we learned collectively from the GFC is that quantitative easing (printing money) does work, and is a quicker route to prosperity than cutting back on spending. Which means that the government will need to spend our way out of the looming recession.
Some industries will inevitably take a greater hit than others. Airlines and international tourism will take longer to bounce back. Those hospitality outlets which are able to survive will be in a better place because competition will be reduced. The changes we have been seeing to conventional (bricks and mortar) retail will accelerate as more people try online purchasing. The industry shakeout that had been predicted to take 5- 10 years could happen in a matter of months. And who will be wanting to go on a cruise any time soon?
The commercial real estate sector is poised to (eventually) bounce back quicker than many. The underlying strengths of the industry are that business needs a place to work from, generally investors are far less leveraged than many investors in other asset classes, and that returns (even at around 4% ) are still greater than bonds or bank interest for the foreseeable future.
But we can see changes coming. In the past, prudent landlords may have undertaken extensive due diligence on potential tenants. With low vacancy rates, i.e. if this tenant falls over there are plenty more, in many cases that due diligence has fallen by the wayside. In the future it will certainly pay to examine the financial viability of potential tenants.
Potentially, the sub 3% vacancy rates could be 15% when we come out of lockdown. And that would inevitably accelerate a flight to quality, with both better quality tenants, and better quality buildings (because they generally have better quality tenants) at a premium.
What will it mean for vacant buildings? For those potential owner-occupiers who survive, with strong balance sheets, it will probably mean opportunity. With tenants harder to find, we predict values for vacant properties to fall. Conversely, it could mean tightening of yields for good buildings with great tenants. Bank interest rates are likely to remain very low for some time, which means that solid and safe returns in other investment classes will be prized. But don’t expect values to rise any time soon.
And as for the industry of buying, selling and leasing commercial real estate - as we learned post GFC, that will take time to recover. Already we are understandably seeing a reticence to commit on the part of both potential buyers and tenants. Expect that to get worse before it gets better – which means that for those who are reliant on commissions from sales and leases, times will be tough.
But to look on the bright side – that will give all of us ample time to improve our skills and knowledge of how business really works.