As the world contends with the rippling effects of COVID-19, questions continue to arise around humanity’s new reality, with one particular question plaguing the minds of many: when will this end?
To borrow the words of Devi Sridhar, a public health expert at the University of Edinburgh: “That’s not the right question. The right question is: How do we continue?”
With COVID-19 changing the way people interact and inhabit physical space, the demand for space might change. In an article from four-US based partners at McKinsey & Company - Vaibhav Gujral, Robert Palter, Aditya Sanghvi, and Brian Vickery – the partners argue how COVID-19 has created an unprecedented crisis for the real estate industry and what it means for the future.
Chart a new strategy
For Gujral, Palter, Sanghvi, and Vickery, the choices the real estate industry make now, will ultimately lead to transformative and last change in behaviour. “To respond to the current and urgent threat of COVID-19, and to lay the groundwork to deal with what may be permanent changes for the industry after the crisis, real estate leaders must take action now. Many will centralise cash management to focus on efficiency and change how they make portfolio and capital expenditure decisions. Some players will feel an even greater sense of urgency than before to digitise and provide a better—and more distinctive—tenant and customer experience.
And, as the crisis affects commercial tenants’ ability to make lease payments, many operators will need to make thousands of decisions for specific situations rather than making just a few, broad-based portfolio-wide decisions. Most real estate players have been smart to begin with decisions that protect the safety and health of all employees, tenants, and other end users of space. The smartest will now also think about how the real estate landscape may be permanently changed in the future and will alter their strategy.”
Since the virus outbreak, the reality for real estate players has changed. McKinsey’s Gujral, Palter, Sanghvi, and Vickery, maintain that service providers are struggling to mitigate health risks for their employees and customers, and many developers are facing construction delays and struggling to obtain permits.
“Meanwhile, many asset owners and operators face drastically reduced operating income, and almost all are nervous about how many tenants will struggle to make their lease payments. Concession and abatement are the words of the day, and players are working rapidly to figure out for whom they apply and how much.”
But, not all real estate assets are performing the same way during the crisis. Gujral, Palter, Sanghvi, and Vickery, are quick to point out that the market seems to have pivoted mostly on the inherent degree of physical proximity among an asset class’s users—even more so than on its lease length.
“Assets that have greater human density seem to have been the hardest hit: healthcare facilities, regional malls, lodging, and student housing have sold off considerably. By contrast, self-storage facilities, industrial facilities, and data centres have faced less-significant declines. As of April 3, by one estimate, the unlevered enterprise value of real estate assets had fallen 25% or more in most sectors and as much as 37% for lodging. It’s no surprise that—when shoppers avoid crowds, universities send students home, and retailers, restaurants, and hotels close their doors—owning and operating those properties is a less valuable proposition. As such, liquidity and balance-sheet resilience have become paramount,” McKinsey reveals.
Lessons to be learned from China’s recovery?
At the height of the COVID-19 outbreak in China, most industries in the country came to a standstill, with the Chinese economy contracting by 6.8% as a result of lockdowns and restrictions.
“Now, many traditional industries are slowly returning to normal. At the same time, others are seizing emerging growth opportunities with potential positive impacts for real estate markets. These include the digital economy, online entertainment, insurance, healthcare, and real estate technology,” notes JLL’s April report on COVID-19 Global Real Estate Implications.
Looking at China, McKinsey says that early evidence shows some staying power in the coronavirus-driven shift to e-commerce. The consultant sees that within certain product categories where supermarkets or mainstream retailers competed with online retailers, substantial market share could transfer to online players.
What will the new normal look like?
Real estate owners and operators across almost every asset class are considering several potential longer-term effects of the coronavirus outbreak and the required changes that these shifts are likely to bring.
According to JLL’s recent report, COVID-19 Global Real Estate Implications, the industry needs to look beyond the pandemic, looking at new and emerging trends that will become part of the new normal.
“Businesses will not go back to the way we knew before the pandemic, but will reinvent themselves to be more resilient, adapting their operational models to the ‘new normal’. The short-term impact for occupiers is proving to be significant as their business-as-usual activities are affected with changes occurring on a daily basis. The immediate shock and realisation of the outbreak is now over, and the majority of occupiers are in response mode after a short phase of preparation and immediate actions. Occupiers are preparing for ‘re-entry’ of their facilities and sending their workforces back to work in several waves,” reads the JLL report.
Looking at the changes in the commercial office space, McKinsey’s Gujral, Palter, Sanghvi, and Vickery, say that the multiyear trend toward densification and open-plan layouts may reverse sharply. Public-health officials may increasingly amend building codes to limit the risk of future pandemics, potentially affecting standards for HVAC, square footage per person, and amount of enclosed space.
For hospitality, McKinsey’s outlook is that the COVID-19 experience could also permanently change habits of the sector. “Even a short moratorium on business travel could have lasting impact when alternatives such as video conferences prove sufficient or even preferable. Near-shoring of supply chains may further reduce demand for cross-border business travel, and consumers who are afraid of traveling overseas may shift leisure travel to local destinations.”
Finally, the biggest shift will be seen in the retail industry as consumers adjust their buying habits.
“Before the pandemic, consumers were already shifting their spending away from physical stores…The shift to e-commerce may also further boost already high demands for industrial space. Relatively niche asset classes (such as self-storage and cloud kitchens) could see an improvement in their unit economics, as demand density goes up when more people work from home, while other asset classes (such as co-living) may suffer. And universities forced to educate remotely for entire semesters could convince students and other stakeholders that existing tools are sufficient to provide a high-quality education at a lower cost, and a new type of hybrid (online–offline) education could become even more widely embraced,” reveals McKinsey.