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30 JUL 2020

Pandemic deepens retail property pain while offices set to evolve

RICS Global Commercial Market Survey, Q2 2020

  • Sentiment among US real estate investors and occupiers slips deeper into negative territory signalling a fall in momentum across the region
  • Net balance of investors and occupiers expect capital and rental values to fall further over coming months
  • Office footprints set to shrink over next two years, but employee health and wellbeing to come to fore in property strategies
  • RICS calls on landlords and tenants to develop new relationships to deliver enhancements to boost workforce health and wellbeing

U.S. sentiment and activity down amid COVID-19-related slowdown
As the global economy continues to grapple with the fallout from the pandemic, US commercial real estate professionals are reporting a significant deterioration in conditions across the sector in Q2 2020. Sentiment on demand remains firmly negative, with occupiers and investors showing a net of -49% and -25% respectively, indicating a sharp contraction in activity.

Looking at individual sectors, enquiries fell sharply across the office and retail segments, though demand was reported to have risen in the industrial sector.

This trend is also reflected in the results for twelve-month expectations. Survey respondents predict rents and capital values declining across the office and retail sectors over the course of the next year. The outlook for alternative asset classes is also down, with hotels expected to see a significant drop in rental values in the coming year. Again in contrast, the outlook for the industrial sector is positive, particularly for properties in prime markets. Data centers as well stand out as more resilient for now, with rents expected to remain relatively stable.

When looking at where in the property cycle survey participants see the market, more than two-thirds believe the market is in the downturn phase. Furthermore, credit conditions have reportedly deteriorated over the last two quarters, offsetting an improvement in 2019 and adding another headwind to an already challenging environment.

Lockdown accelerates global retail woes as ecommerce popularity grows
At a sector level, retail has taken the biggest hit, as the pandemic and subsequent lockdowns have exacerbated the pre-existing challenge of ecommerce. Global demand for retail space fell sharply in Q2 (net balance of -81%) with the reading in the US reaching -98% (implying almost all respondents saw retail tenants reducing demand for space over the period).
Looking ahead, rent expectations for the next 12 months will continue to weigh particularly heavily on retail, with a deteriorating outlook for offices’ rental property values too. By contrast, expectations for industrials/logistics have returned to positive territory, albeit masking significant differences at a country level, pointing to the rising popularity of ecommerce and changing supply chains.
Simon Rubinsohn, RICS Chief Economist, commented: “As the economic impact of COVID-19 has deepened, so to has the impact on commercial real estate. Sentiment among investors and occupiers has naturally weakened, with broad acceptance that rental and capital values will fall over the next year.

“What is clear, however, is that there will be no going back to the old normal, even after a protracted economic recovery and significant government interventions. Underlying trends have been accelerated by lockdowns, whether the global rise of ecommerce or remote working, coming to the fore, changing the nature of demand for many ‘traditional’ commercial assets. We will see investors, landlords and tenants continue to adapt to a new reality – not least, in their approaches to office space.”

The changing face of commercial offices as demand for city center space declines
The results of the latest Global Commercial Property Monitor also suggest offices face three key additional or accelerated structural changes globally: organizations reducing their overall footprint, a notable shift in location from urban to suburban, and a greater premium placed on the health and wellbeing of workers.
Real estate professionals expect office footprints to shrink; more than half indicated that office footprints would likely shrink by up to 10% over the next two years. While around one-third suggested that it would be greater than this, 14% judged there would be no change.
Respondents also predicted a shift in office space from urban to suburban locations as another aspect of the fallout from Covid-19. One in ten view this as a strong trend, while an additional 50% believe it will take place to some extent.
Greater emphasis will also be placed on health and wellbeing in the workplace in a post-pandemic world, pointing to further changes to existing and new office space. 89% of respondents agreed this enhanced focus was likely. Questions remain over how improvements will be funded, however, as only around one-third of respondents felt that tenants would be willing or able to shoulder the cost of enhancements.

Paul Bagust, Global Property Standards Director, RICS: “The commercial office sector is under pressure, but the ‘death of the office’ has been called far too prematurely. Yes, many organizations are re-thinking their footprints, and questioning the need for such large spaces in city centers – especially in the current economic climate and with the proven efficacy of remote working. But rather than disappear, office use will evolve. Property strategies will be increasingly data-led, based around the performance of buildings, and how they add value to and support the productivity of employees.

“The health and wellbeing of workforces has rightly moved to the top of the agenda for occupiers too, and this will drive significant change for commercial property and support business performance. It is vital that enhancements are not limited to flagship office spaces, but filter through all types of commercial property. We need to see a new collaborative, flexible relationship model emerge between tenants and landlords to realise this, helping share both the responsibility and cost.”

ENDS

 


Notes for editors:

Global Commercial Property Monitor
RICS’ Global Commercial Property Monitor is a quarterly guide to the trends in the commercial property investment and occupier markets. The report is available from the RICS website www.rics.org/economics along with other surveys covering the housing market, residential lettings, commercial property, construction activity and the rural land market.

Methodology
Survey questionnaires were sent out on 12 June 2020 with responses received until 13 July 2020. Respondents were asked to compare conditions over the latest three months with the previous three months as well as their views as to the outlook. A total of 2083 company responses were received, with 496 from the UK. Responses for Ireland were collated in conjunction with the Society of Chartered Surveyors Ireland. Responses for Spain and Portugal were collated in conjunction with Iberian Property. Responses for Malaysia were collated in conjunction with the Royal Institution of Surveyors Malaysia. Responses in the Americas were collated in conjunction with the Association of Foreign Real Estate Investors.

Net balance = Proportion of respondents reporting a rise in a variable (e.g. occupier demand) minus those reporting a fall (if 30% reported a rise and 5% reported a fall, the net balance will be 25%). Net balance data can range from -100 to +100. A positive net balance reading indicates an overall increase while a negative reading indicates an overall decline. The RICS Occupier Sentiment Index (OSI) is constructed by taking an unweighted average of readings for three series relating to the occupier market measured on a net balance basis; occupier demand, the level of inducements and rent expectations. The RICS Investment Sentiment Index (ISI) is constructed by taking an unweighted average of readings for three series relating to the investment market measured on a net balance basis; investment enquiries, capital value expectations and the supply of properties for sale.


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