The commercial property sectors to watch in 2021

While the Covid-19 pandemic has caused disruption across New Zealand, the commercial property market has proved resilient on the back of stronger than expected economic performance.

Chris Dibble, National Director of Research, Communications and Partnerships at Colliers International, looks at how the key asset classes performed in 2020 and what to expect in 2021.

Industrial

Covid-19’s impact on the industrial property sector has been mitigated by a number of factors. Many manufacturing companies were classified as essential services and therefore permitted to continue to trade during lockdown, while demand for services such as storage and distribution increased.

Demand fundamentals have been strongly supported by a rapid return to expansion within the manufacturing sector and growth in logistics service providers. The accelerated adoption of online shopping that Covid-19 lockdowns drove has seen a sharp increase in demand for space from the logistics sector. Looking ahead, the roll out of the government's multi-billion-dollar infrastructure programme will inject additional demand for industrial workspace.

Despite a slight easing in vacancy rates across Auckland, Wellington and a number of regional centres over recent months, it is likely, given current demand drivers, that vacancy rates are at, or close to peak levels. This means tight market conditions are likely to return. This has elicited a significant response from the development sector with building consents reaching new record highs in Waikato, Gisborne, Hawke's Bay and Southland.

High levels of development activity have elevated the demand for industrially zoned land which, in many centres, is in short supply. This is resulting in further upward pressure on land values, particularly within established precincts.

An extended period of low interest rates has stimulated investment activity in the industrial property sector with demand strongly underpinned by the defensive qualities that the sector is perceived to possess. High net wealth individuals, syndicators and property companies are all active in the market. Low interest rates have also increased the appetite of occupiers to investigate purchasing their own premises as borrowing costs, in some cases, have dipped below rental costs. In many cases, the market is currently constrained only by a shortage of prime assets being brought to market. After a short period of stable yields in early 2020 when investors took a more cautious approach, competition and purchasing intent has escalated, driving yield compression in most centres.

Office

Office markets across the country are experiencing a rise in space availability as businesses reflect on the changing economic situation and pivot to new workplace strategies due to Covid-19. However, different market dynamics are evident across the country and more positive economic projections are emerging that could lead to a growing number of positive occupier absorption stories ahead.

In Auckland, the overall vacancy rate increased to 8.8 per cent in December 2020, with prime grade vacancy at 6.8 per cent. In Wellington, where the market is more insulated by the significant government presence, overall vacancy increased from 6.4 per cent to 6.9 per cent over the six months to December 2020, while prime grade vacancy was just 0.6 per cent. In Christchurch, where supply has been more readily available, vacancy within the CBD was 14.9 per cent.

There has been significant new supply added to total office stock across the country in recent years. While Covid-19 deferred the number of previously planned office projects, developers are now dusting off their plans to reignite delivery discussions. However, over the short-term, new development will predominantly be dependent upon tenant commitment being secured.

Tight market conditions in recent years have seen upward pressure to rents bolstered by the addition of new supply which has set new rental benchmarks. However, the level of incentives on offer has increased, primarily through an increase in rent free periods or more generous contributions toward fit out.

The low interest rate environment has heightened interest in higher yielding property investment assets. There is a wide variation in purchaser types, but local purchasers remain the most prominent, a situation likely to persist until border restrictions are removed. Experienced investors continue to look through the disruption to office occupier conditions caused by Covid-19, with high levels of enquiry for well-located properties with strong fundamentals.

Retail

The economic backdrop for New Zealand's economy and the confidence provided for consumers to increase their spending levels continue to surprise to the upside. This paints a more positive expectation for 2021 than originally forecast, even at the end of 2020.

While there are still many challenges, uncertainties and the chance of disruption remains in the retail sector, the initiatives from the government and the Reserve Bank have provided a support base for New Zealanders. With some higher expectations on job security and house prices, this has flowed through to many retail spending measures showing higher levels of activity at the end of 2020 than at the end of 2019.

Retail sector trends prevalent pre-Covid-19 have been accelerated, with online spending the primary example. What was originally expected to occur incrementally over time, happened instantly and on an unprecedented scale as more and more New Zealanders were forced online due to lockdowns. A study conducted by NZ Post and Datamine showed that over 170,000 Kiwis shopped online for the first time in the first half of 2020. Retailers that are not equipped for a more online world are likely to struggle in the future retail landscape. Large format retail such as supermarkets, which were classed as an essential service, have benefited and the DIY sector is going through a resurgence period as well.

While there are elements of positivity, cautiousness is apparent. Lease agreement conditions and rental payments will remain a significant focus for landlords and tenants moving forward. While conditions in New Zealand remain more positive than other parts of the world, the sector is not out of the woods yet.

While there has been some respite in rental growth, some declines in asking rents and rising incentives for retailers, more positive economic conditions, which may gain further pace in late 2021, could see a slight adjustment in this trend for selected prime retail premises.

From an investment perspective, values have reasonably corrected, leading to price expectations between vendors and purchasers that are more in alignment with the market fundamentals that have been evident for years. However, given the softer yields in some retail sectors in comparison to the industrial and office sectors, purchasers are still factoring how they can maximise on the returns and mitigate the risk. This will mean a competitively cautious investment environment in 2021, with high calibre retail premises that have strong tenant covenants and long lease terms the more sought after.