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Future of commercial real estate

Tuesday, March 23, 2021 @ 1:27 PM | By Sebastian Ferguson


Sebastian Ferguson %>
Sebastian Ferguson
Across the commercial property sector, retail, among many others, continues to evolve through the Internet as it increasingly favours e-commerce as an alternative trading medium to brick and mortar shops. With a few notable exceptions, COVID-19 has catalyzed this process by extinguishing footfall and dragging the profits of non-essential retailers to all-time lows.

As a result of this bifrontal attack, many of the country’s largest retailers, including North West Co. and Leon’s, have been pushed to the controversial Canada Emergency Wage Subsidy (CEWS) scheme for support.

However, this is a far cry from the spectacular performance that online retailers (e-tailers) have experienced throughout the pandemic. Whilst in-store clothing sales decreased 17 per cent since March 2020, e-commerce sales in this area increased by 54 per cent. One clear group of COVID-19 “winners” are athleisure retailers like Vancouver-based Lululemon, whose stock prices reached all-time highs in 2020 thanks to a 35 per cent increase in online sales. Similarly, online building material and garden equipment sales shot up 140 per cent and across all subsectors there was an average 63 per cent increase in online retail trade.

Clearly, this is bad news for commercial property owners. Whilst retail is an obvious case in point, this problem extends far wider into other areas such as office space, with the likes of Zoom and Microsoft Teams illustrating the effectiveness of remote working.

Following the simple microeconomic principle of supply and demand, with fewer businesses seeking office spaces and high-street lettings, a paradigm shift in the landlord-tenant relationship is being witnessed.

Whilst offices and physical shops have by no means been made redundant, things are certainly changing. 

How is retail property sector responding?

Given that prospective tenants are gaining the upper hand in negotiations, flexible lease terms are becoming commonplace. Flexible lease terms include:

  • Turnover rents. As the name suggests, these terms stipulate that the company simply pays a percentage of its turnover as rental fees. This means that in periods of low footfall, businesses aren’t stuck with extortionately high fixed charges.

  • Earlier break clauses or shorter lease terms. Again, these are relatively straightforward yet effective solutions that are increasingly sought after by prospective tenants.

Another recent phenomenon is the emerging popularity of fractional ownership on the investment side of commercial property transactions. This idea isn’t revolutionary, and in fact, the concept was popularized through vacation timeshares around 60 years ago. The idea is that investors can hedge and distribute the risk whilst allowing businesses to use things that they don’t truly own. In a way, this is an intermediary between renting and full ownership.

Finally, a product of this flexibility is the revival of companies such as WeWork and IWG. In 2020, WeWork failed in its flotation attempts following the overvaluation in the company’s IPO roadshow. However, there are rumours that the company could be raising $500 million through a revamped special purpose acquisition company (SPAC) pitch this year. If you’d like more information on what SPACs are, you can refer back to the article I wrote explaining how they operate. IWG has also recently reported new deals with Japanese telecoms giant Nippon to provide access to its global network of offices for their 300,000 employees.

Defensive taxation

The Department of Finance announced plans to introduce a digital service tax in July this year for companies including Facebook, Amazon and other online market places. In the fall economic update, Finance Minister Chrystia Freeland told legislators that the OECD was acting too slowly, and that Canada was unwilling to wait for a multilateral agreement to be signed.

Given that digital service tax costs will likely be shifted down the chain from companies like Amazon, to e-tailers, to the consumer, digital service taxes may play into the hands of commercial property landlords.

This being said, it seems very unlikely that digital service taxes will have a big enough economic impact to reverse the trend of online retail, particularly given that protecting commercial landlords’ interests is not a policy objective of the tax.

COVID winners

It must be noted that COVID-19 did not negatively impact the entire property sector. In fact, aside from “essential retailers,” two other areas bucked the trend of succeeding through the pandemic:

  • Industrial and logistics. This is perhaps an obvious example; when the pandemic passes, we are not going to forget the convenience of home delivery. There has been far greater awareness around supply chains over the past year. However, one key challenge is the competition for suitable land, particularly for urban logistics. As such, the idea of urban or “vertical” farming is becoming a popular idea. 

  • Residential. Given that banks have not suffered this time around, interest and mortgage rates remain very low, both of which are feeding into the housing bubble. However, there is a risk that this bubble will trigger new measures from regulators. 

Emerging ESG investment trends

Environmental, social and corporate governance (ESG) is playing an increasingly important role in investment and more than 35 stock exchanges around the world have already issued (or are in the process of issuing) ESG reporting guidelines. ESG is no longer a “nice to have” but is becoming mandatory for a lot of investment portfolios.

Further, many banks, including HSBC, have stated that ESG now strongly factors into lending considerations. Therefore, commercial property developers are being forced to incorporate energy efficiency, mental and physical well-being and spatial-awareness alongside a broader consideration for social equality in order to receive institutional investment moving forward.

Having said this, ESG certainly isn’t viewed as a headwind for all real estate investors. Those who embrace ESG as part of their core strategy, particularly by considering ideas mentioned earlier such as vertical farming, stand to hugely benefit from ESG incorporation.

Sebastian Ferguson is a law postgraduate currently working as a paralegal in the U.K. with a keen interest in commercial law, banking and finance. Contact him via LinkedIn.

Photo credit / TAK ISTOCKPHOTO.COM

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