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How Covid-19 will change commercial real estate

09 May 2020

By Uwin Lugoda Sri Lanka has now endured several weeks of curfew imposed by the Government in order to contain the spread of Covid-19 and has seen many office and retail spaces close up shop and move towards remote working arrangements. This has led the country's commercial real estate sector to unchartered waters, as the pandemic-fuelled economic crisis is set to change the industry as a whole. A research conducted by the Research Intelligence Unit (RIU) in Sri Lanka showed that pre-Covid, the country had 1.9 million sq. ft. of Grade A commercial space, which is the top tier in the market with key attributes such as high-end construction and interior finishes, modern architectural design, state-of-the-art mechanical systems and technology, and a variety of property amenities. This accounted for about 30% of Grade A and B commercial spaces in Colombo, and has had a 90-95% occupancy for much of the last 10 years. Most of these could be found spread out through Colombo 1, 2, and 3 with Colombo 5 slowly coming into the fold with the progress of Havelock City Towers. The RIU has a 17-year track record of providing research and advisory services for both the public and private sectors, and currently has offices in the UK, Sri Lanka and the Maldives.   Supply-demand mismatch During a virtual forum held on 6 April by the RIU, in association with the Sri Lanka Chamber of Commerce, to discuss Sri Lanka's real estate market and the post-Covid-19 outlook, RIU Senior Business Consultant Dr. Anil Baddevithana stated that even before Covid, the entire real estate market in Sri Lanka was showing signs of stress due to oversupply or supply in the wrong places. RIU Founding Director Roshan Madawela added to this and explained that this was especially the case with regard to commercial real estate, as the demand for high-end office spaces has traditionally lagged behind the supply in Colombo. RIU research presented at the virtual forum showed that for the most part, developers have opted to construct residential developments that yield more immediate returns, within a short period of three to five years, and consequently, the supply of commercial space, which is typically leased and not sold, had been neglected. However, Madawela stated that in the last few years, the firm has seen a real estate market equilibrium with residential real estate, as commercial real estate developers have come in and initiated new projects. The RIU presentation showed that some of the key drivers of commercial real estate are the rapid growth of the service sectors such as IT, telecom, and ride-hailing companies, and the rising demand for multinational corporations (MNCs) in commercial cities like Colombo.   Rental payments The presentation also went on to highlight the impact of Covid-19 on the sector, as research has shown that many occupants of high-end commercial spaces are foreign companies (MNCs), with their earnings largely derived from the US dollar, making current rental rates in Colombo very attractive to them, especially amidst a perennially weakening Sri Lankan rupee. The research showed that most building owners have not decided on the reduction of the prices even though tenants have asked for concessions. As of now, building managements are adhering to a "wait and see" approach with no decision being taken so far and discounts being negotiated. "We have noted that already many of the service office space providers have given discounts and concessions to their tenants, which is a trend we expect will dominate the market here in Colombo for the next two or three quarters,” said  Madawela. Furthermore, the presentation stated that co-working space discounts are being seen across tenants who have subleased office buildings, and land owners of smaller commercial properties have already extended grace periods for their tenants, although discounts on rent are less common.   The tenant experience Madawela stated that the tenant experience is the top priority for most commercial real estate leaders, and that this experience is going to change post Covid-19. He stated that the on-demand economy is reshaping tenant expectations about how real estate is consumed, and technology-enabled facilities and personalised experiences are already transforming the sector. He went on to explain that most foreigners are concerned about the security and sustainability measures and are willing to pay a slightly higher premium. Speaking on office space, Madawela stated that tenant behaviour will change with working from home and remote working concepts normalising, and the prominence of online platforms such as Zoom, Google Hangouts, and Skype will increase in the coming months. Tenant expectations also give a higher priority to sanitation when it comes to picking an office space. However, Ekroma Realtors Managing Director Onesh Subasinghe stated that the industry will have to make a lot of changes. He explained that he is currently working on a Grade A office space and has made one of their key focus areas the ventilation and air filtration of the space, due to the potential risk of the virus being transmitted through air conditioning. Due to this, he suggested the sector look into working with their consultants to try to figure out a way to filter the air, to lower the risk of infection. Subasinghe stated that now they also need to focus on good hygiene practices and work with property management companies who are capable of administering those hygiene practices. In terms of office sizes, he explained that most companies will be downsizing post Covid, and many employees will opt to continue working from home, as it will be the new norm. He went on to state that offices will also look to increase the number of sq. ft. per person, increasing it from the current  1-70 sq. ft. and 1-80 sq. ft., adopted by most office spaces, to 1-110 sq. ft. and 1-120 sq. ft., in order to accommodate the social/physical distancing regulations. Subasinghe also predicted that the concept of open office spaces will be replaced by a cubicle-style office space, at least until a vaccine is found.   Residential and retail However, according to John Keells Holdings Property Group Sector Head Nayana Mawilmada, office spaces, when compared to retail and residential spaces, are most likely to be the least affected post Covid-19. He explained that while the shift towards open work spaces and environments will slowdown, the general demand for office spaces should sustain. "I think businesses generally tend to continue post crisis. However, we will probably see a change in patterns when it comes to workplace arrangements; this will be seen in the temporary step back from open work spaces and intimate work environments. But the office space will be less impacted than the overall economy,” Mawilmada noted. Despite this, he stated that many firms renting out work spaces will struggle to pay rent, and this might lead to a slight adjustment in where the demand is. Subasinghe agreed with Mawilmada and stated that similar to office spaces, the demand for commercial real estate overall is still modest, and probably will be the least affected sector compared to the residential sector. "As for the research presented by the RIU, we can see that we are already at a 90-95% occupancy, so I think the commercial space is going to pick up faster,” Subasinghe noted. Speaking in terms of retail spaces, Subasinghe stated that it will take a longer time to recover since it has a correlation with the country's tourism sector. "We have seen a lot of brands come into Sri Lanka in the last two to three years, and we have a lot of exclusive brands locally as well. However, they all depend on foreigners coming here and spending money,” Subasinghe said. He also stated that retail spaces will have to adjust to the general walk-in traffic they get and adapt their spaces in line with social distancing regulations. Mawilmada agreed with this and stated that retail spaces will take at least six months to start recovering, since it is linked to leisure, hotel, and sales revenue of the brands they house. Compared to retail spaces, he stated that office spaces will completely transform and there will be a change in the behaviour of tenants, because office spaces have a better response time, in terms of being able to adjust. However, Mawilmada suggested that stakeholders must remember that this outbreak is temporary, and there is no need to fundamentally change everything. “What we need to remember is that this is a temporary situation and we will bounce back; real estate is a long-term asset, so projects that start now will be completed in four years when this thing will be something of the past. So I think we need to be cautious of overreacting to a short or medium-term phenomenon, and fundamentally changing everything around us.” During the discussion, Chamber of Construction Industry President Ranjith Gunatilleke stated that for real estate as a whole to recover and for projects to resume work, it will take around six months, unless some sort of push is given to real estate developers by the banking sector. "Right now, people are prioritising a lot of other things over investing in real estate, so recovery might take longer for the industry. If the banks were to give the developers a push to finish the ongoing projects, I think the industry should be ready when the interested parties come in," Gunatilleke said.

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