Lasting implications of COVID-19
Three trends are anticipated to impact real estate.
It’s hard to differentiate the temporary effects of an economic deep dive from the longer-term implications of behavioral, geopolitical and technological changes. As with past crises, as opposed to economic recessions, the events of 2020 have lasting implications. In real estate, there are three effects that could change the landscape:
1. Radically shifting behavior and demand
As people socially distance, they are staying away from offices, while shops and hotels have had to close. As an immediate consequence, many tenants have struggled to meet rent payments, some even filing for bankruptcy. Longer-term, it seems likely that people’s behaviors will have altered for good. The trend toward e-commerce has been turbocharged, while major office tenants, surprised by the success of the “work-from-home” experiment, have declared that they are looking at reducing their space requirements.
2. Retreating to national borders
Since the pandemic began, governments have responded with country-first approaches. This presents a number of new challenges. First, lockdown decisions in most countries have been led by national scientific advisors. How we design buildings in future may now be influenced by science at a local level. Second, the pandemic has highlighted the need to prioritize the resilience of local supply chains over the efficiency of global trade. If this persists, we could see increased stress on certain types of wholesale and distribution assets. Third, if a nation-first focus presides, will global capital such as sovereign wealth funds retreat, no longer investing in the world’s major real estate centers and projects? That would have implications for the funding of new projects and for multi-lateral and bi-lateral relationships.
COVID-19 has forced the pace of change in retail, while unleashing sudden “creative destruction” in offices.
3. An acceleration of digital disruption
While e-commerce had been steadily disrupting retail and warehouse real estate for over a decade, offices were only slowly approaching a tipping point. COVID-19 has forced the pace of change in retail, while unleashing sudden “creative destruction” in offices as businesses quickly adopt remote working, backed by broadband technology. This sudden transition may prove as great and long-lasting as anything that happened in the 19th Century industrial revolution.
Disrupting all sectors
These lasting, interlinked implications have different effects depending on the sector, as well as other factors such as location. For instance, sectors such as hospitality, retail and office are likely to suffer as social distancing has led to behavioral shifts. While the retreat to national borders could affect prime urban real estate sought after by international capital.
There are some generalizations that can be made according to sector. What’s certain is that many of the past’s tried-and-tested models must be adapted. Skillful adapters and disrupters, especially those mastering the digital economy, will emerge stronger than ever. Below is a summary of the changes affecting each sector.
Office retreats and reconfigures
The work-from-home experiment is here to stay.
The likely long-term downturn in demand for office space is a big surprise. The massive enforced working from home experiment has shown firms the potential for cutting costs without compromising productivity.
As many large employers publicly state that they’re planning to cut back on expensive office space, this turning point has become accepted wisdom. For instance, more than half (53%) of US corporate real estate executives who participated in an EY survey in April2 foresee a moderate or significant fall in their space requirements. And nearly three quarters (74%) of US CFOs plan to move at least 5% of their employees to remote working, according to a survey conducted by Gartner Inc in late March.3
of surveyed US corporate real estate executives foresee a moderate or significant fall in their space requirements.
While the office isn’t going to disappear, the changing nature of the way we work is going to redefine its purpose. Across the globe, office tenants are reviewing what tasks are suited to the office and under what circumstances employees should work from home. In many industries, we expect to see offices morph from central bases where staff work every day, to culture and client hubs, with a focus on collaboration, team-building and learning.
Offices located in central business districts may shrink, giving way to satellite locations. These local offices – best depicted as “airport lounge-style hubs” – would be both lower in cost and nearer employees’ homes. In many ways, they might resemble co-working spaces, although allowing for physical distancing and with robust financing models.
Ultimately, office owners must think creatively about the “purpose” of their buildings in the new world. Is the purpose to create nice offices or spaces that enable productive work? The two can have very different strategies. Setting out your purpose helps to shape your business model and identify new revenue streams.
Technology and data will also equip offices of the future and offer invaluable insights into employee behavior. That will lead to informed decisions about space requirements and how your space can be re-configured and best utilized.
Retailers re-evaluate store portfolios
Increases in online retail challenge brick-and-mortar shops.
The global pandemic has changed buying behaviors as consumers made deep cuts in the early stages of the crisis. The extent of change in the long-term remains to be seen. But one thing is certain: there has been a mass migration to online shopping. Consumers are increasingly shopping online for goods such as durables and even groceries.
Even before the pandemic, shopping was increasingly going digital at the expense of brick and mortar, although the picture varied by country. Take China, for example. Online retail penetration stood at 6% in 2013 and was expected to reach 34% by 2023.4 In the United States, the respective numbers were 8% and 22%, while Germany was set to see slower growth with 8% penetration climbing to 14%. “Soft” goods such as clothing and bedding were set to grow most, followed by “hard” goods such as electronic appliances or sports equipment, followed by groceries.
The online retail penetration expected to be reached in China by 2023, up from 6% in 2013. This mirrors global trends.
But the crisis is likely to have accelerated the shift to online significantly. For example, Walmart’s online app downloads almost tripled in March 2020, increasing by 190%. That said, stores are neither dead nor dying. There will still be a place for stores that, for instance, redesign the store experience or embrace value-for-money offerings.
As retailers rethink the role of stores and optimize their portfolios, real estate companies will need to adapt in ways that include more flexible leasing structures and repurposed space.
Industrial recalibrates and automates
New warehousing requirements change demand.
The surge in e-commerce is increasing demand for space in last-mile delivery capacity and warehouses. In a sign of the likely lasting boost, Amazon alone is keeping on 70% of the 175,000 extra US employees it hired in the early period of the pandemic to cope with increased demand.5
Even so, the outlook for industrial real estate varies according to type and location. While e-commerce is driving up demand for some warehouses, “nation-first” policies related to building resilient local supply chains could lead to lower demand near major ports and airports in some parts of the world.
The flux in warehouse usage has already led to innovation, with vacant space listed on technology platforms to be leased for short durations. This outsourced warehousing market is expected to grow to US$26 billion by 2023, with the on-demand warehousing market hitting US$25 billion, according to IBISWorld.6
The amount the outsourced warehousing market is expected to grow to by 2023.
Increasingly, retail space is being repurposed as warehousing. CBRE reports that 24 retail-to-industrial projects have commenced in the US since 2016, turning 7.9 million square feet of retail space into 10.9 million square feet of new industrial space.
At the same time, the crisis may accelerate the shift toward conducting distribution and manufacturing by robot.
Residential adapts to new lifestyles
Changing behaviors call for new designs.
As the pandemic leads to lasting changes in how people want to live and work, there are longer-term implications for the residential sector.
Major long-term lifestyle changes are likely. Remote working could become the new normal for many employees, leading to “reverse urbanization” where tenants move to the suburbs for more space and lower rents. In developed and developing countries alike, the appeal of mega-cities appears to be diminishing.
The future of “co-living” no longer seems so clear. Even if a vaccine is discovered, people may no longer wish to live close to others from outside their families or friendship groups.
Turning to more specific areas, student accommodation is expected to suffer falling demand in some cities. If virtual teaching takes off in the longer term, will demand for student accommodation ever be so high again?
And the health crisis in care homes around the world may lead to a rise in the elderly living longer at home with relatives. Or at the least, care homes may have to be reconfigured to protect residents from future disease outbreaks.
Taken together, these themes are likely to force planners and developers to rethink their approach to housing and its associated asset classes.
Steps for navigating an uncertain future
Re-think your strategy to meet the demands of tomorrow.
It is very early to absorb the lasting implications of 2020’s historic pandemic for real estate and to take decisive steps for the future. Many real estate companies are firefighting as they seek to overcome more immediate difficulties such as falls in rents and capital values. Yet it’s fair to predict that the most skillful adapters, the most dynamic disrupters, and those at the forefront of the digital economy will lead real estate’s reinvention and recovery.
At EY, we believe there are three major areas to consider when reinventing real estate businesses for a new world. Most real estate businesses will find there are steps they can take in one or more of these areas to prepare for real estate’s new era.
1. Transform your business, embrace innovation
- Reassess your portfolios: Where do you think you will have excess space in the longer-term? How could the space be re-purposed or diversified? Where are the new growth areas that require more space – data centers, telecom centers, multi-purpose hubs – that can be adapted for different circumstances?
- Collaborate with tenants: Talk to them now to understand the challenges they face and find solutions together. By collaborating you will be able to influence the outcome rather than simply reacting.
- Review your leasing structures and terms. Businesses are unlikely to want to be tied into long leases. Inherent structural changes are needed to meet new, emerging trends and demands
- Revisit “space-as-a-service”: While the space-as-a-service model has been tarnished by recent events, its long-term flexibility is suited to the new office world.
2. Invest in technology and trusted intelligence
- Innovate to succeed: Reinvent the IT function and IT-related outcomes, including technology architectures, infrastructure, cloud, enterprise resource planning, digital engineering, data and AI strategies. For example, offices may be repurposed so that companies can use them on a “pay-per-use” basis. Technology will be the fabric to this.
- Use data and analytics: Understanding how the space is used in your buildings will help you make informed decisions.
3. Build flexibility into your business processes
- Reinvent business processes, including through shared services.
- Outsource core activities to reduce fixed costs. Consider employing a managed service for core activities like leasing, account payable, payroll. Reducing the costs enables greater flexibility.
Real estate is at a turning point. After many years when asset prices rose quickly and tenant demand was robust, it’s no exaggeration to say that the sector faces its biggest challenge in living memory.
It’s too early to fully understand how the interplay of lasting behavioral, geopolitical and technological changes will impact individual assets and businesses. Yet there are already some signs of themes emerging and, consequently, there are strategic and operational steps that can be taken.
Throughout history, crises have led to significant change in society and economies. And often it has been the most innovative and decisive companies that have emerged the strongest for a new period of growth.
Show article references#Hide article references
- Commercial property prices down 10%. May 5, 2020. www.greenstreetadvisors.com.
- EY survey of 70 corporate real estate executives conducted in early April.
- Gartner CFO survey reveals 74% intend to shift some employees to remote work permanently.
- Source: Euromonitor.
- Amazon to offer permanent roles to 70% of 175,000 new US hires. New York Times. 28 May, 2020.
- outsourced warehousing market is expected to grow to US$26 billion by 2023, Cnbc.com, 28 August 2018
The abrupt disruption of the COVID-19 pandemic may change the face of real estate permanently. To thrive in this new world, stakeholders must embrace innovation, invest in technology and trusted intelligence, and build flexibility into business.