Commercial Real Estates' Perfect Storm

Even before the recent Covid-19 outbreak, commercial real estate (CRE) was facing a perfect storm of high street collapse, new ways of working, increasing supply of property, investment-heavy, smart buildings and enhanced customer expectations. How should CRE players respond?

Three to four months ago I was working with a CRE vendor, looking at how they could digitally transform their business. Everything we discussed required a significant investment and disruption to the status quo. Not surprisingly, they fell into the trap of (pun intended) just wanting to keep the lights on and wait until next year to see what, if anything, changes. 

The challenges facing the CRE market is that for so long there was little reason to change. Rents kept growing, albeit at a declining rate, so the emphasis was on minor tweaks to what was already there. Recently several technologies have accelerated at pace. Smarts in our Homes and Offices, including the ubiquitous voice assistants, mean we can operate our environments more efficiently and sensors mean we can operate to a degree of precision that we have not had before. 4G and the emerging 5G networks mean we have connectivity, particularly in the built-up urban areas, like never before. Virtual and Augment Reality (VR & AR) combined with Artificial Intelligence, Chatbots, Machine Learning and “Big Data” means the traditional ways of CRE engagement have become outdated and near redundant. The unfortunate truth is this investment can no longer be stalled. The time to act is now. There will be no second-mover benefit. “Me too” is not enough to differentiate. Clients and Customers want “Wow & Now”, and if your portfolio doesn’t have it, they will go elsewhere.

If you think the cost of keeping up is high, wait till you see the cost of falling behind.

The key elements of this perfect storm are:-

1)   Bloodbath in Retail – Although some online stores are looking to have a physical presence, their rate of uptake is significantly lower than the number of physical stores being closed. Footfall reduction, increased Business Rates, growth of multichannel, increased competition and margin pressures all make retailing very difficult. This is before adding the impact of the Covid-19 lockdown and social distancing or the disruptions caused to the supply chain. This means there will be even more vacant property on the high street and in the shopping centres.

2)   New Ways of Working – Organisations have been considering how to modernise the way they work. Collaboration and mobility are key. The modern workplace requires flexible spaces, not cubicles or open plan. Optimal use of space, for example, a diner-themed informal meeting space which at breakfast and lunchtime reverts to serving food. Modern businesses ebb and flow and the modern office needs to be able to accommodate this.

3)   Remote Working – This has been the biggest change and why it is separate from “New Ways of Working”. Before Covid-19, a business would often send mixed messages about their workforce. Our people are our business; however, we don’t trust them to work from home. Now the remote working genie is out the bottle and it will not be going back anytime soon. This is a double edge sword for CRE. Offices don’t need to be as big (so be ready to see some shrinkage post-pandemic), however, our domestic accommodation needs additional space to work from. This will be a major change from the pre-pandemic world.

4)   Increased Supply of Commercial Property – Look around any town or city and the count the cranes. Around 20 years ago, I was doing an SAP audit in Oslo. We were there for a week but we finished early so we spent an afternoon in Sky Bar of one the hotels. Looking out across the Oslo skyline, that’s when I first noticed the cranes. Since then, wherever I go, I notice cranes. Why? Generally, more cranes, more development so the greater the investment in that area. The combination of more development combined with the greater number of existing properties coming to the market will create an oversupply of commercial real estate. You don’t need a Nobel prize in Economics to know that oversupply means prices fall.

5)   Failure to Innovate – In short Smarts. New buildings designed from the ground up with sensors, internet of things, cameras and other Smart technology. These not only provide a more efficient environment but more importantly a more enjoyable and productive environment to work in. Trying to retro-fit Smarts into an existing building is difficult, time-consuming and expensive – I worked with one organisation that found it was cheaper to move it’s Data Centre to a new, purpose-built facility on the outskirts of town than to try to update its existing facility in its prestige, Grade-I listed head office.

6)   Sustainability – The modern commercial real estate has to be sustainable, whether through better insulation, microgeneration solar or wind power, more efficient water usage etc. Again, easier to design into a new build than retrofit to an existing building.

So even before the Covid-19 outbreak, the storm clouds were gathering for CRE.

Then came Covid-19 and resultant lockdown. Covid-19 will be the harbinger of the Perfect Storm. Already we have seen empty streets and closed offices. This is not a good look for CRE. Post pandemic, how the economy picks up, will determine the severity of the impact.

However, CRE can use this time to prepare what it needs to do to mitigate the worst effects.

The first area is to visualise the future modern workplace, the modern way of life will be like. Understanding how we can and will want to use buildings in the future will be key. The process will need to be consultative and inclusive. Inward looking just by the CRE players themselves will not be sufficient, especially if the past few years are anything to go by. 

Employers' duty of care towards its employees is now at the forefront of thinking. Whether supporting social distancing, testing and contact tracing, more frequent cleaning regimes and refuse collections, regular sanitisation stations, contactless access, increased air circulation and purification etc, these are now necessary costs if the employee is to be safe in the office. Landlords, tenants, employers and employers will need to collaborate if the correct level of personal protection is to be provided.

The process will also need to be agile. The initial starting point will not be the final, end solution, and in fact, over time the solution will evolve as the way we live and work evolves. So, the solution will need to support mixed-use, which can be flexed depending upon prevailing economic circumstances.

Creating an active community or ecosystem with users will be vital for future success because ultimately the situation facing CRE is a zero-sum game. This has to be taken on board by all parties in the ecosystem, including the government. The most profitable way for the CRE to grow sustainably is by working with the ecosystem for the mutual, long term benefit of all parties. The voice of these parties needs to be heard and incorporated in whatever future strategy is decided.