Commentary

The economic impact of Covid-19 on the New Zealand economy is expected to see New Zealand enter a deep recession. Although estimates vary widely, median economic forecasts are in the range of 5% to 10% reduction in GDP. Oxford Economics are forecasting New Zealand unemployment to increase from under 5% to 7.6% (the highest level since the early 1990s), and a full recovery will be prolonged. We expect Hawke’s Bay should mirror the wider New Zealand economy.

Pre COVID-19, the Hawke’s Bay commercial and industrial property market was extremely buoyant stimulated by strong economy growth, reducing cost of capital and low margins on non-property investments. During this period, rental growth was steady and slightly exceeded inflation (although stronger growth was experienced in sectors, most notably industrial). However, the main driver of value growth was reducing yields (capitalisation rates), which resulted in strong value growth.

While commercial and industrial sales activity is insufficient since Covid-19 to see the results of this in value and rental evidence, there is good justification to expect the changed economic conditions to have a significant impact on the property market.

During and after the restrictions regarding economic activities in lockdown and Level 3, difficulties of rental collection emerged in the commercial and industrial property markets across New Zealand. According to a study of rental payment collected by CBRE property management for the month of April, relative to normal collection rates, only 54% retail tenancies paid, 93% office paid and 89% industrial paid. The office sector in this CBRE data is inflated by a high percentage of government tenants under management. Similar figures reported by Re-Leased showed just 37% of April rent paid within two weeks of the due date for retail, 55% for office, and 70% for industrial. This data matches our opinion that retail could be the worst affected commercial sector due to coronavirus, with offices next, and industrial not faring too badly. These statistics need to be taken into context with the fact that the ADLS 6th Edition lease provides for rent relief in a situation where the property cannot be accessed. Probably around 50% of leases we see when doing commercial property valuations are ADLS 6th Edition leases, so this level of overdue is not necessarily an indication of the tenant’s capacity to pay.

Capitalisation rates, which prior to Covid-19 reached historically low levels, are expected to increase, despite falling interest rates. Added Valuation forecast total returns on commercial investment property to reduce, mostly as a result of the loss of capital gain, but also due to rent reductions and increased vacancies. The yield difference for tenant-calibre, lease terms, property quality (lettability) and vacancies, will widen. Prior to Covid-19, premiums for well leased property were minimal, due to strong owner occupier demand and low vacancies across all property sectors, but particularly industrial. That was a historic anomaly which will not continue going forward, as investors anticipate longer vacancy periods. Vacant property yields are expected to rise significantly. Purchasers will place more weighting on tenant quality and lease terms.

For the reasons stated above and under the Retail, Office and Industrial pages of this website, we anticipate capitalisation rates for retail to rise the most, with office less effected, and industrial even less so. Quality, well leased property in all sectors might fair fare, but we anticipate some rise even in prime property; but vacant or poorly let secondary property could see significant capitalisation rate rises.

Land and new developments may be among the most affected as there is normally no rental income to support either construction or development. Also, banks will hold conservative views on new developments because of a negative economic growth. Tenants are more likely to occupy mature properties. This will be a significant shift from recent strong value growth.

Currently the scale of Covid-19 effects remains uncertain. The valuation of commercial and industrial property will be challenging in the near term because of increased income uncertainties and lack of empirical transactions evidence.

The market is now well informed on seismic strengthening requirements, with discounts now more reflecting of actual costs plus a significant margin for profit and risk, where previously the discount was greater due to uncertainty on costs and procedures/legislative requirements. Owner occupiers are less concerned about seismic strength, particularly in the industrial sector. The market continues to look beyond current legislation requirements with retail and office tenants seeking buildings of at least 67% of New Building Standard (NBS).

While Covid-19 will affect all sectors of the urban Hawkes Bay property market in the short to medium term, we still believe the long terms prospects for the region are positive.