After the pandemic what is the future of the office REIT market?
David James |
26 April 2021
The pandemic has been devastating for the office rental market with prime rents in Melbourne or Sydney falling by almost a quarter since late 2019. What will happen in the wake of the pandemic?
It is widely agreed that work patterns will profoundly change after the devastation of the economic lockdowns. Morgan Stanley recently opined that the impact is likely to be permanent, saying it disagreed with investors who argue that work from home is temporary.
But if that turns out to be the overall trend it may not apply to the whole market, or to all investment opportunities. According to UBS, investor interest in office REITs has “increased lately as discount to valuations combined with jobs growth surprising on the upside and employees slowly return to the office.” But it notes that projections from commercial property analysts CBRE are “a timely reminder that office leasing conditions will remain subdued with demand not normalising until ~2023 (previously ~2022).”
UBS is saying that there is now less upside in its "Buy office" rating. “The trough is slightly deeper than previous forecasts and the recovery is more sanguine.” UBS says there is a “more conservative approach” in the market because of slower vaccination programs than expected, potential delays to borders reopening and a tapering of government support, all of which affect demand for office space.
“Prime net effective rents from peak (Dec 19) to trough are expected to be down 22% in Sydney and Melbourne, with incentives increasing from 22% to 32% (gross) in Sydney and 26% to 40% (net) in Melbourne. This is consistent with our long held view on a ~20% decline in net effective rents; however the low interest rate environment/discount rates mean asset values are only forecast to be down 5-7%.
UBS is predicting there will be little recovery in demand for Sydney office space until 2023, with supply largely unchanged over the next year. Sydney prime vacancy is expected to peak at 9% in December 2022.
“The recovery may be slower than initial expectations, but the inflection point is
important. Rents are expected to grow from the trough in 2H21 at ~4% pa.”
UBS has Buy ratings on Goodman Group and Charter Hall Group. “For malls, we see risks building as conditions normalise (record deposits run down, retailers cycle elevated comps, tourism restarts once borders reopen)”.
UBS has sells on Vicinity Centres and Scentre Group, and makes small cap picks on Centuria Industrial and Aventus Group.