As the virus spreads across the world, investors are desperately trying to forecast which direction yields will go. They will see that post-SARS and Bird-flu the bounce back in the property market trend eventuated as a ‘V’ shape, however we all know that we are dealing with quite a different animal here, so to speak. The effects of previous pandemics were not even close to having the economic effect of Covid-19 and whether the reason is the virus itself or the countries leaders’ response to it, is another story.
Investors may then look to the aftermath of the GFC and they will see that there was a lag in the commercial real estate drop but when the values did fall, they fell by approx. 30% which was nearly on pah with the UK and USA. The reason for the lag is not tagged to only one variable however a significant cause came down to business owners hanging in there for as long as they could until the effects of subdued demand finally took its toll and they had to close down. When the tenant disappears in a post-GFC environment the timely replacement of this tenant without significant discounts is highly unlikely. Property values subsequently fall.
The difference between the GFC and Covid-19 is that the GFC did not discriminate on who it was going to take down. Covid-19 however, unlike the people it infects, does have a specific taste on the business type and hence commercial class that it favours. Commercial property values have always been tied to the risk of the future cashflow of the investment. In a changing world where Amazon is supplying wholesale goods to our warehouses and Alibaba makes importing from a ‘free trade’ China nearly as easy as buying an item on Trade Me, the manufacturing sector in NZ with its relatively higher labour cost must be concerned. Similarly, a commercial investor trying to accurately forecast the security of their income needs to seriously look at trends of this nature and decide on the strength of the tenant covenant.
Some sectors that are tied to immigration will undoubtably be hit hard as countries around the world will be slow to re-open their borders. Commercial tenants such as accommodation providers, travel agencies, immigration service related, airlines, tourist operators, souvenir shops etc. are going to find it hard going and may require relief from their commercial landlords.
Conversely, landlords with ‘essential services’ and/or government funded tenants have been able to sit back to a degree, knowing that their investment is relatively recession proof. The lower cap rate and hence higher price they paid for the investment in the first place is now paying off. Given that there are now less prime commercial property investments in the market, coupled with a low-interest environment, these type of gilt-edged investments will only increase in value.
So what are we to do with a significant number of commercial investors around NZ that are housing compromised tenants, some of whom are tettering on bankruptcy.
Since the Christchurch earthquakes we have seen a new clause (Clause 27.5) inserted in the sixth edition lease that was designed to provide guidance in a time where tenants are barred from operating of of their premises.
The relevant part of Clause 27.5 states: “..Then a fair proportion of the rent and outgoings shall cease to be payable for the period commencing on the date when the tenant became unable to gain access to the premises to fully conduct the Tenant’s business from the premises until the inability ceases.”
Since the clause was inserted in the ADLS lease the NZ courts have not defined the words ‘Fair proportion’, however I have no doubt that this will change post Covid-19.
Banks are offering deferments in mortgages to take the pressure off landlords, however the ‘mortgage holiday’ as touted by the press created confusion as the word ‘holiday’ in commercial circles relates to a ‘rent holiday’ where the rent has been forgiven.
This however, is not how many tenants nor landlords see the situation plus the parties that do not have the sixth edition lease are all looking towards the government for more guidance.
The NZ Govt, not unlike many other democratic governments around the world, are not keen to interfere in the free market system in this regard but instead have tried to provide help by allowing :
- depreciation and other tax incentives for this financial year and
- extending the time period that landlords can cancel leases from ten to thirty days.
- The Govt has also funded business with staff with a wage subsidy to help keep business’s running and encouraged banks to provide loans to business’s that have at least a $250k turnover.
- Through the IRD, a loan up to $10,000 from May 12 to June 12, 2020.
- The reserve bank to relax the LVR restrictions
- Business Finance Guarantee Scheme – $500k
The LVR restrictions and the Business Finance Guarantee Scheme (If your turnover is $80M plus) are touted as Government help however the banks rightly still remain cautious and you would very lucky indeed if you found a bank that would actually follow these guidelines. After very little regulation in past pre-financial crashes, banks are now starting to think for themselves and taking their own precautions.