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The New Normal in Commercial Real Estate: Survival - A Shared Cause

Colliers International Philippines is one with the nation and the world in Doing What is Right for the people, clients and communities in combating the spread of COVID-19.

When this is over, it will not be business as usual. This pandemic will change the way of life across the board. In commercial real estate, we see significant changes in how this sector will rebound and evolve when this pandemic is over. While we are all busy coping and surviving this challenge, we intend to share our knowledge to accelerate the success of our partners by writing a series of papers about The New Normal in Commercial Real Estate. We need to be ready and preparation starts now.

Mapping the COVID Crisis

The National Economic and Development Authority said that the impact of COVID-19 to the 2020 GDP is a reduction of growth from 6.5 – 7.5% to only 4.3%. The Asian Development Bank (ADB), on the other hand, says that the Philippine economy could just grow by 2% which is weaker than the forecast of 3% by the World Bank. Meanwhile, the International Monetary Fund (IMF) already declared a global recession last March 28, 2020. In the same report, the IMF projects the recovery to start in 2021. This pandemic has affected everyone and everything in the world. Unlike an economic crisis where people can still go out and be productive, this pandemic has practically paralyzed all of us. Organizations now heavily rely on stable home internet connections and online communication platforms to still bear a semblance of business as usual by working from home which we covered in the first part of our series.

Based on the initial results of the Colliers International Philippines office market survey, demand, in the form of transactions, declined by 24% year-on-year. On the supply side, the projected office stock for 2020 will be adjusted downward by at least 20% as developers have halted construction due to their workers being unable to go out and travel to their properties. Vacancy, on the other hand, stood at about 5% but this is expected to inch up because of the softening of demand. In the past few years, the Philippine office market was driven by Business Process Outsourcing (BPO) locators, Philippine Offshore Gaming Operators (POGO) and traditional occupiers. Each sector comprises roughly 30% of the total office lease transactions annually. With the global economic recession, it is expected that the BPO expansion will slow down initially, but a strong rebound is expected after, like what happened several months after the Global Financial Crisis (GFC) in 2008-09. While the wave of BPO expansions happened after six (6) to nine (9) months after, the recovery from COVID-19 may be longer as the impact could be worse. The growth of the POGOs, meanwhile, may be hampered by issues related to visa applications and the concerns raised by the Chinese government regarding the legality of gambling and money laundering which is detrimental to their economy. Lastly, the traditional occupiers will follow the global economic recession and the rebound shall be led by consumer goods sector while the luxury sector is expected to rebound the last. 

Surviving the Onslaught

While a rebound is sure to happen since the property sector is cyclical in nature, the real question is: When is the end of this? Meanwhile, both the landlords and occupiers, who are equally affected, are assessing how best to survive this onslaught. With the directive by the Philippine Government for owners of malls to give rent relief to their tenants, the office occupiers started asking their own landlords for the same relief – not to gain, but all in the name of outlasting this pandemic. The landlords, on the other hand, are also looking to find relief elsewhere – they are waiting for banks to grant reprieve on corporate loans which has yet to happen. In the meantime, both continue to spend on salaries of their employees and some other fixed expenses which are draining the well of cash. Survival is a question of how much cash resources a company has to withstand this pandemic. Some of the clients we have spoken to only have cash that will last two (2) to three (3) months which is reflective of the fast-paced and fluid economy that we are operating in.

The most vulnerable in this difficult situation are the small businesses which typically occupy small spaces in office buildings. We looked at our database of occupiers in Metro Manila which occupy less than 500 to 5,000 sqm of leasable space and categorized them as follows:

new normal

The total office stock in Metro Manila as of Q1 2020 stood at 11.96 million sqm of leasable space. Our simple calculations show how much space these small businesses occupy which is anywhere between 1.9 - 4.7%. This means that the current vacancy of about 5% could possibly increase significantly depending on how these companies are affected and unable to maintain their office spaces.  The combined share of these occupiers to the total office stock in Metro Manila is 14.7%. This is on top of other possible outcomes like a slowdown in other sectors such as the POGOs which comprise about 10% of the total office stock.

Navigating Business Relationships

If what the IMF is saying materializes, then we expect that this pandemic will peak by around May or June and the remainder of the 2020 will be about resetting in preparation for the rebound which may happen starting 2021. A rebound will happen sooner and faster if the office market will not hit rock bottom with high vacancy and falling rental rates. In the GFC, the vacancy reached 8.6% while rents fell by about 30%. While supply and demand are always at the center of market discussions, relationships between landlords and occupiers are equally important. For occupiers, the concerns they expressed revolve around devising a shared solution with the landlords for continued partnership in the long term by avoiding worse case scenarios such as bankruptcies, employee retrenchments, having high vacancies and falling rents. A former top officer of one of the top real estate developers said that during the GFC, some occupiers were given concessions depending on the standing of the occupiers as evidenced by payment history, reputation and credibility. Some of these were rent reduction for one (1) year in exchange of lease term extension of three (3) years, rent escalation deferment for two (2) years, lifted restrictions on sublease rights, etc. For new leases, substantial rent discounts were given on the first year of the term. These measures were taken because the minimum occupancy rates to cover and keep buildings operational are 50% for existing buildings and 60% for new buildings.

With all the problems brought about by this pandemic, they also present an opportunity for market leaders to differentiate themselves in the way they engage their partners. For the commercial real estate sector, we believe that the considerations that companies will extend during this time will add intangible value on the relationships between landlords and occupiers. 

Having said that both sides are equally affected, Colliers International suggests that occupiers should look at possible ‘gives’ to the landlords in exchange for rent relief, rent abatement, adjustment in the dates of handover, lease and rent commencement, longer rent-free fit-out period, etc. such as the following:
> Apply the Advance Rent to be applied to the last 3 months of the lease term now
> Apply the Security Deposit after the Advance Rent is applied, subject to replenishment immediately thereafter this pandemic
> Rental deferment for a few months in exchange for a longer lease term equivalent to the length of the rent deferment period
> Rental discount for the duration of the pandemic to be paid by the occupier 12 months after in cash or in staggered basis
> Rent-free within the lease term can be exchanged and applied now
> Modification of the rent and escalation structure to recover the rent relief extended 
> Adjustment in other fixed charges like common area charges and aircon charges equivalent to the savings on water and power consumption
> Waive parking rental
> Waive signage rental
> Removal of pre-termination option
> Removal of the “No Reinstatement” provision
> Removal or modification of the Sublease and Assignment provision
> Revision of the following provisions: 
  • Renewal provision to modify a collar on renewal rent
  • Tightening of the obligations of the occupiers in the contract of lease (e.g. shortening of curing periods)
  • Softening of any Interruption of Services provision in favor of the landlords
It is heart-warming to see the spirit of Bayanihan being proudly displayed by the Filipino community during this difficult time. We believe that this concept of Bayanihan can also apply in the commercial real estate industry wherein better-off parties can share in the struggles of the others who need a lifeline so that all will come out of this stronger together. Survival should be a shared cause, according to Maricris Sarino-Joson, Director of Client Services at Colliers International Philippines.

This is second part in a series of insights from our Office Services team. Click here to read Part 1.

 

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Maricris Sarino

Director

Office Services Landlord Rep

Manila

Maricris has worked in real estate since 1998. She began her career as an Investment Consultant in Megaworld Corporation handling the leasing of Megaworld's office buildings, residential condominiums and commercial warehouses. In 1999, Maricris was tasked to conceptualized, set-up and operate the Eastwood Locator’s Assistance Center (eL@C) in Eastwood City CyberPark, the first ICT, mixed-use master-planned city in the Philippines. eL@C serves ICT and BPO companies as an one stop shop for real estate solutions, information center as well as a business center facility and headquarters for service providers and satellite government offices.

Maricris joined Colliers International in 2012 to provide real estate strategies and solutions to its current clients as well as to source new clients for the company.

In addition, Maricris founded the Children's Environmental Awareness and Action Foundation (CEAAF) that focuses on the development and implementation of programs and educational materials on Philippine flora and fauna as well as Filipino pride projects and events.

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