JLL NZ’s webinar series episode 1 - Providing clarity

On Wednesday 8 April we held the first of a series of exclusive webinars to provide some clarity in these uncertain times. Moderated by JLL New Zealand’s Head of Research and Consultancy, Paul Winstanley, the panellists included:

• Grant Robertson, Donaldson Brown Insurance Brokers Key Account Manager
• Andrew Ballantyne, JLL Australia Head of Research
• Michelle Hill, Dentons Kensington Swan Partner
• Todd Lauchlan, JLL New Zealand Managing Director

If you were unable to attend, click below to view the webinar recording.

There were a series of questions from our guests throughout the webinar – more than our panellists had time to answer – so we collated responses from our panellists after the webinar and have included the full Q&A below.

Where do you see the costs of funds going in the next 12 months?

Andrew Ballantyne: The cost of debt is determined by the reference rate and margin applied. At the moment, the reference rate has lowered and margins have moved out. We expect that lender appetite for core assets with long leases will remain firm, but for secondary grade assets with income risk, borrowing costs will move higher

When do you believe that governments will start allowing business to recommence within their own borders?

Andrew Ballantyne: The uncertainty over the duration of the virus makes this a difficult question to answer and it will be highly dependent on the individual country. China has already started to lift restrictions and we are seeing a recovery in office and industrial leasing enquiry, while foot traffic through shopping centres is starting to recover.

New Zealand and Australia have taken proactive measures to curb the spread of the virus, flatten the curve and see a significant reduction in new infections.

What do you believe will happen to rents within a) 12 months and b) within 5 years?

Andrew Ballantyne: Rents will be under downward pressure over the next 12 months. Retail will be the most challenged followed by the office and industrial sectors. Assuming a V Shape recovery in the economy and using recent data from REIS, I would expect rents to recover in the second half of 2021. The 5 year outlook will be more dependent on the demand and supply dynamics of individual markets.

Being that largely insurance companies have not had to pay out for COVID-19, will it have a cost impact on insurance policies and how will it otherwise adversely impact policies?

Grant Robertson: The immediate market reaction has been to place a freeze on any property rate increases, except for high risk property (such as property in zones with high earthquake risk or high fire risk such as EPS construction). This should provide some short term relief from any inflationary rate increases that would otherwise be applied. Given that the property insurance industry has been spared from major losses, the medium term view is that this crisis will not directly impact rates, either up or down. Longer term, however, we see a reduction in profitability from insurance companies due to the low interest rate environment and returns from investments not reaching expectations. This should result in insurers continuing to return to underwriting profitability as their core focus and return long term rates closer to their “technical rates”.

We are also seeing the Directors & Officers market almost disappear for certain industries, such as property development and construction becoming very hard to secure new cover or increased cover for. This pandemic, combined with the Mainzeal case and collapse of large contractors in the past 18 months has resulted in the development industry being under extreme pressure. Insolvency exclusions are becoming harder to remove and require companies to demonstrate sound financials, which is increasingly difficult given the current operating environment. This appetite will take some time to come back and tends to follow economic cycles in terms of pricing and capacity.

We see the Travel insurance industry having to adjust rates due to the significant claims that they will have had to pay out over the past few months, so pricing will increase in that product line.

Finally, we are seeing insurers apply specific COVID-19 and/or pandemic exclusions going forward to make it clear to policyholders that insurance will not be available for this or any similar events in future.

What does the future of commercial property look like – where will demand come from?

Andrew Ballantyne: Organisations are concentrating on the potential impact of COVID-19 on their core business. In the short-term, the demand for office space is likely to contract. We expect organisations to have more clarity following the initial lock-down period and stronger leasing activity over the second half of 2020. The industry sectors expected to lead the office leasing market recovery are those related to the digital economy, health and insurance.

Do you see landlords enforcing lease remedies if tenants can’t meet their obligations?

Michelle Hill: If the tenant does not have a right to an abatement of rent, and the landlord and tenant have not otherwise reached an agreement regarding the tenant's obligations, then the tenant will be in breach of their lease. This would give the landlord a number of remedies including, ultimately, a right to cancel the lease (if the requisite notice process under the Property Law Act has been followed).  Whether a landlord would enforce such remedies is unknown and will be a decision made landlord-by-landlord, tenant-by-tenant. However, it is expected that most landlords will work with their tenants to emerge from this crisis - particularly given that the market for replacement tenants may be subdued.

Following ADLS clause 27.5 for a very small retail business that is fully closed with no income, what is a fair proportion of the rent that ceases to be payable?

Michelle Hill: Unfortunately, there is currently no correct answer to this question as there has been no judicial interpretation as to what is a 'fair proportion' and there is much debate as to what factors should be taken into account.  There appears to be some consensus amongst some property lawyers that what is 'fair' is something that takes into account the position of both parties (landlord and tenant).  However, a retail business with no income is likely to be at the top end of the abatement scale.  There are also some current views emerging that 100% abatement is not within the scope of clause 27.5 as it is no proportion at all (it is full). 

If you can't negotiate, is clause 43 (Arbitration) the best option? Can the landlord use clause 43.4 to cancel?

Michelle Hill: To provide some background, clause 43 of the ADLS Lease requires the parties to submit a dispute to arbitration if they haven't managed to resolve it within 30 days. Clause 43.4 goes on to state that such procedure shall not prevent the landlord from taking proceedings for the recovery of unpaid rent or other money or from exercising its rights and remedies in the event of a default prescribed in clause 28.1. The defaults in clause 28.1 include (amongst other things) rent still outstanding after expiry of Property Law Act notice demand, tenant having entered into a composition assignment or other arrangement for benefit of its creditors and tenant going into liquidation (or other insolvency event).

In answer to these questions: If you can't negotiate, is clause 43 (Arbitration) the best option? As above, if the parties can't agree, the ADLS Lease directs the parties to go to arbitration (although they are always free to mutually agree some other form of dispute resolution such as mediation). However, arbitration is an expensive and protracted process so I would not say it was the best option, unless the value in dispute is substantial and warrants this.  The fact that it is expensive and protracted would hopefully motivate the parties to reach agreement by some other means of dispute resolution.

Can the landlord use clause 43.4 to cancel? It would be a somewhat risky move for a landlord to cancel a lease solely because the tenant has not paid the rent that the landlord considers is payable (i.e. where the parties have not agreed what a 'fair proportion' of rent abatement should be) and this could backfire on the landlord (i.e. the landlord could instead find itself in breach for doing so).  However, the landlord could cancel the lease for other reasons under clause 43.4 e.g. if the tenant has suffered an insolvency event under clause 28.1(d).  Note that, if a landlord cancels a lease, the tenant has 3 months within which to apply to the High Court for relief against such cancellation - and the Court generally decides in the tenant's favour if the tenant can show it has the ability to honour its lease obligations into the future.

How do you see the future of the residential market here in New Zealand and its flow-on impacts to the economy and commercial sector in general?

Paul Winstanley: Based on evidence from previous economic shocks and downturns, residential values tend to be more resilient than commercial values. This is largely because so many residential owners are also occupiers and, additionally, residential investors tend to be very long term in their focus with regard to potential capital gains. Therefore, if owners don't have to sell (and in the current environment where repossession is being actively discouraged by Government through bank support this is less likely than during other downturns presently), most people will not. This lack of sales momentum reduces supply and, by definition, supports prices. Demand may well fall back too - even significantly - in the short term due to economic concerns, greater unemployment and tightened bank lending criteria, but this is more likely to lead to a lack of activity rather than widespread falling prices. I would, however, expect the median house price to fall as the only properties likely to transact in the short to medium term are either distressed assets or forced sales (estate disposals, marital separation cases etc). The key will be to watch transaction numbers when gauging the market rather than median price statistics in my view.

Will we see any further editions to the NZ ADLS after the lockdown to reflect the issues around Clause 27.5 in the current environment?

Michelle Hill: The Auckland District Law Society Inc is currently in the process of re-drafting the ADLS Lease (and has been for the last year or so). They have recently announced that they will be taking COVID-19 into account in their review, but it is unlikely we will see any prescriptive changes to the clause. Instead, I would see that clause negotiated by the parties on a case-by-case basis (taking into account the particular business, property and position of the parties).

Are you seeing any major impacts on any particular subsets of the industrial occupier market and what are you forecasting in terms of impact on industrial occupancy/vacancy rates?

Todd Lauchlan: Too early to tell, but we’re likely to see a slowdown in demand of existing industrial stock and new developments along with an increase in vacancy rates in line with the reduction in economic activity and reduced levels of business confidence.

Do you see an increase in sale/leaseback or vacant possession sales post COVID-19?

Todd Lauchlan: Yes, we are already seeing an increase in companies that we work with considering and progressing with sale and leasebacks to boost their cash reserves. There is also the potential for some business dislocation that will provide opportunities for vacant possessions sales as well.

Our second webinar is also available on-demand: Understanding the Capital Markets landscape in the APAC region