Real opportunity or real risk?

The coronavirus pandemic has had a huge impact on the property sector as companies decide they no longer need as much office space, staff call for permanent homeworking and lending rates fall. So what are the immediate ramifications for the corporate and residential real estate markets?

At the height of the lockdown in May, an unnamed Russian billionaire paid £15.45m to buy a five-bedroom townhouse overlooking London’s St James’s Park, complete with – as you might expect for that money – rooftop terrace, champagne store and private rear garden. 

It was the biggest single residential transaction to take place during the lockdown. And it showed that the impact of the pandemic on the real estate sector might not be quite as straightforward as many think.

In real estate, when there’s a crisis, one person’s distressed asset often turns out to be another person’s buying opportunity – as investors and asset managers may well be finding out in the coming months.

And while some sectors of the property market have undoubtedly been hit hard by coronavirus – think retail and hospitality – others, including much of the residential market, may come out looking relatively unscathed.

Commercial property investment is where the greatest pain is being felt. “In March, some 50% of rents were not paid by the rent payment date,” says Simon Burgess, a chartered surveyor who leads Ocorian’s real estate funds business globally. 

“In some sectors, no rent has been paid. That’s led up to the June quarter and even worse non-payment, with over 11% lower average collection rates than the previous three months. 

“We had one case involving an investment in the leisure sector where, on the June-quarter day we received no rent when normally we would have seen receipts of £1m. 

“The UK government’s moratorium on landlords’ ability to take recovery action has given business tenants who can pay permission to ignore their contractual obligations. 

“And as a landlord, like any business, when you have no income, all of a sudden you have a problem of how you are going to pay your debts.”

Insolvency threat

Businesses that find themselves in that position risk insolvency, says Burgess: “And that’s the issue that’s going to be vexing landlords.” 

Landlords may as a result find themselves in breach of their own covenants to their lenders, which may result in them defaulting on their borrowings, sometimes when they are in the midst of construction work to improve the property. 

“There’s a triple whammy, and that’s the question of valuation,” Burgess says. “A landlord may have secured the lending on the value of his property, which is based on the assumption that it’s income-producing now or in the future. 

“If that income stops, or at best is now highly uncertain for a short period until the economy recovers, how much will the value have fallen and how does it compare with the amount you’ve borrowed? 

“If the landlord is in the middle of refinancing his business, this could stop the lender in their tracks.”

Over the next three months, these problems will crystallise, says Burgess – first with tenants’ businesses getting into trouble, as many retailers already very publicly have. Oasis, Carluccio’s and Cath Kidston are just three examples. 

Even blue-chip retailers such as John Lewis and Boots, which have decided to close stores, will create a knock-on effect for landlords. Retail was already facing structural change, Burgess points out, and Covid-19 has simply hastened the journey. 

Out of office

Investors in offices face a different issue. With millions of staff working from home since lockdown began, offices have been sitting empty. 

Richard Daggett, a Partner at Ogier, who specialises in real estate, says: “The shift to working from home is as much a mental change as a physical move. Even as offices are now gingerly allowing staff to return, staff aren’t necessarily wanting to do so – and all research in this area points to this new-found desire to work remotely being a lasting impact of lockdown. 

“Owners of office buildings will be looking at how they can effectively change the manner in which such assets are used – to allow more flexible use, accommodate lower occupancy and to change offices to mixed-use buildings as and when existing leases come to an end and renewals look unlikely.”

Paul Welch, CEO and founder of Largemortgageloans.com, has personal experience of this situation. He’s been working in Guernsey since lockdown began and says his office in London’s Canary Wharf, for which his company pays £250,000 rent annually, has only three people working there. 

“The world has changed,” he says, “and I don’t see how it can go back. My staff prefer working at home, they perform better and they are happier. So if I could get out of that lease tomorrow I would, because I don’t need it anymore.”

Burgess takes a more sanguine view, insisting that people have always needed places to meet other people, and will continue to do so. 

He thinks demand for office property will “moderate” in the near future and anticipates a flight to quality – which means the prime locations will fare best. 

The indirect impact of softening demand, he says, will be delays in construction, since it takes several years in the pipeline for new office space to come on stream.

Areas of opportunity 

The coming months will be a time of opportunity for some in the commercial property investment sector. Sales of distressed assets will mean keen pricing for those who have cash, so long as they can find tenants who can pay in future or find a different use for the building.

There are areas of commercial property that may even benefit from Covid-19. Logistics is the obvious one: retail sales have continued their shift from the high street to online, and that means delivery and fulfilment have become even more important. 

“Hubs that supply the ‘last mile’ of the delivery chain are one such example,” says Burgess. 

Daggett adds: “Logistics-focused REITs with strong rental flows, such as Urban Logistics [which purchased a portfolio of seven warehouses in April] and Segro [which acquired an urban warehouse estate for more than £200m in June] are seeing their share prices reflect the strong demand in that sector.”

The move towards working from home, meanwhile, also has significant implications for the residential housing market, with a widespread expectation that it will lead to people looking for different kinds of properties in future.

“People will be looking further out in cities and they will be looking for more outdoor space, and possibly for properties that have an office where you can work,” says Jack Goguelin, Principal Representative in Jersey at mortgage broker Enness, which specialises in high-net-worth clients. 

“They won’t necessarily move out of cities like London, but certainly if they have a second home they are more likely to look outside city centres.”

Welch says: “People are making lifestyle decisions based on the new world order. For many that means they don’t have enough space, so we’re seeing a lot of interest in ‘let to buy’ – where you let your existing home and buy another one that suits your new needs.” 

The Channel Islands could be a beneficiary of that shift, he adds, since the incidence of coronavirus has been low and they offer an exceptional lifestyle.   

Residential ups and downs

Initial expectations at the outset of the pandemic that residential property prices would crash seem to have been confounded so far. 

Part of the reason for this is that the experience of lockdown has made ‘home’ much more important for many people. But a lot will depend on the nature of the recovery, and whether there is a prolonged recession. 

Daggett says: “Obviously, the lockdown – and the government prohibition on actually moving house – ensured that residential transactions ground to a halt. 

“While the UK housing market is coming out of its deep freeze and estate agents talk in buoyant terms of huge demand triggered by the ease in restrictions, the nervousness of homeowners wondering whether a house price crash will follow the looming recession means that sales are still slow.

“Whether UK Chancellor Rishi Sunak’s stamp duty holiday, announced in July, will stimulate the housing market to overcome such nerves remains to be seen.”

In the super-prime segment of the market, says Goguelin: “Some people were expecting to benefit from mega-discounts, but they won’t. The best property, with all the security and other features that entails, won’t be reduced.”

So what does all this mean for how real estate is viewed as an asset class? 

“Every wealth manager will review their exposure and for some that will mean that they will switch some of the assets they manage from commercial real estate to technology,” believes Welch. 

At Ogier, Richard Daggett is less convinced. “Real estate is generally a longer-term asset,” he says. “Investors will look beyond the immediate shocks and short-term analysis that comes with the equities markets. 

“Covid-19 flare-ups or stories regarding hope for a vaccine will impact hugely on those invested in the stock markets (both positively and negatively), but they’re unlikely to have much bearing on the value of a real estate asset three years from now.”

Simon Burgess is equally upbeat. “I’ve been involved in real estate since 1985 and I’ve never seen a serious change in sentiment towards real estate investing as an opportunity to get good risk-adjusted returns,” he says. 

“Canny investors will see the current situation with Covid-19 as an opportunity.”
 
Well-capitalised investors will win through, he says, and for the Channel Islands firms that look after them, demand will continue.