Go out on any high street and you find empty shops, retailers arguing with their landlords over how much rent they can afford – and a general apprehension that there are still bankruptcies to come.
No-one can doubt that shop rents pre-pandemic were too high for the post-pandemic conditions we now see. Whilst people are making their way back to some shops, a lot of the extra online activity is sticking.
Traditional retailers need to hold less stock to cut financing costs. But, as they unclutter their displays, they run the risk that then they do not have the shape, colour, specification or size a particular customer wants. If people go too often and find that the specific item they want is not on the shelves, there is the danger they will just go online. The high street is drifting to more coffee shops and pizza and burger restaurants away from hardware and clothes.
Changing patterns of behaviour
Wander into any office area of a city on a working day and you will see few people circulating and many offices with few staff. There is a knock-on adverse impact on the cafes, bars and restaurants of the city centres. No-one is sure right now how much hybrid and home working will survive the final end to lockdowns, but there is a general feeling fewer people will go daily into offices. Business are not rushing to surrender space, but they will be looking at hot desking and a smaller floorplate if they settle down to a lot more hours being worked from home.
Look at the prices of Real Estate Investment Trusts (REITs) on either side of the Atlantic this year and you will see a recovery underway. This reflects the great success of warehousing and general commercial space as the online revolution sweeps up so many more facilities to stock, pick, package and despatch a vast array of goods – and as the high technology companies grow and seek more space for everything from cloud storage to entertainment.
This part of the mix has become a much larger share of the whole over recent years. Retail is diminished as a proportion of the total property universe, as values creep down. Shop rents are falling, voids are rising and, in due course, physical space will be removed or converted. In the UK index of REITs industrial property Segro is now 20% of the total value and by far the largest single holding whilst Hammerson, with more shops, is only 2.5%.
In the UK, progress is quite slow in putting old shops back to work. The stickiness of rents despite the long period of low or no payment is getting in the way of conversion, as on the old valuations shops are still too expensive to convert at a profit to offices or residential. It seems likely that more shops will need to be valued at alternative use value before more widespread and rapid conversions are underway.
Landlord shares the pain
The whole pandemic response has shaken traditional UK commercial property activity. It has become accepted that rents are not paid by distressed businesses, with a formal moratorium period sometimes allowed. It has become clear that a large part of the retail market will have rent reviews to cut rents instead of the traditional upwards-only reviews. Turnover-related rents are becoming more common, so a tenant and a landlord share the pain of poor trading.
Meanwhile, successful landlords are focused on the green agenda. Large company tenants with money to pay the rent want space which will help them hit increasingly exacting green targets. Older buildings are getting makeovers to alter heating and water systems, beef up insulation and meet modern standards for social interaction and staff comfort. New space is built to higher standards and advertised as “employee friendly” as well as “net-zero compliant”. All this comes with a cost, driving a two-tier market of high-grade accommodation for the companies with good cashflow, and a lower tier of less-modernised space for those whose businesses have been hit by Covid-19 and by modern trends.
Property yields are high compared to equity dividends or bond yields. Some of this is fear of further falls in rents in the damaged areas. Some is a reflection of the low levels of liquidity in owning property.
More investors are leaving property unit funds, with regulator encouragement, owing to the difficulty of getting out of them when the market is out of favour. The yields on warehouses have fallen a lot as investors have come to see how relatively-cheap they were – and how much scope there is for rental growth. If a regional office is around £15 a square foot and secondary shops still well above that, warehouses at £6-£7 a foot still seem good value, given the relative economic strength of the different business models.
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