Being a vital part of the economy, the commercial property market is intimately linked to people’s lifestyle and consumption patterns, all of which have seen a shift over the past year. But what does this change mean in practice and how does it affect bricks-and-mortar assets?
Allsop’s commercial valuation team has compiled a list of the top 5 most frequently asked questions to help businesses and investors better navigate the commercial property sector in the current climate.
How do you assess covenant strength in the current market?
The current crisis has highlighted the shortcomings of judging a tenants’ covenant strength by reviewing historical accounts data alone. Whilst the accounts of many of the retail casualties of late, like House of Fraser, did not paint a rosy picture prior to the current pandemic, few crystal balls would have predicted the total collapse of Topshop.
Valuers, property owners and those with a vested interest in real estate must consider live data such as share performance, pedestrian volume and flows, and level of competition as better performance indicators. Assessing the future sustainability of a business is key, particularly for those businesses with high overheads. Many tenants in the retail sector have signed up to expensive leases they can no longer afford, and for these businesses to survive, rents will need to be rebased. Re-gearing leases may provide a respectable solution for both the landlord and tenant.
Going forward, in certain sectors, covenant strength may be perceived as less important, particularly where occupation is flexible. In high street retail, for example, are we about to witness a shift towards shorter, more flexible leases and in the leisure sector, will turnover rents become the norm? Under both scenarios, a landlord is far less likely to be concerned with covenant strength as long as the market can demonstrate strong re-letting prospects, and the fact that the fundamental property characteristics are positive.
Are rental values spiralling downwards?
There is no single hard and fast rule. For one market that is seeing downward pressure on rents, there is another that is performing robustly. Each market and submarket needs to be considered in its own right.
Whilst the difficulties of high street retail are well publicised, rents have generally held up well for local neighbourhood retail owing to affordability, essential-type retailing and the many nearby chimney pots.
In the office and industrial markets, rents are a product of demand and supply. Whilst occupier demand in the office sector is, on the whole, more subdued than normal and greater incentives may currently be offered, this pandemic has made it fundamentally clear that the office is here to stay and is the bedrock for facilitating a strong brand/corporate identity, staff development, diversity of thought, and mental wellbeing. Many towns and cities still suffer a supply shortage owing to the conversion of much office accommodation into residential through Permitted Development rights over the last decade which has meant rents, and thereby values have held up reasonably well. Towns and cities, on the other hand, where supply exceeds demand, fare far worse.
In the industrial sector, there has been little new supply and heightened demand due to the increasing importance of logistics and last mile distribution driven by the growing importance of e-commerce. The sector is also moving away from the just-in-time model to just-in-case, increasing the need for space. This supply and demand imbalance has created significant upward pressure on rents in recent years, and the current development pipeline does not suggest these imbalances are to go away anytime soon.
Is it just the Beds & Sheds market that is performing robustly in the current climate?
The beds and sheds market (comprising residential and warehousing), has stolen the press headlines over the course of the pandemic and for good reason. However, there have been other robustly performing sectors.
‘Alternatives’, which include care homes, petrol stations, nurseries etc. have grown significantly over the past decade, benefiting from a weight of money due to investors seeking to balance their portfolios. Such properties generally provide long and often index-linked income, which is particularly attractive in the face of shortening commercial leases across most of the traditional asset classes. There has been no let up during the current pandemic, with £13.3 billion worth of ‘alternative’ property assets sold over the course of 2020 with an average NIY of sub 4.5%.
The supermarket / convenience store subsector has also remained strong being seen as a safe haven. Within this market, retail sales volumes have grown significantly over the last 12 months benefiting from a surge in demand for home deliveries but also from the ‘treat’ culture which has resulted in consumers spending more on higher-quality goods to enjoy at home. Unsurprisingly, this sector witnessed hardening yields over the course of the pandemic, with over £1.83Bn of supermarket assets traded in 2020 surpassing 2019 levels.
Central London trophy assets are still in demand. International investors remain attracted to such properties owing to a favourable exchange rate, rarity, but also due to London’s reputation for being a safe haven in comparison to other international cities. Over the second half of 2020, this market witnessed fierce competition, none more so exemplified by the Allsop-advised sale of 21 St James’s Square in December 2020 for £187.5M, reflecting a NIY of 3.65%. This property attracted substantial interest predominantly from ultra-high-net-worth families, following a global marketing campaign which resulted in two rounds of bids.
What lot sizes are most attractive / liquid and who are the buyers?
Liquidity has never been more important. With many institutional funds being gated and international travel being curtailed during the first six months of the pandemic, there was a pause in the market for the larger £20M+ assets. However, activity remained strong below this threshold, with property being seen as an asset providing credible investment returns against a backdrop of all-time low interest rates and falling dividend payments from over half of the FTSE 100 companies.
The private investor and small and medium-size property companies proved particularly active, with our auction teams witnessing strong demand throughout the pandemic, with £750M raised between our commercial and residential auction teams over the course of 2020.
From a commercial perspective, competition has been strongest for long income across all sectors, particularly where the rent has continued to be paid and is seen as sustainable. Mixed-use property and those with the opportunity to add value have also performed well, being seen as helping to spread risk and providing long-term advantage.
The activity disparity between the large and small lot sizes narrowed as we closed out 2020 with institutions, REITs and international buyers returning to the market in strong numbers. This provides hope that 2021 will be a much more balanced year from an investment perspective.
Is it fair that landlords are bearing the brunt of the pain resulting from the eviction moratorium?
It has been announced that the current moratorium on landlords’ ability to evict commercial property tenants will be extended to June 2021. The measure continues to leave landlords unable to enforce lease covenants and is hurting many property owners. With approximately 60% of the UK high street owned by pension funds, the public sector and individual investors, the loss of income affects the wider economy, including pensions, long-term savings and public sector services.
Whilst the moratorium was put in place to protect tenants and served as an important function at the outset of the crisis, it has provided tenants with a position of advantage, which some large national and international companies have abused by continually failing to meet lease obligations when they are in a position to do so.
Clearly, many tenants need support but if a business is not viable and can’t meet its rental obligations, should it be propped up? There is no right or wrong answer to this question. Whilst it has provided those tenants with viable businesses but short-term cash flow issues a safety net, a landlord is only likely to seek to evict a tenant when it perceives the business to have no longevity and where there are realistic re-letting prospects. The moratorium could end up hurting more people/businesses than necessary – those businesses that were on a path to failure are unlikely to move off this path, but we may well see landlords face serious financial difficulties if support continues to be one-sided.
