How good an asset is commercial property?
John Redwood, chief global strategist for Charles Stanley
Prior to the pandemic hitting, the prospects for property investment looked good. The income available on putting your money into good quality offices or warehouses was generous compared to the income on shares or bonds. In the UK most tenancy agreements were based around regular upwards only rent reviews, typically after five years, allowing for the income to at least keep up with general inflation.
Whilst it has been true for some time there were question marks over a lot of retail property especially in town centres, as too many shops chased too few shoppers, people were still attracted to shop investment in high footfall areas like airports, train stations and the best big city centres.
Today, the quoted yields on commercial property still make the case for investment. When you can get less than 1% on a typical UK government bond, and under 2% on world shares, prime UK property yields are said to be around 5% for offices and 4.5% for industrials, with retail yields now considerably higher.
If you thought current rent levels were likely to continue, these would indeed be attractive returns to secure by your investment. It seems more likely, however, that rent levels will decline in a number of types of property and places.
The premium locations at travel hubs are currently very out of favour as tourism and commuting have collapsed and no-one is sure what levels will resume when the pandemic subsides. Hotels and leisure businesses are not sure what a new normal level of demand will be after lockdowns ease. Owners of student accommodation worry lest new generations of students choose the option of going to a university they can access from their parents’ homes, or they can mainly attend online.
The news remains poor about rent collection levels in many High Streets and elsewhere around the commercial property estate in the UK. Freed of an immediate legal challenge from landlords many tenants are seeking an early review of their rent levels and withholding payment in the meantime.
In the retail sector, many tenants fancy the idea of a turnover related rent where they only pay when they are doing business. Some have renegotiated zero rents, others turnover rents in the range 2% to 12% of turnover depending on location and prospects.
In distressed areas, landlords may be forced into accepting a zero rent, so the tenant pays the business rates and other charges which would fall to the owner if the property stood empty. So far office rents have held up better. Many companies are still trading close to the pre-pandemic levels, but doing so with most of the staff working from home. Large City centre offices sit empty, but the tenants still honour their obligations and consider some return in due course to more office working.
The longer the absence from offices continues, the more doubts there must be over what future work patterns will be like and what kind of office space companies will want. It is currently fashionable thinking to say the pandemic has given a one-off boost to trends that were growing before the crisis. Employees want more flexibility between working hours, family hours and leisure hours. Many think they want to work a few days a week in the office and from home the rest of the time. Employers are often coming to the same conclusion. Some do so because the bosses too, fancy the mixed week. Others do so because it looks as if the talent they need will be more choosy about hours and location of work.
So what is the office for? The new answer is for collaborative time. It is the place to go when you do need to work as a team, brainstorm new ideas or work closely with a colleague on a difficult task or project. It is also the place you might go to meet clients and suppliers, put on events and supervise the technology that drives both office and homeworking.
If this does emerge as a common model it seems likely firms will want less total office space in city centres and will need better home and office linked technology. It may also continue the flowering of the suburbs and more rural areas beyond the cities, as employees buy more property with better surroundings for a lower price than the centre city and as firms put in satellite offices with access to the local river, hotel and restaurants for some of the collaborative working.
All this implies a big work out to settle new values for office property. It also probably means a substantial landlord and tenant investment in new fitting out of office spaces with less emphasis on everyone having their own 5 days a week workspace and more emphasis on team areas and meeting rooms. This, of course, can only be the way forward once the virus is tamed, as Covid-19 drills currently militate against hot-desking and shared technology.
We have been urging caution on property other than logistics and technology space for some time. The property experts are slow to form a new view of what the market will look like or how pricing will develop, and many funds have been locked owing to an absence of reliable valuations, Residential property has emerged from the crisis well bid, as the stamp duty holiday has combined with the wish of some to buy more space outside the cities and congested areas.
Property should be an ideal asset for long term funds, offering steady growth in income and providing a relatively stable capital value outside bad recessions. Today we still await the impact of the Great Reset on relative values. It is also likely that there will be increasing pressure on landlords to green their buildings, as businesses demand ever-higher standards of insulation, air quality and flows and low carbon counts on the heating and cooling systems deployed. The building a business uses is always a statement about it. More will now be wanting to make statements in stone that show their attentiveness to the green imperatives, and to the social awareness employers now need to demonstrate. These are all property costs as well as uncertainties which mean we still do not know what future rents and returns will look like on much of the stock which has taken a bit hit from the pandemic.