By Michael Morris, chief executive, Picton Property Income
All things considered, many sectors within real estate have held up quite well over the past 12 months, despite the impact of the pandemic.
This view is reflected in the latest figures from MSCI’s UK property index, which show how the various sectors of the property market have performed over any given period.
While values overall are only down 5 percent since February last year, industrial was actually up 5 percent and offices were down 6 percent; the sting in the tail was in retail, where values were, unsurprisingly, down 16 percent.
These figures demonstrate why owning the right sort of real estate has never been more important. As we look ahead to what may characterise the market, four key themes emerge.
One of the key attractions of real estate as an asset class is the recurring income it provides to investors. Lockdown has tested this quality to the extreme; however, not all assets are created equally and there are big differences in the stability of income across the various sectors.
For example, retail and leisure have been particularly hard hit, but ‘meds’, ‘sheds’ and supermarkets have weathered the storm relatively unscathed. While a boarded-up Sainsbury’s in EC1 is probably a better reflection of the office-based nature of its customers, the supermarket sector as a whole has thrived over the past 12 months and rent collection has been stable as a result.
Despite many offices currently running on skeleton staff, many occupier businesses have found innovative ways to continue operating remotely while they wait for lockdown restrictions to ease.
This ability to innovate, combined with the unprecedented level of Government support many occupiers have received, has given landlords the confidence to agree payment plans, deferrals or relatively short rent holidays.
By partnering with their occupiers in this way, providing support to help them through the pandemic, it is highly likely that the underlying businesses will survive and be able to continue generating recurring rental income into the future.
Assuming the lockdown exit roadmap is followed, business cashflow should improve and, as a result, UK real estate will retain its reputation for providing investors with stable, dependable income.
Right asset quality
The key to generating recurring income is owning the right assets, which means buildings that occupiers and their employees want to work in.
Assets in the industrial sector are currently popular with investors, although supply is tight. Relatively basic in structure and simple to develop, selecting an investable asset is down to a combination of location, road connectivity, access, and security.
For the office sector, working from home is likely to dent demand in the short-term, but not forever, albeit the dynamics of future occupier requirements will probably change. For example, businesses that decide to move will be more likely to want to upgrade space in order to attract their employees back to the workplace.
Poor quality space will remain difficult to lease. Similarly, within retail, there is currently just too much supply. When there is too much choice for occupiers, rents remain under pressure. Even good quality retail units are going to struggle, which means income from large parts of the retail sector will be at risk for some time.
As occupiers become more aware of their carbon footprint, there is going to be increased focus on developing not just energy efficient buildings but also buildings which promote wellbeing. This is likely to lead to greater demand for better quality assets at the higher or newer end of the market, where sustainability can be incorporated into buildings and leases.
This is another attractive feature of real estate. Its ability to reinvent itself.
Historically there are some great examples. The whole of Canary Wharf was transformed from thriving docks to a major financial centre within 100 years; Oxford Prison is now a hotel; The Millennium Dome was rebranded to become the 02 Arena and the former BBC White City complex has been converted into offices and residential.
Not all real estate today is fit for purpose, though. With so many vacant shops and restaurants, and not enough good quality offices, new uses for some of this real estate will need to be found. While this trend may have been exacerbated by Covid-19, it is a natural process of obsolescence that has always occurred at all levels in the market.
At the smaller end of the scale, over the last few years we have obtained planning permission and successfully converted a number of properties, turning:
- offices into an Aldi supermarket with associated housing;
- a former Homebase, into a Lidl supermarket; and
- a warehouse into a gym.
We are currently onsite in Birmingham converting a former restaurant complex into warehouse offices overlooking the canal basin. This is the fourth known change of use at this location: 40 years ago, it was the Rum Runner Club (for anyone who is a fan of 1980s music culture) and 100 years ago it was an industrial site.
This shows that providing you own the right type of real estate in a good location, buildings or even space within buildings can nearly always be successfully repositioned.
Repositioning has also been facilitated by recent changes in planning law that have come into force during the last 12 months. This Class E provision allows certain buildings to be more easily repositioned between retail, office and residential uses.
Knowing the residual value of a property is critical before a decision can be taken to undertake any repositioning work. If the alternative use doesn’t stack up financially, it won’t make it to the next stage, and this is one of the reasons why values have fallen so much in the retail sector. Ensuring your assets are correctly valued to reflect current market conditions is key.
The property market is never static. It continually evolves in response to a range of factors including supply and demand and fluctuations in the economic cycle.
It is clear that for the next few years, we are in for a period of change as the market adjusts to the longer-term impact of Covid-19; however, if investors stick to some of the fundamentals outlined above, there are likely to be many opportunities to build strong, resilient portfolios of assets with good long-term potential.