Join our community of smart investors

Boom and doom: which corners of the property market will flourish in 2021?

Logistics companies have thrived in 2020, but other areas of the property market may offer more value next year
December 18, 2020
  • The pandemic has accelerated the polarisation of the commercial property market
  • Home working during the pandemic has prompted some employers to rethink their working arrangements

Just a day after warehouse provider Segro (SGRO) revealed it had splashed more than £600m of recently-raised funds on acquisitions and land earlier this year, beleaguered retail landlord Hammerson (HMSO) unveiled its own plans to tap the market. Yet expansion was not the motivation behind the latter capital-raising, but emergency efforts to bolster the balance sheet. 

Both provide perfect illustrations of how the pandemic has accelerated the polarisation of the commercial property market. While the two government lockdowns naturally disrupted the operations of some industries more than others, they also highlighted the existing fragility of some businesses. 

Unsurprisingly, those letting space to retail and leisure operators – already blighted by rising company voluntary arrangements (CVA) and administrations – have suffered the highest shortfalls in rent payments over the last three quarters. Even 60 days after the September rent collection day, retail landlords had suffered an average shortfall of 28 per cent of the amount due, according to data from property management platform Re-Leased. That was higher than the 21 per cent loss recorded by office and industrial landlords during the final quarter of this year. 

While the acceleration towards ecommerce and enforced closure of non-essential stores has heaped pressure on bricks-and-mortar retailers, the moratorium on evicting tenants over non-payment of rent has also weighed on rent collection rates. That moratorium was extended to 31 March 2021 earlier this month, which could mean some occupiers will soon not have paid rent for up to a year. 

The blanket extension will create a cliff-edge on 1 April, according to Alison Hardy, partner at law firm Ashurst, when legal disputes between landlords and tenants are expected to rise. It is also unclear whether the final extension of the protections for tenants will delay the wave of CVAs that the law firm is expecting to see in the new year, she says. “In the meantime, we can expect to see more landlords drawing down on rent deposits, recovering monies from guarantors and clogging up the courts with debt actions,” says Ms Hardy. 

Shares in the UK’s major retail and leisure landlords including Hammerson, Capital and Counties (CAPC) and Shaftesbury (SHB) trade at sharp discounts to the last reported net asset value (NAV) of each of the respective groups, an indication that the value of the underlying assets is expected to fall dramatically. That judgement seems accurate. In September, shopping centres and high-street retail property values were approaching the levels they fell to during the aftermath of the 2008 financial crisis, according to data from Savills and are considerably below their five-year averages. 

The bleak outlook for retail rental income streams has led some landlords to explore redeveloping properties to serve another use. For property groups such as NewRiver Reit (NRR), that has included residential development. However, the challenge is finding opportunities where it stacks up to redevelop something into a profitable alternative use, says William Matthews, head of commercial research at Knight Frank. “Those opportunities aren’t that numerous really,” he says. That is partly because the least attractive retail space can often be in towns where there is high unemployment, which can make the locations unattractive for other uses too, Mr Matthews adds.

 

Logistics leads the way

Yet the loss of those letting properties on the high street has been to the gain of logistics landlords. The acceleration of the trend towards ecommerce during lockdown meant UK-listed landlords such as LondonMetric (LMP) and Warehouse Reit (WHR) continued to let space above estimated rental values and grow underlying rental income. 

Rising rental income across the sector has defied some expectations. “At the start of the year we were expecting a material slowdown in rental growth,” says Andrea Ferranti, head of industrials and logistics research at Colliers International. That was led by fears of a downturn in household consumption. 

Yet the pandemic has intensified a desire among companies to strengthen their supply chains, says Mr Ferranti, which has also been prompted by efforts to prevent disruption when new customs checks are brought in after Brexit. “A lot of supply has been absorbed quite aggressively by occupiers,” observes Mr Ferranti. He now expects average rental growth across the logistics sector to accelerate in 2021. In fact, standard industrial space and distribution warehouses are forecast to record the highest increases in rental value over the next four years, according to Colliers International, at a compound annual growth rate of 2.3 per cent and 1.7 per cent, respectively. However, others argue that growth may be more discriminate in future and focused on areas where land supply is at its shortest, notably in London and the south-east. “I think we’ve probably had the big structural adjustment so here on in it comes down to a year-on-year supply/demand balance,” says Mr Matthews.  

The resilience of rental income has made logistics landlords such as LondonMetric and Segro part of the exclusive group of real estate companies to raise their dividend payouts in the face of the pandemic. That is a club that also counts medical centre landlords Assura (AGR) and Primary Healthcare Properties (PHP) and social housing provider Civitas (CSH) as members. Rent collection for these property owners has been undisturbed by the pandemic. With UK gilt yields at historic lows and the pace of economic recovery uncertain, the prospect of rising dividends is likely to continue driving up the market valuations of these groups next year. 

 

Searching for value in uncertainty

The outlook for the office sector is more difficult to place. Rent collection levels and asset valuations have been largely stable. Yet the home working experiment necessitated by the pandemic has already prompted some employers to rethink their working arrangements. That has sparked concerns of a downturn in demand for space and fall in rents. 

According to research carried out by Colliers International, occupiers are broadly considering a reduction of between 10 and 15 per cent in their overall space requirement, says Guy Grantham, director of research and forecasting at the real estate services group. “There’s an awful lot of space now swimming around on the market,” says Mr Grantham. “A lot of it doesn’t differentiate from the building next door or across the road.” 

However, what those in the industry expect is most likely to emerge is a three-tier market – newly developed space, good quality second-hand offices and older space. Surplus space is concentrated on the latter, Mr Grantham says, as there is still a sharp shortage of newly developed offices in London. 

That is a fact not missed by overseas investors, who are taking an increased interest in the City of London’s offices. “When you factor in currency and factor in the cost of buildings around Europe, which are in many cases a lot more expensive than in London, then you do start to see a value case,” says Mr Matthews. 

That is a cue that retail investors would do well to heed next year. Shares in quality office landlords such as Helical (HLCL) and Derwent London (DLN) trade at sizeable discounts to NAV. Given the ultra-prime location of their offices, broadly stable asset valuations and solid balance sheets, that looks to be an overly harsh judgement of their prospects by the market. Investors are likely to have to pay a high premium for exposure to safer returns from popular logistics stocks, but those willing to stomach greater risk may find more compelling value within the office sector.

 

 

% rent collected (by day 60)

   
 Dec qtr 2019Mar qtr 2020Jun qtr 2020Sep qtr 2020
All commercial84676875
Retail84596072
Office 81747679
Industrial90747579