The future of commercial property post-Covid
- The pandemic has brought real challenges for commercial tenants and landlords
- Strong asset allocation, prudent negotiation with tenants and strategic portfolio shifts have helped mitigate the impact of the crisis
- From here, the portfolio is geared into a number of long-term structural changes
This has been a difficult time for many companies with rent one of their largest and most important expenses. It has also been a tough time for commercial landlords. Many have had to negotiate with tenants to help them through a period of significant distress and, in some cases, rental income has had to be waived or deferred.
However, the Covid-19 crisis has also brought opportunities – a motivation for some tenants to speak to landlords for short-term cashflow help and so the chance for landlords to help in return for longer term benefits such as the extension of leases – often a win-win for landlord and tenant. For investment, the acceleration of a number of structural market changes has insulated and often enhanced prospects, for instance increased online sales in retail benefitting industrial and logistics exposure. Whilst the potential is there for more compelling pricing for commercial property assets, discounts are currently more prevalent in the retail market which, for much of the sector, for example shopping centres, is fraught with risk around tenant solvency and negative rental growth. On the UK Commercial Property REIT, we have sought to mitigate tenants’ cashflow difficulties in the short-term, and have for many years been reducing our holdings in retail whilst increasing exposure to industrial and logistics to strengthen the portfolio.
The Covid-19 outbreak has accelerated a number of structural changes that were already underway across the retail, industrial and office sectors. The structural decline of high street and shopping centre retail, for example, is a well-established trend, but lockdowns have seen consumers move to online shopping faster – internet retail penetration spiked to 30% during lockdown, from below 20% at the start of the year. Online spending has reached its targets far earlier than had been predicted. It is clear that there is far too much retail space, with demand increasing for well-located industrial and logistics space.
We saw the way the world was moving in 2015 and took the decision to move away from retail and into areas such as logistics or warehousing, particularly warehousing that facilitated shorter delivery times for e-commerce. As a result, we currently have only around 19% in traditional retail assets whilst over half (54%) of our portfolio is in the industrial and logistics sector, which provides greater stability of income and capital.
With such negative unemployment and economic forecasts stretching into 2021, permanent loss of UK productivity means we believe there is considerable risk around many sectors of the market – retail and central London offices in particular.
The working from home revolution
Covid-19 is likely to have significant repercussions for the office market as well. Do companies need such large offices in the centre of big cities if many of their staff are working from home two or three days per week? We would resist the temptation to see a wholesale change – not everyone will work at home and indeed many staff will be keen to return to an office for the collaborative and social aspects of that environment, but not a long London commute five days a week. Looking beyond the virus, we expect yet more structural changes to the ways businesses and employees wish to use office space after the largely successful experiment of working from home. Many outcomes and working models have been put forward but it seems clear that demand will be different and with it the risk of surplus space and negative rental growth. This is particularly true in London where we sold our sole City of London office this year.
In a world where we foresee persistent low interest rates and low inflation in the UK, the income return from property is interesting but it will be more important than ever to find areas of structural growth and sustainable income, weighting the portfolio to those areas.
Asset management and ESG
Much good asset management is about the relationships we have with our tenants and taking the time to understand them. For many, Covid-19 has brought cashflow pressures to their business which has focused tenants’ minds on their rent, lease and property. This has enabled us to increase our dialogue with our tenants, helping to navigate this crisis more effectively. Our rent collection statistics have been reasonably strong at 77% and 74% to date across the April to June and July to September rent payment quarters. We spend time talking to tenants with cashflow issues to understand their accounts and situation and for many can help by simply moving from a ‘quarterly in advance’ rent payment to a monthly payment. For others where there is greater distress, we have negotiated individual agreements. For example, we may have created a rent-free period for six months, with either a period of enhanced rental payment afterwards to repay the missed payments, or the extension of the duration of a lease to improve our future cashflow and current asset value – this has worked for our tenants, but also preserved the long-term cash flow of the Trust.
Many of our industrial properties are multi-let. This means that they offer more opportunity to change the tenant mix and shift usage according to demand. Commercial property is not readily bought and sold and as such, it is not always easy to change the make-up of a portfolio at times of crisis. Multi-let buildings give us more optionality and can help weather difficult conditions, as well as providing diversity of income to reduce risk.
Asset management is about enhancing the assets we hold to maximise their appeal to high quality tenants. From an ESG perspective we recently published a paper, ‘Dialing up the Integration of ESG’ which brings to life the achievements we made in 2019 on sustainability and reporting. It also states our future commitments, from net zero portfolio emissions by 2050 to a two year study on the societal value generated by our investment activities. Not only is this a good thing to do, but it is increasingly at the forefront of the minds of potential tenants and investors seeking durable income into the future.
The portfolio today
We currently have capital of around £194m available to invest. Being structured as an investment trust means that we don’t have to sell assets to provide shareholder liquidity. Our shares have good liquidity on the stock market, and instead we can capitalise on any distressed pricing in the market.
Our portfolio today is strongly tilted towards the resilient industrial/logistics market at 54% exposure but remains diversified by geography, tenant, and sector. Importantly, we believe the Trust is well equipped for the future with a strong balance sheet, capital available to deploy at the right time, and very low gearing currently.
Risk factors you should consider prior to investing:
- The value of investments and the income from them can fall and investors may get back less than the amount invested.
- Past performance is not a guide to future results.
- Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
- The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
- There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
- As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
- Property values are a matter of the valuers’ opinions and can go up and down. There is no guarantee that property values, or rental income from them, will increase so you may not get back the full amount invested.
- Property investments can take significantly longer to buy and sell than other investments, such as bonds and company shares. If properties have to be sold quickly this could result in lower prices being obtained for them.
- The Company invests in a specialist sector and it will not perform in line with funds that have a broader investment policy.
- Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.