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Property investment – a move to flexible working spaces

Property investment – a move to flexible working spaces

Richard
Richard Shepherd-Cross, Managing Director of Custodian Capital Limited and Investment Manager to Custodian REIT.

On the day Custodian REIT released its highlights for the period 1 July to 30 September 2020, Richard Shepherd-Cross, Investment Manager comments on the commercial property market:

Investment activity is increasing and appears to be tracking the emerging picture of forecast occupier demand. There is confidence in the industrial and logistics market where record investment volumes have been matched by record occupational demand for warehouse space. This occupational demand, driven by the continued growth of e-commerce and onshoring of supply chains, combined with low vacancy rates has led to the continuation of rental growth. Much of the investment capital that might have been focused on the office or retail sectors has been redirected to industrial and logistics. We see continued opportunity in this sector as the UK has yet to build a sufficient logistics network to support the continued growth in e-commerce.

Despite widespread remote working and the resulting low utilisation of offices across the country we expect recognition from occupiers of the social and well-being impact of returning to offices in some meaningful way, post the COVID-19 pandemic. Office owners must invest in their existing buildings to create flexible working spaces which may result in greater space requirements per head but perhaps for fewer workers. Offices allow space for organisational productivity, rather than individual productivity which may prove better when delivered working remotely either from home or smaller satellite offices. The lettings market has already seen an increase in enquiries in satellite office locations reflecting this trend which could be positive for Custodian REIT’s portfolio of small regional offices, acknowledging that forecasting office demand is currently subject to significant uncertainty.

The retail market has borne the brunt of the impact of lockdown with a huge reduction in footfall and consumers switching to online retailing instead. The COVID-19 pandemic disruption has accelerated trends that were already embedded in retailing when online retail already made up almost 20% of all UK retail sales, namely an oversupply of shops, downward pressure on rents and a rise in the number of retailers failing.

ONS data indicates online retail sales reached 32.8% in May 2020 during the national lockdown compared to 18.8% in May 2019¹. As lockdown was eased in the summer, so people returned to the shops and online sales dipped, which is a positive signal for physical retail. While online sales will remain an important part of retailers’ strategies, the physical shop is not yet dead. This physical presence is particularly relevant for prime city centre locations where retailers benefit from high footfall promoting brand awareness and enabling ‘showrooming’. We also believe the physical shop will survive in convenience-led, out of town locations, especially for goods which are less likely to be bought online: DIY, furniture, homewares, and discount brands. We expect Custodian REIT’ strategy of a low weighting to high street retail and a greater focus on out-of-town retail, let at affordable rents, will position the portfolio well to pick up as and when consumers can return to the shops with confidence.

There remains a risk to the collection of deferred rent or rents arrears due from tenants adversely affected by the COVID-19 pandemic. This rental risk continues to have an impact on property valuations but as deferred rents start to be recovered, as indeed they are, this risk adjustment applied to rents within valuations will diminish.

We believe that as we see increasing confidence in the collection of contractually deferred rents and once landlords can formally pursue non-payers, positive sentiment towards the income credentials of commercial real estate investment is likely to return. In a low return environment, where dividends are under pressure across all investment markets, we believe that property returns will look attractive and the search for income and long-term capital security will bring many investors back to real estate. However, if we see an acceleration in tenant failures as Government support packages are withdrawn and while Company Voluntary Arrangements (“CVAs”) remain legitimate practice, this could work against the prospects for real estate.

You can read the full statement here.

¹ https://www.ons.gov.uk/businessindustryandtrade/retailindustry/timeseries/j4mc/drsi