The future of commercial real estate after Covid-19

Yesterday, RICS chaired an interesting panel webinar regarding the impact of Covid-19 on commercial real estate. 

Whilst China’s initial economic recovery as it comes out of lockdown is a positive indicator, the panel were broadly sceptical of a V-shaped economic recovery in the UK: the longer the current situation lasts, the greater the likelihood of a prolonged U-shaped downturn, with Simon Rubinsohn of RICS considering that the level of the UK’s economic output would only return to early 2020 levels by early 2022. 

As Walter Boettcher of Colliers noted, this is reflected by the markets not being significantly impacted by the various government responses around the globe (however large). The markets are instead waiting for news on developments with the virus. 

Kathleen Fontana of MITIE noted that the UK government was slow to respond to Covid-19 initially, with some organisations making decisions about their workforce and transactions before the government started to act. Nevertheless, Peter Cosmetatos of CREFC Europe flagged that there may be unintended consequences to hasty government policies. 

For example, Peter Cosmetatos noted that the government’s three month moratorium on forfeiture for non payment of rents (summarised in this Macfarlanes article) encouraged a lot of tenants not to pay their March quarter’s rents, even where they were in a financial position to do so. Without rental income, landlords are finding it difficult to service their debt. The PRA has written to the CEOs of UK banks, to encourage flexibility where borrowers were clearly viable before Covid-19 and to provide helpful guidance on lenders’ regulatory capital requirements. However, whilst banks may be able to avoid testing financial covenants until the crisis abates, funds (who provide around 10-12% of commercial real estate finance) do not necessarily have this luxury, especially where the funds are themselves leveraged or are coming to the end of their life. The more complex, risky property assets against which funds lend are exactly the type of assets that more conventional lending institutions tend to avoid and would be difficult to refinance in this market. Peter Cosmetatos considered that the forfeiture moratorium could therefore cause a major issue in the real estate finance sector in the near future. 

In the longer term, the panel discussed how the current level of government spending could result in HS2 being scrapped, despite the importance of regional connectivity, and there was also a concern about the government’s lack of focus on the looming Brexit date. 

Howard Meaney of UBS Asset Management noted that the effect of Covid-19 on the commercial real estate market needs to be considered on a sector-by-sector basis: 

1. Retail is particularly struggling, as shown by recent CVAs and significant furloughing. Whilst supermarkets, game console sellers and pet retailers may be bucking the trend, Howard Meaney highlighted that Boots saw an 8% decline in sales in March despite being “essential”, and that luxury retail is not immune either given its dependence on global tourism. This could see high streets being decimated, but Simon Rubinsohn considered that in the future this could create an opportunity to repurpose space in urban centres as affordable housing, with a shift from retail to residential. 
2. The hospitality industry has had to close completely and recovery will only be seen when the current lockdown is lifted. As Howard Meaney flagged, this sector employs around 9% of the workforce and is the third greatest contributor to the economy, so most balanced property funds are exposed to the difficulties in this area. 
3. Rental revenue from offices does not appear to have been impacted in the short term, as most tenants have disaster recovery protocols and allow for working from home. Kathleen Fontana was keen to emphasise that, in the longer term, “the death of the office” has been greatly exaggerated, but there may be increased flexible working and the productivity of buildings may be scrutinised more rigorously in the future. The serviced offices sector, on the other hand, has been stressed in the extreme, and WeWork is now trading at approximately 35% of its previous level. 
4. Student accommodation will suffer due to the closure of universities next term, with many providers looking to refund rent to students. The length of the current crisis could also impact how many students (especially if international) take up their places in September or instead look to defer for a year.

Overall, it is clear that Covid-19 is currently having a major impact on the commercial real estate industry, and it will be interesting to see how the various sectors recover in the long term. However, whilst some business models may not transition effectively, the panel considered that the market, once recovered, may become an even more solid platform for sustainable growth going forward.