The future of real estate for business

6 July, 2020

Coping with Covid-19 has accelerated the pace of change in the way we use our spaces. Behavioural cycles that might have taken years to complete are taking months.

 

How we shop, how we work and how we interact has changed more in the last few months than the last five years. How is this affecting the real estate sector as we seek to recover from the pandemic? How do we think it will change real estate in the future?

 

Where we are now

The pandemic has rocked the foundations of real estate. Following a blow to the economy of this magnitude, real estate suffers a directly proportionate aftershock. We are now in full blown mitigation mode.

 

Rent is a problem shared

The relationship of landlord and tenant has been turned on its head. Tenants have stopped paying rent either because they can’t or they choose not to. The government-imposed moratoriums on lease terminations and winding-up petitions have taken away two of the few remedies landlords had at their disposal. All landlords can do is issue proceedings for rent arrears which is of little concern to troubled tenants who have far more pressing matters to deal with.

 

Many landlords have been quick to offer assistance. Such supportive behaviour is being actively encouraged by the government-endorsed Code of Practice for the Commercial Property Sector. Rental holidays and suspensions have become common place and never have insurance policies been pored over so forensically.

 

When the government classified Covid-19 as a notifiable disease, the insurance industry went into panic mode and both tenants and landlords made a dash for the filing cabinet to check the wording of their business interruption policies. It remains to be seen how that particular story plays out following the FCA‘s decision to bring a test case against some insurers who have refused the initial claims.

 

Reality will come flooding in

Furlough, business interruption loans, eviction and winding up holidays have propped up the economy but also created a cloud cuckoo land which gives us no clue as to the actual state of the market. Many owners and occupiers are simply hanging on.

 

In the June rent quarter in 2020, it is understood that only 38% of rent on commercial properties was collected. Less than 20% of retail tenants paid their rent in June and of the office tenants (of whom 75% paid their rent in March) only 53% paid in June.

 

A hard dose of reality will flood in come the Autumn when owners and occupiers will have stark conversations about the reality of their negotiating positions.

 

Retail hardship and what’s ahead

The retail industry has been described as going from a slow-motion car crash to a high speed pile up. Retail heavyweights such as John Lewis, Harrods and Arcadia have cut thousands of jobs.

 

Our insolvency regime may once again be used in dubious ways to carve out non-performing assets and renegotiate leases that were agreed in better times. CVAs and administrations are being used by operators to choose their best performing premises and lose the rest.

 

Some businesses will survive but in many cases the hardship is real and businesses will disappear. An example of what might happen to retailers is TM Lewin, recently acquired by Simba Sleep. All TM Lewin stores have been shut and the acquirers have kept the on-line business.

 

Retailers who are left will demand steeper rent cuts. Rental values will tumble to the point where some shopping centres may become attractive investments again but many will fall. The demise of Intu ought not to have happened – not yet anyway. It has some good assets but the business was over-stretched before the pandemic and lockdown was the final straw. Let us hope that Hammerson, with many excellent destination schemes, survives.

 

Some shopping centre owners are fast-tracking their plans to repurpose their centres. Nicholsons in Maidenhead is being converted into a mixed-use scheme (residential units surrounding a new town square, offices and numerous smaller retail units) which will be a welcome improvement on the existing 70s shopping centre.

 

Local authorities may take a leaf out of Stockton Council’s book and acquire shopping centres to regain autonomy of the town’s future. The government’s proposal to overhaul the planning system to facilitate the change of planning use will help with this.

 

The value of office space

The market is seeing the first signs of an incoming tide of office premises. Some premises have been abandoned by failing businesses. Other new offices, nearing fit-out, have no-one there to occupy them. Such developments have already swung the pendulum in favour of those looking for office space.  

 

How we return to the office depends on how we manage the virus over the next few months. One way routes, glass screens, desk spacing and team rotas will all play a part but some level of familiarity will return.

 

How then will we want to use our buildings? London office space could diminish in value as supply exceeds demand. Some businesses have already decided to close or down-size their London offices. These businesses realise their teams, now used to working remotely, can be trusted to be productive from home.

 

Confidence in future development

Developers are continuing to work up sites for a point of sale in 2-3 years’ time. In many areas, developers still have confidence that the market will return by the time the site is complete. However, many sites are being put on ice until confidence returns and many developers are seeking to postpone the day on which they have to incur a major financial outlay.

 

The rise of alternative lenders

Alternative lenders are busy offering property investors and developers alternative rates where traditional lenders have pulled the plug following a series of downward valuations and further restrictions on lending.

 

The ‘next normal’: real estate’s response to behavioural change

Our behaviour has been transformed by the lockdown and ongoing concerns about Covid. By staying at home, much of our built environment has been rendered surplus to requirements. Work-life balance has shifted to the top of the agenda and many people have realised that they want more choice over how they spend their days.

 

Whilst we will return to some level of normality, how will we want to use our homes, offices, leisure and high street spaces once the economic shock subsides?

 

Real estate as an experience

Many highs streets and shopping centres will need repurposing to become destination experiences. For retail, in particular, the experience of window-shopping may be key. The Ali Baba ‘New Retail’ stores could be a model of the future – a seamless convergence of offline and online retail where the customer browses an ‘experiential’ store, selects what they want on the app and gets their goods delivered later that day.

 

Office occupiers will also need to work out what sort of space they need and landlords will need to deliver. What type of space will returning workers be looking for when they no longer wish to come into the office every day? It will be different for everyone and offices will need to adapt to accommodate.

 

Flexible space underpinned by stable technology

The future is about how we flex between office and home. Lease flexibility will be key and connectivity will be essential. Interactive and video-conferencing tools will connect office and home workers. Customers and clients will no longer require physical meetings. Tech stability will be everything.

 

Many CEOs and MDs will now be considering how to reduce their property overheads. This could have significant implications for the London office market where real estate is so much more expensive than elsewhere.

 

National businesses might reduce overheads by moving to a smaller London ‘hub’ office with a collection of regional ‘spoke’ offices for teams to use as required. Why would clients pay London rates when businesses don’t need to occupy London space?  What becomes of London weighting when employees cut their commute to the London office?

 

Collective action for a resilient real estate sector

Real estate will adapt and survive. But the sector has taken a battering like so many others and it needs to come up with a rapid response. The sector is not known for its appetite for rapid change. It was already behind others in its adoption of technology even before the pandemic. Its slow reaction to the on-line retail sector speaks for itself.

 

However, there is a strong case for arguing that the consequences of the pandemic will galvanize the industry into collective action. With the help of a supportive planning regime, public and private collaboration, and a clearer sense of urgency, the industry can take advantage of this era of rapid change and resolve to fix what have been drawn out problems.

 

In the meantime, the world still has faith in the UK property market. Foreign investors continue to make big investments into UK property companies who appear to be undervalued. Developers are still working up schemes with a view to bringing back the construction pipeline and in the expectation of a shortage of office and housing supply in a few years.

 

There are reasons to be positive but we must make this bright future happen – it won’t come to us.