Warehouses versus offices

What’s next for commercial property as restrictions lift?

warehouse factory commercial logistics property

Warehouses and distribution centres have soared over the past year with the AIC’s Property – UK Logistics sector up 56% versus 22% for the Property – UK Commercial sector.1 Logistics property has played a critical role in enabling lockdown living, but with restrictions being lifted should investors continue to back the online boom or are there opportunities in retail and offices which now look attractive?                                                               

The Association of Investment Companies (AIC) has spoken to property managers about the prospects for warehouse properties versus wider commercial property, the investment outlook for shops and offices, and the suspensions of open-ended property funds.

Annabel Brodie-Smith, Communications Director of the Association of Investment Companies (AIC), said: “The strong performance of logistics investment companies over the past year reflects the crucial role e-commerce has played during the pandemic. Whilst investment companies investing in retail and offices have had a more difficult time, things are looking up with the reopening of retail and a gradual return to the office.

“Despite the challenges of the past year which have had an impact on some share prices, investment companies’ closed-ended structure has allowed investors to buy and sell their shares freely. In contrast, the major open-ended property funds were suspended for most of last year and some are yet to open. Investment companies provide a suitable structure for investors to access a wide range of property from Amazon-style warehouses to accommodation for the homeless.”

Future of logistics – shift to online “inevitable”

Richard Moffitt, Chief Executive Officer of Urban Logistics REIT, said: “We have seen unprecedented growth in the structural adaptation to e-commerce with it providing 50% of all retail sales in June 2020. It is inevitable that this structural shift will continue. All of our warehouses, bar three which closed for a few days at the beginning of lockdown, remained operational during the pandemic. We have received 100% of our rents for the last six months which is a good reflection of the importance of logistics buildings and the sectors our tenants operate in.”

Andrew Bird, Managing Director of Tilstone Partners Limited, investment adviser to Warehouse REIT, said: “Knight Frank Research estimate that the continuing online market penetration will generate demand for an additional 92 million square feet of warehouse space in the UK before the end of 2024. However, supply remains very constrained with the report estimating there is currently only 10 months of available stock. This acute shortage of supply will continue to drive rents from their historic low base (with Warehouse REIT’s prevailing average rent of just £5.50 per square foot). This will ensure the sector continues to outperform throughout the medium term.”

Logistics versus wider commercial property

Richard Shepherd-Cross, Managing Director of Custodian Capital and manager of Custodian REIT, said: “Logistics real estate has been a standout performer over the last few years. There continues to be latent rental growth in portfolios, as the sector meets a new benchmark level. However, all of that rental growth and perhaps too much hope appear to be priced into the market at present. It is no longer the case, as perhaps it was two to three years ago, that investment in logistics is the easy choice.

“I think we need to look more widely to identify value. Correctly priced, out-of-town retail can be a very defensive investment. It is possible to secure large land holdings, close to town centres, with properties let to substantial tenants, paying market rents, at close to double the initial yield of prime logistics assets. Regional offices with strong ESG credentials in cities where highly skilled staff want to live, should remain in strong occupier demand. Again, initial yields offer a significant boost to income compared to prime logistics, and occupier demand should support rental growth to enhance returns over the medium term.”

Richard Moffitt, Chief Executive Officer of Urban Logistics REIT, said: “It feels to me like the traditional real estate cycle is being distorted by this structural shift into e-commerce. The yield compression for bond-type income has been evident, but 78% of our total return has come from asset management not market movement since IPO – we believe the ability of our team to deliver these solutions will underpin future performance. Beds and sheds seem to be the anointed sectors currently but it is more complicated than just buying into the sector. The bond proxy income in any sector simply rises and falls with bond yields and managers don’t have the opportunity to add value in the same way as we do in this sub-sector of the logistics market.”

Prospects for retail and offices very positive

Richard Shepherd-Cross, Managing Director of Custodian Capital and manager of Custodian REIT, said: “The queues outside shops on the day that non-essential retail opened and the popularity of a return to pubs in city centre streets tell us that retail and leisure will continue to draw the crowds. If centres can create footfall, this paints an optimistic picture for high street retail. However, as shops form only part of the customer delivery story, with online sales picking up a share, then we must expect rents to reflect at least some of that lost market share.”

Matthew Howard, Director Property Funds, BMO Commercial Property Trust, said: “The prospects for the retail and office sectors are, in our view, very positive and we’ve seen a clear desire from tenants to move back into these shared spaces once restrictions are eased. We also have a strong conviction the leisure and food and beverage sectors will bounce back quickly and we take great encouragement from that. Since reopening on 12 April 2021, our flagship St Christopher’s Place Estate in London has already seen approximately 70% footfall compared to April 2019, even with ongoing restrictions.”

Out-of-town retail is here to stay

Richard Shepherd-Cross, Managing Director of Custodian Capital and manager of Custodian REIT, said: “Many essential retailers in out-of-town retail parks prospered through lockdown. Food, discounters and DIY all traded strongly. Much of what consumers enjoyed about out-of-town shopping: convenience, free parking, click and collect and easy returns, will be every bit as valid as the economy unlocks and can be complementary to online shopping. However, rental levels will be in sharp focus for occupiers and some of the rental inflation driven by successive consumer booms will need to reverse.”

The future of the office

Matthew Howard, Director Property Funds, BMO Commercial Property Trust, said: “Whilst the office sector is not without challenges, trends like hot desking and flexible working are nothing new and offices have been adapting their spaces accordingly for a number of years. Although there will be more flexible working arrangements moving forward, we still expect the majority of office space to return to near pre-pandemic levels of occupancy during the middle part of the week, plus a greater need from occupiers for more collaboration areas and meeting pods for video conferencing.”

Richard Shepherd-Cross, Managing Director of Custodian Capital and manager of Custodian REIT, said: “No doubt we will see an increase in flexible working, which has been on the rise for a decade, but has now been proved to be both possible and productive. This does not sound the death knell for offices, in fact it makes a good case for having offices, but the occupiers’ priorities will have subtly changed. Rather than simply negotiating rental levels and lease terms, other factors will come to the fore: flexibility of space; flexibility of lease term; environmental performance of the building, from enhanced ventilation through to green energy and low emissions; sustainability of location, access to public transport links; and an acknowledgement that the space must accommodate staff who will combine office time with remote working.”

Suspensions of open-ended property funds

Richard Shepherd-Cross, Managing Director of Custodian Capital and manager of Custodian REIT, said: “Perhaps more important than what has happened will be what happens next. Surely, retail investors will have had their fingers burnt once too often from investing in open-ended property funds. The liquidity promise cannot be met, income returns are not competitive and long-term returns have tended to fall short. Property investment companies should be the natural home for capital looking for real estate returns, over the long-term, accepting there will be short-term volatility. The volatility/liquidity/return trade-off between the two structures should be strongly in favour of the property investment company structure.”

Andrew Bird, Managing Director of Tilstone Partners Limited, investment adviser to Warehouse REIT, said: “It has been well publicised that the open-ended funds have been selling assets to realise capital in order to meet investor redemptions. With a total lack of liquidity in the retail sector and, to a lesser extent, in the office sector, it has been the warehouse assets that have provided the liquidity within these mixed-use portfolios. Having built a track record for speed of executing transactions, Warehouse REIT, through its investment adviser Tilstone Partners Ltd, has benefitted from these willing vendors.”

Richard Moffitt, Chief Executive Officer of Urban Logistics REIT, said: “The dissatisfaction with open-ended property funds is well documented; the appetite from investors for specific specialised vehicles is evident. We are the only pure play in the urban logistics space and that makes us attractive from an investor's standpoint.”

Rent collection – tenants engaging positively with landlords

Richard Shepherd-Cross, Managing Director of Custodian Capital and manager of Custodian REIT, said: “Perhaps the great surprise of the last 12 months has been the extent to which most occupiers engaged positively with landlords to either pay rent or contractually defer rent, despite the government’s moratorium on the eviction of tenants for non-payment. Most landlords of diversified portfolios have recorded rent collection rates of 90% plus, with the majority of the uncollected rent contractually deferred. The challenging sector for rent collection has been retail, in large part due to the prevalent use of company voluntary arrangements (CVAs), aimed squarely at prejudicing the landlords’ contractual position on rent. Happily, there is life beyond a CVA, ideally with a new tenant who respects and values the landlord and tenant relationship.”


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Notes to editors

  1. Share price total return of the peer group weighted average for the Property – UK Logistics and Property – UK Commercial sectors from 1 May 2020 to 30 April 2021.
  2. The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment.  Today, the AIC represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs. The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s mission statement is to help members add value for shareholders over the longer term. The AIC has 360 members and the industry has total assets of approximately £239 billion.
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