With the government now advising workers to work from home where they can, the pandemic continues to ask big questions about the future of commercial property. What does the future of the office look like? What could happen to unused office space and how are tenants coping?
There are also big questions about the future of open-ended property funds. On Wednesday 30 September, new FCA regulations come into force requiring these funds to suspend if there is material uncertainty over 20% of the fund’s value. However, the regulator has already begun consulting on new proposals requiring notice periods of 90 or 180 days for investor withdrawals.
The Association of Investment Companies (AIC) has gathered views from investment company managers in the Property – UK Commercial sector about the future of commercial property and the funds that invest in it.
Annabel Brodie-Smith, Communications Director of the Association of Investment Companies (AIC), said: “Whilst some of us had begun a tentative return to the office over the summer, recent announcements from the government suggest a fuller return is going to be much further down the line. There’s been a lot of discussion about the new normal, but it remains to be seen what the longer-term impact will be on the office, its location and its purpose.
“While these questions are undecided, it’s important that investors who want to invest in commercial property can do so within a suitable fund structure with reliable redemption rights. Proposals for 90 or 180-day notice periods for open-ended property funds are a step in the right direction, but we would question whether they go far enough. In Germany, the notice period is a year. The basis on which an investor can leave the fund should not change, regardless of the level of redemptions.”
The future of the office
Richard Shepherd-Cross, Manager of Custodian REIT, said: “Betting against central London has not worked for anyone over the last 20 years, so by hook or by crook I suspect it will survive as an office location. That said, the days of the five-day-a-week commute into a central London office are perhaps behind us. Remote working, whether from home, suburban or regional offices is likely to be a feature for the future. I would back regional offices in towns and cities where people want to live, rather than choosing where to live because of the train timetable, and they can benefit from a short commute to a satellite office. Locations that support a high-quality built environment and access to open space are often the cathedral or university cities such as Cambridge, Oxford, Bristol, Guildford, York or Norwich. Offices will still be in demand for professional and service sectors, where collaborative teamworking and business meetings are required. Headquarters offices to promote corporate culture, brand awareness, staff training and board-level strategy will also remain in demand. Accessible city centre locations are likely to be the preferred location for these functions.”
Jason Baggaley, Fund Manager of Standard Life Investments Property Income Trust, said: “There is likely to be an increase in the supply of available office space – with poorer quality offices becoming much harder to let, and suffering the biggest rental and capital value decline. It is too early to say what the extent of that will be, but our expectations are that central London and the West End in particular will be hardest hit, as long and expensive commutes will increase the desire to work from home. Generally we expect city and town centres to remain more popular than out-of-town offices, and that car-based commuting will only be a short-term solution.”
The future of open-ended property funds
Calum Bruce, Manager of Ediston Property, said: “The FCA’s recommendations are a step towards addressing the fact illiquid assets simply do not belong in open-ended funds. The lengthy redemption notice periods proposed by the FCA will effectively kill the viability of open-ended property funds for investors and turn attention to property investment trusts, which have long been superior vehicles for liquidity, performance and income. Fundamentally, the open-ended structure is not suitable for holding illiquid assets such as property.”
Richard Shepherd-Cross, Manager of Custodian REIT, said: “Open-ended funds have yet again proved themselves to be unsuitable structures to invest in real estate, particularly for retail investors. The funds are promoted on the basis of liquidity and investment in real estate. In truth they do not offer liquidity when it is really needed and they invest so little in real estate, often holding 25% or more in cash, that they cannot offer what is best about real estate investment, which is a high income return. I think that retail investors will be wise to this and will liquidate their holdings when the funds re-open. Should those same investors re-invest in closed-ended funds they will enjoy a low entry price in the current market, the prospect of significantly higher dividends than they have been used to and liquidity when they want it. Furthermore, over the long term they will see outperformance relative to the open-ended funds they left. I think the writing is on the wall and this will be re-enforced by the FCA’s recommendations which will make it very hard for retail investors to invest or for their wealth managers to advise investment.”
Jason Baggaley, Fund Manager of Standard Life Investments Property Income Trust, said: “A huge amount of time has been spent with individual tenants discussing their needs. Some tenants, mainly the larger corporates, have refused to engage, or simply refused to pay rent even whilst they have traded. The vast majority of our tenants have engaged in constructive discussion. With our smallest tenants we have suggested a write-off of rent for a period – they need to be helped to have a future business, and during lockdown the safety and well-being of them and their families was the main priority. For our larger tenants we have agreed a range of solutions, based around their business needs. It has been heartening to have had so many positive conversations and to have been able to help those who have needed it the most.”
Calum Bruce, Manager of Ediston Property, said: “We are doing what we can to keep on top of events and will provide support, reassurance and appropriate assistance to those tenants struggling as a result of lockdown where necessary. We have agreed rent deferment and repayment plans with tenants who have demonstrated genuine hardship. To date, no outright rent-free period has been granted unless we have received some benefit, like a lease extension, in return. Unfortunately, several well capitalised businesses which can afford to pay their rent are taking advantage of the pandemic and are choosing not to pay any rent. A landlord’s ability to pursue these arrears is fettered because of the government-imposed moratorium on the use of the usual arrears recovery methods, which has recently been extended and will be in place until at least the end of 2020.”
Richard Shepherd-Cross, Manager of Custodian REIT, said: “In common with most landlords, we have supported tenants with rent deferrals, rent-free periods as part of lease renegotiations and in isolated cases have considered rent concessions. While government legislation has handed control in rent recovery negotiations to tenants, without any support being offered to landlords, it should be noted that collectively the commercial landlords of Great Britain, many of whom are individual savers and pensioners, investing via REITs and funds, have offered huge economic support to GB plc. Investors have foregone dividends, endured illiquidity as material uncertainty forced open-ended funds to close while at the same time suffering CVAs and administrations, which in turn have diminished asset values. Let us hope that the tenants of Great Britain return the favour and revert to paying rent as soon as they are able.”
Will unused office space be converted?
Jason Baggaley, Fund Manager of Standard Life Investments Property Income Trust, said: “Over the last five years we have seen a great deal of conversion of old offices into hotels and residential units. That is likely to continue, although the demand profile for residential will evolve as people prepare to work from their home more of the time – and we are unlikely to see significant hotel demand for a while.”
Richard Shepherd-Cross, Manager of Custodian REIT, said: “The process of converting unused office space into residential space or student accommodation has been underway for some time. Permitted development accelerated this activity and created the opportunity for rental growth in regional office markets. Secondary office space that neither fits with current environmental standards nor provides a COVID-safe working environment will quickly fall into vacancy and disuse. Happily, in most towns and cities, the pricing dynamics of residential or student property will support conversion and I would expect this trend to continue. Even if we see a reduction in demand for office space, the conversion of the secondary office space will help to keep supply and demand sufficiently in balance to support office rental levels.”
The future of retail
Calum Bruce, Manager of Ediston Property, said: “It is our belief convenience-led retail warehouse assets, which constitute 61.6% of our portfolio, will prove to be more resilient than other parts of the retail market. Retail warehouse assets have proved to be more resilient than both high streets and shopping centres during the COVID-19 pandemic. During lockdown several out-of-town retailers were able to stay open for trade as they were classed as providing ‘essential services’ by the government. As lockdown restrictions were lifted, but social distancing continued, the attributes of out-of-town retail parks appealed to customers, as evidenced by higher footfall numbers. Their accessibility, ample car parking provision, and the space they provide for queuing (avoiding contact with other shoppers) plus the fact that they are open-air, make them the ideal location for shopping in the post-lockdown world.”
Richard Shepherd-Cross, Manager of Custodian REIT, said: “Town centre retail is oversupplied and rents are reacting accordingly. Too many retailers are misusing CVAs to drive down rents and circumvent their contractual obligations, which is in part made possible by the oversupply of shops. If we look beyond the pandemic, retail town centres are likely to be smaller but with a wider range of local operators, previously pushed out by the national multiple chains, and a strong mix of retail and leisure.”
Jason Baggaley, Fund Manager of Standard Life Investments Property Income Trust, said: “Nearly all landlords have found rent collection difficult given the economic headwinds. Over 85% of rent owed to us has been paid. The majority of those tenants who are in arrears have agreed a schedule to repay the rent from Q2 and Q3 in the future, mostly in 2021, and several have agreed terms to extend their lease commitments in return for a write-off of some rent. In most cases where rent arrears exist, we anticipate recovery by way of an agreed repayment schedule for deferred rent, or a write-off in return for extended lease terms.”
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