The state of property investment after Covid-19

Property is no longer the solid investment it once was, with upwards-only rent reviews and more reliable income flows than dividends on shares.

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  1. Charles Stanley

This week, the New Look portfolio of 470 shops is under new lease arrangements. The Company used a procedure to force new terms with its creditors to recapitalise the Group and change the basis of its lease obligations at the same time.

As a result, 68 of its shops now pay no rent and the other 402 are on turnover-related rents, where the company promises to pay between 2% and 12% of the shop turnover they achieve to the landlord. In return for this unattractive deal, the landlords have the option to get out of the lease more quickly if they can find a tenant who will pay more – and have greater certainty that the company will make the new reduced payments.

Some landlords will accept zero rents if it guarantees the hard-pressed tenant nonetheless pays the Business rates and service charges. An empty building to the landlord is not just a lost rent but a cost centre in its own right. This large settlement may turn out to be something of pacesetter for retail properties generally.

Most shop groups would like fewer shops than they have, and all want much lower rents. This has just taken down rents by a marked amount, difficult to calculate in advance where it is turnover related. The landlord becomes an active observer of the company's trading performance, unable to influence what they sell and how they sell it but dependent on their success for a decent return.

Because we cannot easily foretell how much rent a landlord will receive under this freewheeling turnover system, valuers will probably have to be gloomy. After all, the rent hinges not just on the economy and the general strength of consumer spending, but also on the balance between online and shop trade and the success or failure of the particular merchandising policy of their tenant. This means a likely further downwards revision in retail property values and rental forecasts. 

Meanwhile, there is not the same visibility yet for the future of office property. There are some who are still relaxed about the prospects. They expect a return to the office in due course and, if anything, more space being required to the extent that some social distancing is still required.

Others think that there will be a large and permanent change with many more working at home for at least part of the week. Companies could switch from one large central city office to a series of smaller local offices with car parking and better access. There could be a switch to many more people working most of the time at home, with the offices used for meetings, active management and team building. The result will be many larger companies wanting less central city space. When the virus recedes, this may include hot-desking again, and a higher ratio of meeting space to workspaces. It would seem prudent to expect some attrition of rentals in city centres, and the need to convert some of the unwanted space into residential or other uses. 

Maybe there will one day be an announcement from a large company that seems as important as the New Look approach to shop tenancies. Recently, we have heard from BP that it could close half its city offices owing to cuts in the workforce of 15% allied to much more homeworking. John Lewis is pulling out of Partnership House in London and National Westminster is closing its Regents House office.

It's not just older model businesses cutting space. Booking.com has stated it is shutting its London and Cambridge offices. Most businesses that are generating decent revenues are watching developments and waiting for leases to come up for renewal. On current form, it is likely many will decide to work with much more home working and use that as a reason to cut their space requirements. The property industry will take time to adjust and remains unsure what this means for rents and capital values. 

We think the REIT prices are right to discount more grief to come. New Look was only a shock to those who wished to deny the reality that the UK has far too much shop space. There may in due course be a similar moment in the office market. There will be uses for remodelled, refurbished or redeveloped property – for industrial space for the new tech and online logistics businesses, and for homes.

Property is no longer the solid investment it once was, with upwards-only rent reviews and more reliable income flows than dividends on shares. Landlord interests are the bottom of the priorities as governments seek to help distressed companies and worried tenants through the pandemic response. 

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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