Rapid changes are under way across the spectrum of different asset classes, and investors will need to adapt their approach.
Investors are working hard to assess what recent pandemic-driven changes will mean for different asset classes. In the retail sector, the crisis has accelerated structural changes already under way, increasing online retail spending at the expense of the high street. European consumers have been slower than their counterparts in the UK, US and China in embracing online shopping, but during the three months to the end of May 2020, online sales grew 20.6% year-on-year.
Some European countries are now at a tipping point that will result in an acceleration of online sales penetration. Retailers are therefore expected increasingly to focus investment on their online offering. As an example, Inditex recently announced its intention to achieve 25% of total sales from online (up from 14% in 2019). It also plans to close 1,000-2,000 stores over the next two years. As part of this strategy, it is investing in stores that are “fully integrated, digital and eco-efficient”, and closing smaller stores reaching the end of their life cycle.
Supermarkets have been thriving, both online and offline, and have added significant capacity to meet demand. Sales have rocketed as a result of stockpiling and more meals being eaten at home. Across Europe, supermarkets and larger stores saw faster revenue growth than the discounters because shoppers opted for fewer, larger shopping trips. Online food shopping is relatively underdeveloped in Europe but has seen strong growth recently. To meet demand, a number of retailers have opted for a click-and-collect model based on existing store networks rather than trying to fulfil demand from fledgling warehouse networks.
With consumers still largely homebound, retail warehousing focused on DIY and home furnishings has benefited from expenditure on making homes more comfortable places to spend work and leisure time. In Germany, DIY stores continued to trade throughout the lockdown because they provided a necessary service for small tradesmen, while in the Netherlands most stores also remained open with social distancing rules in place. Out-of-town retail may prove slightly more resilient than expected as lockdowns ease because the size and configuration of stores should make it easier to accommodate changes in trading to ensure social distancing.
The industrial and logistics sector has not been immune to the downturn, though warehouses have seen increased demand as supply chains move back home. Manufacturers have had to adapt production to meet social distancing requirements; supply chains have been heavily disrupted, and the auto and aerospace industries have seen an almost complete shutdown of production. Nevertheless, sectors such as food retailing and healthcare have proved very resilient.
The crisis has highlighted the importance of understanding both tenants’ business models and capitalisation, and at a broader level, the various industrial and logistics subsectors, from last-touch urban logistics to standard warehousing to specialist storage and manufacturing facilities.
Niche players in segments hit hard by the lockdown, and that were already struggling before the crisis, have been seeking rent deferrals and may take time to recover. But looking ahead, warehouse demand from retailers is likely to increase further as they seek to address any shortcomings in their current fulfilment models which have been exposed by the crisis. There is also likely to be an increase in demand for short-term storage as retailers seek to hold onto some unsold spring 2020 stock until spring 2021.
Overall, demand for warehousing and distribution facilities is likely to increase post-crisis. This has underpinned consistently strong investor demand for industrial real estate, particularly in Germany, cementing its reputation as a safe haven. However, the crisis has confirmed that the ability to deliver income security and rental growth will be a function of understanding the tenants’ business, their location and the type of asset.
Offices, meanwhile, are facing a fork in the road. There are two paths the sector could take. If the office’s prime purpose becomes bringing people together for specific meetings and collaborations, there is likely to be a preference for centrally located, easily accessible locations. However, if public transport capacity is significantly reduced by social distancing for a prolonged period, we may see an increase in demand for locations that support car-based commuting or suburban locations that can be accessed easily on foot as well as by car. The resulting increase in carbon emissions would go against environment, social and corporate governance investment goals and mark a dramatic reversal of trends seen over the past ten years. In the longer term, locations most at risk are probably poorer-quality, less accessible fringe locations within cities, particularly if alternative residential use is a possibility.
Government policy will remain an important aspect driving the trajectory of the recovery. It will also determine how far landlords are protected from loss of income in the short term. In Germany and the Netherlands, the government and industry bodies were quick to establish expectations for landlords and tenants. In contrast, messaging from the French government has been unclear and a framework for landlord and tenants to reach agreement has not been laid out. These differences in governance are likely to further cement Germany’s reputation as a safe haven for real estate investors, particularly those focused on stable income returns.
The crisis has also shone a spotlight on the importance not only of covenant strength, but more broadly of understanding tenants’ business models and balance sheets. This is key to their ability to continue to be able to pay rent. We expect that real estate investors will pay more attention to tenant due diligence and the definition of prime assets will now rely more on the security of the income stream than on location and profile.
