Offices are starting to strengthen, and reduced supply is making even retail more attractive – as value emerges, it’s time to get back in the game.
The UK quoted property sector and indeed much of the direct property market has not had the greatest start to the year. Mitigating circumstances of course, but the quoted sector is playing little part in the reflation trade for the moment and the direct market has been much quieter than many anticipated – especially the key London office market, for both letting and investment.
Nonetheless I remain upbeat for the prospects this calendar year. For the moment the ‘defensives’ are just about winning out. In the last issue of the Property Chronicle I continued with my ‘beds, meds and sheds’ theme, and while the first two categories might not make you much money, they still won’t lose you much either; dividends are safe and growing. Sheds remain very strong for obvious reasons, with healthy investment demand; more stock appears to be coming to market but rental growth is still respectable, more so for last mile than big box, though.
Just over 20 years ago I was sitting at my desk at the Wharf pondering lunch (it was a Friday), but more relevantly the dot-com boom was beginning to fall apart. Nonetheless colleagues who followed that sector were still bullish, and we awaited the noon release of figures for Cap Gemini, traded on the Paris Bourse and a major dot-com beneficiary in share price terms. Whoops – the numbers were way below expectation, the stock went limit down in the blink of an eye, and the salesman responsible for said stock announced that the profits disappointment gave investors “a whole new lower entry point”. Needless to say the shares have never revisited the 11.59am price they enjoyed that day.
The very constrained London office development pipeline will lead to a rapid reversal of the slight current weakness in London office rents
That phrase has stuck with me, and it rather sums up how I feel about much of the quoted sector at the moment. On the first Pfizer vaccine announcement in November, there was a massive rotation out of the expensive ‘safe-haven’ stocks such as Segro and LondonMetric in the UK and the bund-related major German residential companies, Deutsche Wohnen and Vonovia. They all fell by more than 10% on the news as they provided liquidity to buy the deeply discounted names of Land Securities, British Land, Hammerson and Unibail, all of whose shares rallied by 30% or more in very short order. Extreme though those movements were – and a major reversal has since occurred – none of the expensive safe-havens have returned to their pre-Pfizer highs and none of the bombed-out shares have returned to their pre-Pfizer lows. The potential for rotation into ‘value’ companies is clearly present.
Global capital continues to chase real estate, with research from Cornell University indicating that global weightings have risen every year over the last decade and are forecast to carry on in a yield-starved world. Last year saw foreign investment in the UK property market fall to about £45bn – some £10bn down on 2019 but, given travel restrictions, a decent enough outcome. Much went as always into London offices but more into ‘alternatives’, especially student accommodation, and logistics. I don’t believe that capital has gone away in 2021; far from it.
While short-term London office vacancy is rising and rents are under a tad of pressure, I firmly believe that working from home will suit some, for some of the time, but that once normality resumes (which it will) then peer group pressure will be the greatest driver getting people back into the office. With the E in ESG becoming ever more important for occupiers as well as landlords, I believe that the very constrained London office development pipeline will lead to a rapid reversal of the slight current weakness in London office rents.
The quoted sector has sizeable exposure to London offices but, importantly, this time around the companies also have meaningful development pipelines of either committed or yet-to-commit schemes, and this may well prove very much to their advantage.
There is something for everyone. The safe-haven, inflation-linked leases of some REITs have a place in any portfolio for pension funds and private wealth managers. I expect logistics to remain strong and in much investment demand, while money will continue to expand into many of the ‘alternative’ sectors. All that’s missing is retail. It’s been my bête noire for more than five years, since I forecast a 50% collapse in retail capital values, pandemic or not. It’s now worse than that, and the forthcoming results from retail landlords will be ghastly, but almost certainly the nadir.
While all the value pain will have been taken by the owners or their lenders, rents will have rebased to a level where many retailers can make money
Already there is some thawing of the retail warehouse market, with several investment transactions albeit at historically weak prices. Big shopping centres remain in the permafrost, though, with zero transactions after the failed sale of Trafford on a near 9% yield. Small shopping centre portfolios are beginning to trade a bit, but yields are well into double figures. Many, regrettably, will see tumbleweed.
However, and I’m a lone voice in this: when we were unlocked last summer, footfall in the big shopping centres returned rapidly to 80% of pre-covid levels; when they reopen this time around it will be a cold dose of reality, with many store frontages shuttered and vacancy levels anywhere between 10% and 40% – but, but, but possibly the most important thing will have changed. Rents. While all the value pain will have been taken by the owners or their lenders, rents will have rebased to a level where many retailers can make money. The more successful and surviving retailers have never given up on needing to own physical stores as part of their offering; it’s just the rent they had to pay that they disagreed with, especially with their sales moving online.
However, with rents half what they were and leases rather less one-sided in landlords’ favour as rent is linked more to turnover, with rose-tinted glasses I can just about make a case for a recovery here. Supply is being reduced and some centres will see a change of use, but when pent-up consumer spending is unleashed, I can see big shopping centres yielding a lot less than 10%. Retailing is a brutal business, but it has always reinvented itself. Further to fall short term, hence ‘a whole new lower entry point’, but for the first time in years there may just be some genuine value emerging. I may not be a lone voice by the end of the year. There, I said it!
