Covid-19 has upended the world. The New Normal is a 10-part series looking at the stunning ramifications for the world of economics and business. Part two continues with an in-depth look at the commericial property sector which has been shaken to its core by the national lockdown and the explosive growth in online shopping.
Five-hour queues to get into a Preston branch of Sports Direct on the first day that shops re-opened following lockdown owed much to the 50pc discount for NHS workers – but also offers a glimpse into the future.
Edge-of-town retail parks such as the Deepdale Retail Park that boasts the in-demand Sports Direct are a relatively bright spot in a tale of bricks-and-mortar retail decline.
Whether it will endure is among the many questions facing commercial property landlords as they read the runes left by the pandemic and try, like everyone else, to place their bets on what’s coming next.
Coronavirus has touched most corners of the sector, emptying out offices, shops and restaurants as people seek refuge at home.
There are dangers in extrapolating too much about the future from the depths of a crisis. But it’s clear that habits are unlikely to snap back any time soon, given rolling lockdowns and social distancing measures. Tectonic plates are shifting in a sector that was already being rocked by the shift to online shopping.
“It will take a significant drop in infection rates, most likely through pharmaceutical interventions, to exit this second phase of containment and for life to return to something like normal,” wrote Aviva Investors' leading property forecasters Jonathan Bayfield and Chris Urwin at the end of June.
“For investors underwriting an investment over a 10-year hold period, it is reasonable to assume these conditions will prevail for most of that time.”
Long before coronavirus came along, the generational shift to online shopping was upturning commercial property conventions, turning unloved industrial warehouses into prime property to store goods for online sales.
It made heroes out of the likes of FTSE 100 warehouse owner Segro’s chief executive David Sleath, but heaped misery onto the likes of shopping centre backer John Whittaker.
The collapse of his key investment Intu in June, weighed down by its £4.5bn debts, starkly illustrated how coronavirus has accelerated that shift. Weeks before Intu’s collapse, Segro raised £680m on the stock market to snap up assets.
Demand growth for warehouse space is now only set to strengthen, as online shopping grows at pace and supermarkets bolster their logistics operations.
Capital values in the warehouse space have remained largely unchanged, set against steep falls for retail property on the high street and in shopping centres.
“Overall in industrial what's been the high street's loss has been the industrial sector’s gain,” says one leading fund manager.
“The crisis has probably accelerated the decline of the high street by about five years.”
There is a natural check, however, on demand for warehouse space. “The demand means that yields are being pushed down to levels that, for us, we think in some cases there could be a risk to performance relative to others,” says Nick Montgomery, head of UK real estate investment for the asset manager Schroders.
In the meantime, retail landlords are trying to capture some of the growth in online sales, aware that the retailer's attention-grabbing high street property will have contributed towards it.
Hammerson, for example, which is moving towards more turnover-linked rents, is thinking about measuring the number of shoppers both inside and just outside of the store, to feed into rent calculations.
The FTSE 250 landlord started selling its office space in 2012 to focus on retail, meaning it at least does not have to worry about the trend towards working from home.
That is clearly turning from emergency measure into a more permanent shift, with City institutions including Schroders, M&G and PwC all now allowing workers long-term freedoms not to be tied to the office.
Darkening economic clouds are likely to tip the scales further towards working from home. Office space in central London costs most employers in the region of £10-£15,000 per person per year, according to Aviva.
UK office take-up fell 37pc during the first half of 2020 compared to the same period in 2019, according to data from the estate agent Savills, with a 41pc fall in London. Vacancy rates in the capital are also rising.
Some big deals have gone through in the last couple of weeks, however, such as Baillie Gifford’s relocation to a 280,000 square-foot base in Edinburgh. Rents are largely holding up.
Landlords stress it’s a mistake to write off the office. Many employers are even keener on high-quality buildings with plenty of space for collaboration, where work can take place at minimal risk of spreading the virus. Tenants are said to be taking a step back to think about the space they need.
“A lot of companies who have a requirement [such as a lease expiry] coming up are just pausing and thinking, how is this going to affect the type of space we want next?”, says Darren Richards, head of real estate for British Land, which has £9.2bn of office assets under management, focused on London.
“Not whether they want space fundamentally, but whether this changes what they need and how they use it. That's definitely happening.
“There will be a trend towards high quality space: if you are going to have an office, you’ll want to make it count.”
He adds: “Even during the lockdown period we’ve seen encouraging interest in big chunks of space. This demonstrates that some firms with large requirements are already looking past Covid.”
Among the unanswered questions so far is the extent to which offices will move out to the suburbs to be closer to worker's homes, reversing the long-running allure of the city centre with its inflated prices.
Workers have been slower than expected to return to the centre of London, sparking fears for businesses that rely on their income.
The smart money, meanwhile, is following those companies that are doing well out of the pandemic, such as the tech giants.
“We try and focus on towns and cities capturing demand from the growing parts of the economy,” says Montgomery from Schroders.
“Manchester has a burgeoning tech and media centre with Amazon taking a load of space up there, and big professional services firms such as PwC. So there will be winners and losers.
“In our view the death of the office is grossly exaggerated.”
Read part one: Central banks prop up the world after Covid – but who pays?
Tomorrow - part three: How the pandemic has radically altered the flow of money