This has been a difficult time for many occupiers whose income, in many cases, has dropped considerably through restricted trading conditions, in turn impacting their ability to pay rent. It has also been a tough time for commercial landlords. Many have had to negotiate with tenants to help them through a period of significant distress and, in some cases, rental income has had to be waived or deferred.
However, the Covid-19 crisis has also brought opportunities – a motivation for some tenants to speak to landlords for short-term cashflow help presenting a win-win situation whereby landlords can assist in the short term, in return for longer term benefits such as the extension of leases. From an investment perspective, the acceleration of several structural market changes has insulated and often enhanced prospects, for instance increased online retail sales have benefitted the industrial and logistics sectors. At UK Commercial Property REIT we have been reducing our holdings in retail for many years whilst increasing exposure to industrial and logistics to strengthen the portfolio.
Lockdown’s impact on traditional retail
The Covid-related acceleration of structural changes was particularly prevalent across the retail, industrial and office sectors. The structural decline of high street and shopping centre retail, for example, is a well-established trend, but lockdowns have seen consumers move to online shopping faster – internet retail penetration spiked to 30 percent during lockdown, from below 20 percent at the start of 2020. Online spending has reached its targets years earlier than had been predicted. It is abundantly clear that there is far too much retail space, with demand increasing for well-located industrial and logistics space.
We saw the way the world was moving in 2015 and took the decision to move into areas such as logistics warehouses which have benefitted from a consumer shift away from traditional retail/shopping to online, with the resultant need for all that extra demand to be serviced. As a result, we currently have only around 17 percent of our portfolio in traditional retail assets (with no shopping centres) whilst well over half (58 percent) is in the industrial and logistics sector which, depending on the geography and type of asset, provides greater stability of income and capital and potential for income growth.
With negative unemployment and economic forecasts stretching further into 2021, permanent loss of UK productivity means we believe there is considerable risk around many sectors of the market – high street retail, shopping centres and central London offices in particular.
The working from home revolution
Covid-19 is likely to have significant continuing repercussions for the office market. Do companies need such large offices in the centre of big cities if many of their staff are working from home two or three days per week? We would resist the temptation to call a wholesale change – not everyone will work at home and indeed many staff will be keen to return to an office for the collaborative and social aspects of that environment.
At the same time, it is unlikely that they will want to return to a long London commute five days a week. Also, having proven the work-from-home model can work in an emergency, it is hard to imagine businesses leasing large vacant offices as ‘disaster-recovery’ space – just one of the reasons contributing to our belief there will be a considerable increase in the availability of ‘grey space’ on the letting market – second hand office space existing tenants no longer require.
Looking beyond the virus, we expect yet more structural changes to the ways businesses and employees use office space. Many outcomes and working models have been put forward but it seems clear that demand will be different and with it the risk of surplus space and negative rental growth. This is particularly true in London where we have been selling down over the past few years, including our sole City of London office last year.
As we emerge from the pandemic, we foresee persistent low interest rates and low inflation in the UK, so the income return potential from property is particularly interesting. Of course, care is required in asset allocation and selection to ensure the sustainability of that income.
Asset Management, ESG and Rent
Asset management is about enhancing the assets we hold to maximise their appeal to high quality tenants. From an Environmental, Social and Governance (ESG) perspective, we have already made significant progress on sustainability and reporting, with future commitments set down: these range from net zero portfolio emissions by 2050 to a two-year study on the societal value generated by our investment activities. Not only is this a good thing to do, but it is increasingly at the forefront of the minds of potential tenants and investors seeking durable income into the future.
Much good asset management is about the relationships we have with our tenants and taking the time to understand them. For many, Covid-19 has brought cash flow pressures to their business which has focused tenants’ minds on their rent, lease and property. This has enabled us to increase our dialogue with our own tenants, helping to navigate this crisis more effectively. From a pre-Covid normal rent collection rate of approximately 99 percent, our rent collection statistics have been reasonably strong in the Covid environment at 83 percent and 85 percent to date across the March, June and September 2020 quarter billing rounds, covering rent due for quarters 2, 3 and 4 of 2020. We spend time talking to tenants with cash flow issues to understand their situation and for many of those we have helped by simply moving from a ‘quarterly in advance’ rent payment to a monthly payment. For others where there is greater distress, we have negotiated individual agreements. For example, we may have created a rent-free period for six months, with either a period of enhanced rental payment afterwards to repay the missed payments, or the extension of the duration of a lease to improve our future cash flow and current asset value – this has worked for our tenants, but also preserved long-term cash flow, while affording the potential for future value improvement. Our top ten tenants account for over 36 percent of our rent roll (as at 30 September 2020) and are all good rent payers with only one exception, Cineworld, accounting for approximately 3 percent of rent. The top five of those ten tenants are B&Q, Ocado, Amazon, Total, and Cineworld.
The portfolio today
We currently have capital of around £218m available to invest. Being structured as a real estate investment trust means that we don’t have to sell assets to provide shareholder liquidity as our shares are traded daily at high volumes on the London Stock Exchange. Instead, we can focus our attention on capitalising on assets that meet our “fit for the future/modern economy” strategy and opportunities afforded by any owners that may be forced to sell.
Our portfolio today is strongly tilted towards the resilient industrial/logistics market but remains diversified by geography, tenant, and sector. Importantly, we believe the UK Commercial Property REIT is well equipped for the future with a strong balance sheet, capital available to deploy at the right time, and very low gearing currently.
Will Fulton is lead manager at UK Commercial Property REIT
Risk factors you should consider prior to investing:
• The value of investments and the income from them can fall and investors may get back less than the amount invested.
• Past performance is not a guide to future results.
• Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
• The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
• There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
• As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
• Property values are a matter of the valuers’ opinions and can go up and down. There is no guarantee that property values, or rental income from them, will increase so you may not get back the full amount invested.
• Property investments can take significantly longer to buy and sell than other investments, such as bonds and company shares. If properties have to be sold quickly this could result in lower prices being obtained for them.
• The Company invests in a specialist sector and it will not perform in line with funds that have a broader investment policy.
• Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
Other important information:
Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.