Commercial property: the future is bright, but different

- Covid-19 has accelerated existing trends in commercial property - agile working, online shopping, digital transformation.
- Companies are likely to have a keen eye on affordability and functionality in the years ahead.
- Diversification has proved an important tool to manage the impact to our shareholders.

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The Covid-19 outbreak has brought significant disruption and hardship for many industries and commercial property landlords have had to adapt. In the short-term, they have had to deal with tenants’ cash flow limitations sensitively, but they have also had to look at their portfolio of properties and judge whether it is appropriate for a changing world.

None of this is entirely new. Commercial property landlords have long had to deal with significant structural change, from the seismic shifts in retail, to the growth of industrial warehousing. Covid-19 has, for the most part, merely accelerated existing trends – agile working, online shopping, digital transformation. Nevertheless, we believe certain practices have become more important in the wake of the Covid crisis.

Being on the right side of structural change
Covid-19 has not, by and large, changed the direction of travel in many industries. Retail was already moving away from the high street and towards online shopping. Agile working was becoming more prevalent long before the pandemic forced us to stay at home. Nevertheless, the crisis has given these trends a new urgency.

We took the decision five years ago to divest of much of our retail exposure, moving instead to industrial holdings. Today, we need to assess how the office market will change. Will the office become obsolete? Certainly, it is likely to see significant change. The way people get to work will change with cycling and walking set to increase, at the expense of the train or tube. Proximity to affordable housing is likely to be of increasing importance, although a wholesale move to out of town offices remains unlikely

It is clear that many employees are not ready for a wholesale return to the office, but we do not believe the office is dead. Employees have not yet lived through a gloomy winter confined to their homes and there are limits to the amount of creativity and collaboration that is achieved through Zoom. Younger people benefit from an office environment to learn and develop. Our view is that companies will seek to achieve a greater balance. Tomorrow’s agile working may include working two or three days a week from home or different office hours. This will necessitate a different type of work space.

As we see it, town centres will generally still outperform as they offer better connectivity and amenities. Increasingly, technology will impact the whole experience, with interactive apps guiding the decision to go to the office, providing touchless access around the office, helping with desk allocation and meeting room booking.

Ensuring affordability and value for money
The days of high rents and optimistic capital values are behind us. Instead, tenants want good quality properties in good locations, rather than prime properties in the most glamorous locations. We have an office in Birmingham, for example, which is 5-10 minutes from the city centre. It has all the right amenities – public transport links, parking, food retail – but the rent is at a significant discount to property in the centre of town. We have a similar property in Edinburgh, which is close to the university and the technology sector. It is notably cheaper than central Edinburgh properties. Companies are likely to have a keen eye on affordability in the years ahead.

Acting ethically
Environment, social and governance considerations are at the heart of the fund. It is no longer an add on or optional activity. Through simple activities, we can make a real difference. The first area is in energy performance. If we provide energy efficient buildings, we not only reduce the carbon load, but we also reduce operating costs for occupiers.

The second area is in the social or wellness area. Here there is a huge benefit to productivity and individual wellbeing if the work environment has good quality air, natural light, comfortable temperatures, great showers and changing facilities, even add-ons such as yoga studios. We want to form a sense of community in a building. 

As a landlord, we benefit from greater levels of occupation and more sustainable income if we provide places people want to work and are productive. Increasingly just “doing” ESG is not enough, and we need to have a governance framework that measures and verifies what we say. This is increasingly important to occupiers who want to demonstrate to their staff and customers the responsible approach they are taking.

Building strong and transparent relationships with tenants
We have a huge variety of tenants, from sole traders to multi-national corporations. Some have experienced real distress through this period and we have sought to be sympathetic to their changed circumstances. This has meant keeping in regular contact and working out terms that allow them to rebuild their businesses through this difficult time.

This has necessitated some flexibility, but in most cases we have seen that flexibility pay off. Two retail tenants agreed a rent-free period but signed up for a 15-year lease in return. We believe they will be around for the long-term and as we value consistency of tenure, we felt this was a win-win situation. The key has been to know and understand our tenants’ businesses. We have a broad network of asset managers across the UK and their feedback has been invaluable.

Diversification
There are times when diversification can feel painful. For example, we considered our leisure holdings to be an important diversifier for the Trust, but areas such as hotels and gyms have been a tough spot during the crisis. However, this crisis has hit in unexpected ways; the next crisis (and there is always likely to be another crisis) will be different. We believe diversification is an important tool to manage the impact to our shareholders.

We believe that a combination of all these factors has helped steady the ship at a tough time for commercial property. They are likely to be even more important in the world that emerges from the Covid pandemic. 

Jason Baggaley is Investment Manager, Standard Life Investments Property Income Trust Limited. 

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