The Real Estate and Investment Market During Covid-19
With the Right Experience, There are Still Opportunities
Since our last Market Update on 16th April, our lives have continued to be dominated by the COVID-19 crisis, with the Americas currently feeling the brunt of the spreading virus. Here in the UK we have at last seen a material reduction in new cases and much lower daily death rates, although seemingly worse than our European neighbours. The NHS has not been overrun and although heartening to see how fast and efficiently the Nightingale Hospitals were constructed, they were not fortunately required to the extent they could have been. So with the medical impact receding (subject to any second wave), we can start to review the economic impact of the pandemic and how we at Barwood Capital see the changes and challenges in UK property.
Economy – V shaped, U shaped or L shaped?
There can’t be many people that can say in the first few weeks of their new job that they managed to spend £330bn of company money and then came back to the Board a few months later for another £30bn to throw at the same problem. So hats off to our Chancellor, Rishi Sunak for audacity; let’s see if this gamble with the country’s finances works in the long term. I guess getting long term debt rates down to near-zero, before borrowing 18.5% of the country’s GDP is a sensible start.
The two key metrics purveyed by the economic commentators are GDP and employment, which are of course inextricably linked and will define what shape of recovery we face. Capital Economics have recently improved their forecast regarding both GDP and employment following ONS economic figures. Having suggested previously that GDP will fall by 23% in Q2, they believe this will be closer to 15% and that unemployment will peak much later than previously thought, around June 2021, at 7% rather than 8.5% in July this year (see Graph 1). The reasons given were the greater-than-expected rebound of activity and household expenditure following the loosening of lockdown restrictions, together with the take up and extent of the Government’s Furlough scheme. The Government is currently underwriting approximately a quarter of the workforce.
Graph 1 – GDP and Employment forecasts
Despite these better-than-expected figures, we are still living through an unprecedented drop in activity brought about by the halt on supply in our economy, so the Chancellor’s announcement on 8th July for further initiatives to kick start the economy through his ‘plan for jobs’ is no surprise.
UK Property – Acceleration of existing trends
With such a dramatic fall in UK activity, pricing on average across the UK’s property assets has been impacted, as rental growth forecasts fall and Landlords worry about rent collection. However, it has not been consistent across the sectors. As the Guardian reported last week, UK retailers (High Street and Shopping Centres) only paid 14% of their £2.5bn quarterly rental bill to their respective Landlords. At the other end of the scale, both SEGRO and LondonMetric with their majority Industrial holdings, and Bluechip tenants, reported a collection in excess of 90% within the first week and thought they would get up to 98% over the quarter. It is no surprise to see the huge disparity between total monthly returns in Graph 2 for the various sectors. Barwood Capital’s own collection rates on our Multi Let Industrial Portfolio which has 220 SME’s, currently sits at around 80% of rent demanded on the June quarter date. This will improve during the quarter and we have intentionally offered a number of payment concessions (either amounts or timing) to various tenants, in exchange for beneficial alterations to their lease terms.
Graph 2 – Total Returns by Sector (% Y on Y)
As a result, there is also a large disparity between the pricing of the major listed property companies; Warehouse REIT, SEGRO and Tritax all holding majority industrial stock seeing growth with the likes of Hammerson and NewRiver holding retail and shopping centres seeing huge losses.
Graph 3 – Relative change in UK Equity and REIT’s price (% Feb 20 = 100)
* value of holdings are greater than 50% in offices
As we saw in our previous Market Update in April, the lockdown enforced by COVID-19 sent everyone online for their groceries and other purchases. This has meant that the industrial sector has weathered the storm well, as companies accelerate their online growth plans and ‘onshoring’ of stock. CBRE reported last week that H1 2020 had the highest quarterly take up for industrial and logistics stock on record, with the majority of that take up being in Q2 with COVID at its height in the UK. A staggering 19m sq ft was secured in H1, 4.8% higher than the previous half year record in 2018. According to CBRE, only 15% of this floor space was for more short term, ‘COVID’ related reasons; supermarkets or NHS. Barwood Capital itself has recently secured the letting to Bart Ingredients, for our 140,000 sq ft warehouse at Junction One, Central Park in Bristol (See press release)
Tesco reported an increase from 650,000 online deliveries per week pre COVID to 1.2m in the space of 12 weeks. This exponential growth was of course caused by COVID, but are we just seeing an acceleration of an already existing trend? When lockdown ends completely, will all those new customers stop using Tesco online services? That feels unlikely. Although the UK has the highest online retailing percentage over its European neighbours, it is still growing. The beneficiary of course is the industrial and logistics sector which houses this online stock. Barwood Capital continues to seek development and asset management opportunities in this key growth sector throughout the UK.
The office sector has had more of a mixed past 3 months. Although collection rates on quarterly rents have been fairly good on average, there has been much debate within the industry and the wider financial press about the long term requirements for office space by corporates. With most of the working service industry doing their roles from home wherever possible under lockdown, company Boards have seen how it can work. Although face-to-face collaboration between staff, suppliers and clients remains imperative for businesses, there could be huge savings on office space that is not needed to such an extent as currently used. The time given back to employees through the reduction of commuting may well deliver greater productivity due to heightened mental and physical wellbeing.
The tech giants of Google, Facebook and Twitter have all made statements about employees not coming back to their offices until at least the end of the year, which is no surprise for such hi-tech businesses with a fleet-of-foot mentality, but even the more old fashioned industries; Banking, Accountancy and Law have all started to make statements about what changes they will make. Barclays, Credit Suisse, JP Morgan and Deutsche Bank have all come out recently with statements that they will be reducing their office uptake in the City and Canary Wharf by as much as 40% in certain circumstances, looking to replace their traditional work practices with more flexible approaches.
Again, is this caused solely by COVID or rather accelerating a pre-existing trend? Working from home, ‘Hot Desking’ and flexi-working have been rapidly burgeoning concepts, with huge growth of serviced office and cooperative businesses like WeWork, The Office Group, I2 Offices, Business Link throughout the major Regional Cities. Barwood Capital does not hold offices in its portfolio currently and is not looking to do so at this point in time, but we will continue to monitor this ever-changing landscape.
Alternatives – Spotlight on Care Homes
COVID has shone a spotlight on UK Care homes, whether it be the celebration of the efforts of frontline key workers, the lack of PPE delivered in a timely fashion by the Government or the more concerning excess mortality rates. What this has highlighted is the need for innovation and investment in the UK healthcare property sector. Long-term demand due to an ageing population combined with the accelerated closure of underperforming assets is leading to a national bed crisis in care homes. Knight Frank estimates there are a potential 6,500 care homes at risk of closure over the next five years, equating to 140,000 beds. This shortage will be exacerbated by the increased demand for care homes by 2050, as the share of people over the age of 80 is expected to surge over the next 30 years, with one in ten adults set to be over 80 by 2050, compared to one in 20 currently.
Through our relationship with Perseus Land and Developments, Barwood Capital is well placed to review opportunities to address this imbalance, taking land through the planning process to deliver purpose-built care home beds to the market.
Residential Bounce back
The latest RICS survey suggests activity is increasing at its fastest rate since 2013. This was before the Chancellor’s stamp duty cut, which is likely to reinforce evidence that the housing market recovery may be stronger than expected. In June the new buyer enquiries balance leapt to 60%, a level that has only been matched once in the last decade (See Graph 4). There was a similar jump on the new sales balance, which rose to 43%. Those are dramatic improvements on the record lows recorded in April. Overall, it appears that activity is seeing a stronger-than-expected recovery, albeit from a very low base. It has been the out of town, rural locations that have benefitted most from this increase in activity, with people seeking to get out of the cities, post COVID.
The changes in the RICS past prices measure are less dramatic, with the balance rising from -32% in May, to -15% in June. That would remain consistent with a small drop in prices over the next three months. Looking beyond, falls are likely given headwinds to the recovery, though the Chancellor’s stamp duty cut can only add to the potential upside for house prices. Barwood Residential Investment Platform (‘BRIP’) has seen a marked improvement in viewings and reservations in the past three weeks. Based on the rural and semi-rural locations for all the BRIP assets, together with a price point that takes advantage of the new Stamp Duty ruling, we are well placed to take advantage of an improvement to the residential market.
Graph 4 – New buyer instructions and new sales enquiries
In summary, it has been a mixed bag for the UK economy and the wider property industry over the past 3 months, depending on what sector you reside in. Barwood Capital’s investment strategy of pursuing value-add opportunities within the growth sectors; such as warehousing and retirement living have allowed our assets within the Funds we manage to hold up well, and indeed continue to grow during these challenging times. Furthermore, where there is risk aversion during times of such uncertainty, there is also opportunity for those with the experience to find it, under the guidance of our long-established investment principles. With the support of investors and partners, Barwood Capital looks forward to the next chapter of this unusual story.
All graphs courtesy of Capital Economics