Real estate: Do you have a clue what happens now?
As the caricature of King George III sang in the musical Hamilton, “What comes next? Soon you’ll see,” and “Do you have a clue what happens now?”. Well, in terms of the real estate market, we will certainly see and in many instances, we still have no idea what comes next!
Yet the road ahead feels something like the fresh start, perhaps mirroring the feelings the founding fathers had, should we choose to take that opportunity. A new and uncertain market could await, or it could equally be back to normal business.
During the past many months, I have ended many emails and messages to friends and colleagues with an ellipsis. Those simple three dots are in themselves a statement of the uncertainty that we have endured and continue to endure until we are free of the Covid restrictions and can see the real lie of the land and the UK’s position in a post-Brexit world.
We are almost a year into the pandemic and our ivory castle offices have been empty for all almost all of that period, whilst the industry continues to plan for the future. From my perspective as a transactional property lawyer, our industry has experienced an unexpected lift, particularly in Q4 2020 and the start of 2021.
In terms of Brexit, we now have a goods-based deal with the EU, which astonishingly seems not to have considered services (the main output for the UK) and financial services in particular. We now wait to see if the EU will grant us equivalence to trade European shares. Commentators believe this will be significantly delayed or perhaps be unlikely to occur at all. This is clearly key to the future of the City as a pillar of the world’s financial markets and its relevance to occupiers. As the Times analogy stated:
“Imagine Germany were renegotiating its relationship with Europe. Imagine that, when the country’s carmakers came up with a wish list, they were told where to park it. Instead, ministers would prioritise the tiny but culturally totemic Lederhosen industry.”
That is how the UK has treated the City of London and financial services, upon which our economy depends.
Ironically, the timing of Brexit in the pandemic context appears to be helping. The rate of the vaccine rollout is lifting sterling and the pound recently hit a three year high against the Dollar and an 8 month high against the Euro. Given the high death toll, the speed of the programme may again put London into the thoughts of global businesses as a safe and reliable place to do business.
While there have been some companies that have left the UK market due to Brexit, it did not trigger the exodus that many had predicted. The UK’s departure from the EU will continue to be one of the factors to be taken into account in commercial decisions to take on, retain or dispose of premises but, it is unlikely to be the main driving force. Instead, demographic and behavioural trends, such as housing shortages, internet shopping and flexible working will have a much more pronounced impact.
I have written in the past that every business, big and small, will have to consider its own real estate requirements, be that in offices, retail, logistics or any other use class. In the case of offices, my view has not changed that we will still have a want and a need for offices. At the current time with lockdown, freezing temperatures and half-term combined, the clamour gets louder for a return. The use and frequency of use is almost guaranteed to be less as the hybrid working structure becomes the normal and business contract their floor plates, saving significant amounts in the process and forcing flexible working onto those businesses that until now have retained more traditional practices. Others in the industry disagree and believe that economic headwinds and perhaps a move back to “facetime” in offices will mean that some, particularly those that are up and coming in professional services, may quickly return to a more traditional 5 (one suggested “6”!) day working week.
So, what does this mean for real estate and offices in particular?
The existential debate facing offices and how and how much we will use them is one that I first wrote of back in April 2020 and remains in that same state of flux. To my mind, this is one that we cannot really begin to resolve until some normality has returned and we can tangibly remind ourselves how we used to feel about the commercial spaces that we occupy and what we want from them in the next period of time. Thoughts and minds have undoubtedly changed and a snap back to the same ideas without learning anything from the past year would be an opportunity lost.
The contrasting views are evident – as one example, a record rent was recently set for a City office as Dtek, a Ukrainian energy company, agreed to pay almost £110 per sq. ft. for the top floor of the Leadenhall Building, which spans about 7,000 sq. ft. and offers panoramic views.
At the same time, the Estates Gazette reported this week that the London office market broke the record not once, but twice during 2020 for the lowest amount of space let during a quarter. They quote figures of just 887,000 square feet let in the final quarter of the year, “a 7.5% drop of from the previous quarter, which had already been an all-time low”. Tech firms have been the largest occupiers of new space for four of the last five years.
There seems little doubt now that the hybrid model will prevail, with the office used as a space for collaboration and processing tasks completed in a remote way, avoiding the commute and adding to the workforce’s quality of life and productivity. Regular Covid-19 testing is central to the effort, along with more cleaning, and dealing with staff concerns over the use of public transport.
It was recently reported in the Guardian that the population of London is set to decline for the first time since 1988, as City workers seek out of town solace to plan the next phase of working from home or hybrid working, but certainly in larger homes that offer more amenity and comfort. I mentioned the hypothesis previously, as put forward by the Freakonomics podcast, that, like New York, perhaps London had reached “maximum city” and that a decline was due or already occurring, but a potential fall of c. 300,000 residents of the capital would end decades of unbroken growth.
In New York, the Financial Times recently reported that weekly surveys of commercial property occupancy show at best a tenth of offices are being staffed, according to the Real Estate Board of New York, a trade association. Expectations are that by the middle of the year, occupancy rates will approach 50 per cent, helped by the rollout of vaccines. Companies in the US, such as Brookfield are ahead of the game, providing daily testing to its staff, arranging taxis and additional parking to help allay public transport fears and requiring a daily health assessment to be completed via an app. Air filtration has been upgraded and Brookfield Place has installed a new system incorporating technology typically used in hospitals. These are the measures that will give staff the confidence to return and to re-awaken the central city streets that remain boarded up and desolate.
So, what of the investment market? Well, there are clear and evident signs of life, as deals continue to trade. The Estate Gazette reported sales in Q4 2020 totalling almost £3.5bn and almost matching the preceding nine months in those three. Deals in the fourth quarter included Landsec agreeing a £552m sale of office buildings 1 & 2 New Ludgate, to Singapore-based investment firm Sun Venture. Where London is concerned, the expectation is that there remains significant capital waiting to be deployed and it will continue to be a highly attractive city for investors. Whist we remain busy at Memery Crystal acting for well-funded investor clients, once the travel restrictions are lifted, we expect interest in well let core locations from our overseas clients and residential development to schemes to continue at pace.
Retail has been spoken about at length and continues to be the hardest hit, with further consolidation and famous brands such as Topshop and Miss Selfridge being acquired by Asos following the collapse of Arcadia. The unrelenting demise will continue until a baseline level is reached, where we have the “right” amount of physical shops for the public’s requirements. This seems inevitably to be centred around food and presence led retail – barbers, nail bars, take-aways etc. As I was quoted as saying when recently interviewed for the Metro newspaper, there is still a place for retail. Like all sectors must now do, it will need to place the consumer at the heart of its experience. Give people a reason to go to the shops and they will do so. If you have something that they simply cannot get on-line, then what choice is there? I also believe that you will see a movement away from screens post lockdown, where people actively chose to get out and shop (like in the old days pre-2020!) rather than scroll and click yet again.
In the meantime, the moratorium on forfeiture looks set to be extended, providing further protection for businesses and in some instances excuses to non-paying tenants. This remains is the only area in which government has chosen to intervene so significantly and indiscriminately is unclear, particularly as some retailers have managed to trade throughout and still benefit from the same protection.
The residential sector has powered along for many months now, supported by the SDLT holiday and the desire for better housing and home working environments. The risk is that the desire to convert all unused property to residential use takes over too much. The British Property Federation has warned, the pace of any conversion of retail to residential will need to be checked or the high streets will end up as a mixed bag and a diluted destination. Permitted development rights could hasten the death of the high street, with little gained in its place.
2020 was also a record year for ESG (Environmental, Social, and Corporate Governance) and sustainable investment. Some of the world’s biggest investors are tapping into the growing demand for “green” real estate loans, an area where there is growing demand from both the buyers of real estate and the debt providers that fund purchases. Finance has become more innovative in this sector, with loans incentivising sustainable practices by offering a lower interest rate margin if certain sustainability milestones are hit.
Asia’s largest REIT, Link, said in January that it had converted a loan secured against its debut London office purchase to a new £200M sustainability-linked loan. The five-year loan is provided by BNP Paribas and DBS and is secured against the Cabot, an office building Link bought in 2020.
AECOM have completed a $1.1bn loan from Bank of America with both incentives and penalties, based on whether the business succeeds or fails in reducing greenhouse gas emissions, in line with specific targets as well as improving the percentage of women in the firm, adding diversity to the equation.
As we head towards the anniversary of the start of the first lockdown next month, our lives, work and environments have been derailed as we could never have imagined. They are likely changed forever. My hope is that this leads to an emancipation from the worst of the ‘old’ ways and a renaissance of new ideas, new methods, innovation, equality, environmentalism, and life-enhancing outlooks.
So, what comes next? Well, with the road map out of lockdown due to be announced on 22nd February, soon you’ll see …