Commercial Real Estate

2021 is already off to a weird start, but it has been dubbed a “totally new beginning” for the real estate sector as companies look to turn the page on 2020 and tackle the reality of a market reshaped by COVID-19. We examine the most recent events in the real estate industry as the sector transitions to a post-pandemic paradigm.

According to CBRE’s Real Estate Market Outlook Report for 2021, “the United Kingdom worker, employer, consumer, homeowner, or renter will never revert to pre-pandemic behaviours… not in 2021 and never.” If they are correct, this would represent a new beginning for the sector — a shake-up, or perhaps a required and timely shakedown, as some may argue.

The economy of the United Kingdom is not likely to recover to pre-coronavirus levels until mid-2023, with a sustained recovery and growth of roughly 6% in 2021. Central London’s commercial property market is expected to recover from a £3.9 billion dip in sales last year as investor confidence returns to the metropolis. Despite the fact that £8.9 billion in retail development sites, stores, and offices were traded in London in 2020, a 30 percent decrease from the previous year, there were hints of a resurgence in the last quarter due to new developments, with sales totaling £4.5 billion in that quarter alone. Volumes are projected to recover more during the following 12 months.

Office

There are indicators that the worst is past for the office market. Aside from the life sciences industry, which is particularly busy as a result of pandemic-related increases in financing and expenditure, office take up is expected to stay below trend in 2021. Demand is strongly reliant on employment growth, which is expected to be weak, at only 1.4 percent. Regional office rents are projected to hold up better than Central London rates, as London employment is expected to recover much more slowly than the rest of the country.

Employee work location flexibility will be a hot topic in 2021, with more than half of organisations already planning to implement some form of hybrid working. This shift toward lower office turnout may be compensated by repurposing space to aid in cooperation, productivity, and the social interaction that is so urgently needed once the isolation wears off. There is currently debate around COVID-19’s net influence on office demand, and while the concept of the office will not go away, what offices will look like in the future is unknown.

The experience of 2020 has shown that diversity of use is critical to resilience in the event of sudden major change, and one redevelopment to keep an eye on throughout 2021 is Grosvenor’s West End scheme, which has been granted planning consent for a £500 million mixed-use structure connecting Mayfair to Oxford Street. The property will be developed into 204,000 square feet of sustainable grade A office space, 33 houses, 67,500 square feet of stores, restaurants, cafes, and a hotel. This scheme’s popularity stems from a number of factors, including the preservation and adaption of historic structures for modern use, the production of 37 percent less carbon than other buildings built to current U.K. standards, and the 360 bike spaces it will provide. The impact of Grosvenor’s investment is best described by Thomasin Renshaw, Grosvenor’s director of development, as “a big vote of confidence in the West End at a pivotal moment for the capital’s economy.” It will provide so much of what is desperately needed – new jobs and a boost to the economy.”

Other investors remain bullish on the long-term prospects for high-quality property in prime London locations, with British Land exchanging on a £401 million West End office portfolio, selling a 75% stake in a portfolio of three buildings to Allianz Real Estate, and London’s ‘Cheesegrater’ (The Leadenhall Building) setting a new long-term office rent record for the City of London. Dtek, a Ukrainian energy business, has agreed to pay roughly £110 per square foot for the top floor, suggesting not just a want to keep a presence in the capital, but also a willingness to pay a high price to do so.

Construction

The Construction Total Activity Index in December 2020 was 54.6, which is above the 50.0 mark where growth begins and much higher than the 8.2 record low recorded in April. The outlook for the coming year appears encouraging, with higher underlying demand projected to continue and foreign investors more willing to source finance for UK projects now that the prospect of a no-deal Brexit-driven depreciation of sterling has passed.

Retail Leisure & Hospitality

Supermarkets, homeware, and DIY businesses have been resilient throughout the epidemic, but the closure of non-essential stores has put a significant strain on sales and will continue to have an impact in 2021 and beyond. This pressure will result in a preference for turnover leases and a shift toward shorter lease agreements with greater flexibility for tenants. Excess retail space and falling values create chances for retail properties to be reconfigured to include alternate uses, such as innovative pop-up retail, co-working spaces, and mixed-use plans, in the short to medium term. Versatile, agile landlords that can quickly adjust their business models and strategic ambitions to meet what tenants genuinely want (or even need to survive) in the post-pandemic world will be the most successful in the next year.

The effectiveness of the vaccination roll-out will be critical in the recovery of hotel demand, and hotels with little exposure to large gatherings, such as those lacking conference facilities, will recover the fastest. Despite the fact that total U.K. hotel investment declined 70% in 2020, the spike in demand for hotel investment following the 2021 immunisation effort, which will allow our borders and airways to reopen, should allow the sector to once again benefit from a global investor pool. In London, Knight Frank is currently advising on a number of high-value off-market purchases.

Logistics & Warehouse

Following the pandemic’s permanent influence on online retail and a better knowledge of the significance of warehouse space within our critical national infrastructure, investor hunger in the already thriving U.K. logistics sector will grow even more this year. Rents for well-located assets next to cities, urban regions, and other critical “last mile delivery” hubs will continue to climb due to strong demand and dwindling supply of large warehouses.

Lending

We anticipate that new possibilities will emerge in this market as traditional (and even some challenger) lenders exit particular niches, creating demand for others to fill those vacancies. This January saw the introduction of Silbury Finance, which aims to lend £3 billion in construction and student housing over the next six years and is backed by assets managed by Oaktree Capital Management, a multinational asset management group based in the United States. With all eyes on the change of guard across the pond, Schroders announced earlier this month the launch of a new full-service European loan platform centred in London. The platform covers all sorts of senior lending as well as high-yield and mezzanine capabilities in the United Kingdom and Continental Europe, and it comprises loan origination, underwriting, and asset management. Earlier in January, M&G revealed that in December, they made a £303 million loan to Singapore-based Sun Venture, financing the £552 million purchase of an office and retail building at 1 & 2 New Ludgate in London (interestingly, opposite our London office). M&G rated the financing prospect based on the lengthy leases, core location, and quality of tenant mix.

This is undeniably a great start to 2021, but the actual impact of the epidemic on UK debt markets will become obvious in the following months.

Conclusion: Positive Signs, Still Plenty of Uncertainty

COVID-19’s influence is wide and not yet entirely understood, but one thing is certain for 2021. As we move toward a new routine, investment strategies will need to be more fluid, nimble, and versatile than ever before if anything is to be learnt about how and where things might be done differently, and in some cases better. We continue to predict a surge in the number of tenants wishing to renegotiate leases to take advantage of the “new normal” market conditions, as noted in our statement on the September Quarter day. There will be a strategic benefit for the majority of landlords to collaborate with their tenants to discover solutions to help their businesses survive these challenging times. Other options are, of course, available and can be pursued if necessary. The COVID-19 Real Estate Task Force at Faegre Drinker is available to ensure that all topics are thoroughly considered and that any lease variations, agreements, and concessions are strategically agreed upon and adequately documented.