Real estate: Not a restart, a rethink

When the first lockdown began in March and the Prime Minister shockingly told us to stay at home for twelve weeks, I confess that I felt reasonably comfortable about it. I do not know whether it is politically correct to say that, but I had purchased a new hoodie that I planned to rarely change out of (no need for formal wear). I had my hair cut and after almost 20 years of working in London offices, the idea of working in a different way was appealing.

I was busy with work for my clients and Memery Crystal had invested astutely to cater for agile working when we moved to our Fleet Street offices in 2018. Brexit had happened (at least in name) and aside from the effects that were raging of the pandemic, it felt like an interesting time to trial something new. I have already confessed my belief at the time that the twelve weeks would be the extent of lockdown and my naïve expectation that the world would return to normal relatively quickly. That sounds ridiculous as I write this, given what we now know.

Fast forward to the present and this week brought the news that a vaccine developed by Pfizer and BioNTech could be approved for use as early as next month (December). Coupled with that, the government is preparing to spend more than £40bn to help deliver on Boris Johnson’s “moonshot” pledge for mass coronavirus testing across the UK. Talk is of a ‘near-normal’ by Spring.

For the economy and the commercial real estate industry though, the outlook remains somewhat bleaker. The economy has been fractured and has suffered massive disruption to its usual flow and balance. Pandora’s Box has been opened for many businesses that see cost savings on their occupational overheads as an obligation as much as an opportunity when their competitors are doing so to take advantage of, even taking steps that some might consider may prioritise those financial incentives over the happiness of their staff.

We identified four keys drivers of change in our “Real Estate: Disrupted” report from a year ago: Services, Destinations, Smart and Sustainable.  Landlords will have to continue to differentiate their offering, such as touch free access points and well-being benefits to secure the best tenants. All of those points remain key influences for occupiers, but flexibility has to now be added.

It is worthwhile considering for a moment, these trends which were already in play. One of the most interesting commentaries that I have noted came from the “Freakonomics” podcast,  during which the host and also writer of the book by the same name, Stephen Dubner, suggested, in the context of New York, that “we hit peak city a couple of years ago” and that population levels there had been falling since. He argues that this may be an acceleration of an existing trend – with push factors like the expense of living in cities, especially housing. He hypothesised that pandemic induced urban flight could have accelerated an existing trend. Since the onset of the pandemic, the attractions of major cities have become their greatest weakness. The sheer density of people used to sharing restaurants, theatres, trains, offices and co-working spaces represent the virus’s most hospitable arenas and have become environments that we must avoid.

Is there then a link between the suggested “death of the office” and the “death of cities” as a sociological structure? Is there a way back to the old working ways, intertwined with the old living habits? I believe that both will survive, but undoubtedly there will be a re-think of how we live, how we work and how we interact.

Offices will be used less but will continue to be the place for business. I expect that the confluence on central London and the major cities will dissipate and I have mentioned in previous articles that the ‘doughnut effect’ will raise increase the importance of suburban workplaces. Simply having a change of environment will be something that business people will crave, having sent their work force home, broken, surrendered or not renewed their office space. Flexible workspace is expected to make a strong resurgence but will have to prove that it is capable of keeping its visitors safe from contamination with the other users who share the same space.

I suggested in my first opinion piece during the early stages of the first lockdown that the real estate industry was in the midst of an existential examination of how it would be shaped post pandemic. We have been forced to WFH. Will the next step be WPFHAPFTO (working partly from home and partly from the office)? This seems inevitable and it seems likely that hybrid working is set to stay.

Personally, I cannot relate to those business of any scale that say that they will continue to have their staff working remotely indefinitely and never again occupy office space. Perhaps they will not use it as often and I can see how it is possible to hold a business in stasis remotely, but, particularly for professional services, where my experience has been, to teach the younger members of staff and to share ideas and forge new client relationships in best realised with an in-person presence. Not to mention the wellbeing of those that live alone or do not benefit from an ideal working environment at home. There is no doubt that flexible working will continue to allow commuters to split their time between the delights of major cities and the tranquility of suburban or rural living. The undeniable truth is that structural change was already happening and has rapidly accelerated because of the Covid pandemic, before it is even ‘over’.

Opinions remain split on how to go forward however. A good example is co-living. A sector that pre-pandemic was vaunted as a model for the future which allowed shared amenities that single traditional dwellings did not offer. I was asked recently by a contact to help them find funding for the early stages of a large co-living project. They claimed to have strong investor interest for the main project but needed assistance with a small initial loan. When I approached a lender that I have worked with, their response was that they were unlikely to fund a co-living scheme in the post-pandemic world, as their analysis was that demand was for more segregation and less communal environments, to limit any risk of contagion. Can they both be right?

At Memery Crystal, we have stated core values to protect the ethos of the firm. Maintaining them remotely is a challenge, as much of it is intangible and hard to write in an email. It is something that you experience in the workplace and absorb from the way in which colleagues treat and support each other in a friendly and collegiate manner.

It will be the case that offices will be used less as workers take advantage of hybrid working and the associated work/life balance, but they will remain an important focal point, a place to collaborate and share ideas and less a place to simply perform functions such as drafting. In my opinion this will ultimately be proven to be worth the costs associated and whilst they will be used less, they will remain essential.

There has been cause for optimism even in these turbulent times for real estate. PwC, one of Britain’s biggest employers has committed to retaining all of its office space even as a rise in coronavirus cases made staff prepare for months of working from home. The Times reported that “Kevin Ellis, 57, chairman of PwC in Britain, said: “Hybrid working is here to stay and therefore the office will remain a key part of working life. The future of the market for office space is difficult to predict — if anything at the moment we need more space than ever because of social distancing”. The nil sum game that I spoke of in previous opinion pieces remains a valid argument.

Shares in listed real estate companies made huge gains on Monday after drug company Pfizer revealed positive test results for its COVID-19 vaccine, with the possibility that doses could be ready before the end of the year. Retail specialists and companies with big retail or hospitality exposures saw the biggest jumps. Shares in Hammerson rose 40%, West End landlords Shaftesbury and Capco rose 22% and NewRiver REIT rose 18%. British Land and Landsec saw shares rise 26% and 19%, respectively. The housebuilder Persimmon reported a “strong third quarter performance, supported by firm selling prices and resilient demand for new build homes”, echoing the sentiment already expressed by Taylor Wimpey. All of this however masks the issue of how far they have fallen this year and what the future holds for those companies.

In other good news stories, Amazon has opened a new 2m sq. ft. fulfilment centre in Durham, bringing more than 1,000 new permanent jobs to the area. Amazon has purchased nearly a quarter of all the industrial space sold in the UK this year and according to data from Savills published by Property Week in June, Amazon accounted for 23 per cent of all the industrial space sold since the start of 2020, equal to 3.15m sq. ft. of the 13.5m sq. ft. total take-up. Some traditional occupiers have also shown their commitment to London in particular, with law firm Baker and McKenzie taking a pre-let for just over 150,000 square feet of office space at 280 Bishopsgate in the City, and TikTok nearing a deal to establish a new London office, in response to a large increase in staff for the social media company.

The casualties however are also plain to see. Intu has already fallen by the wayside and almost simultaneously with gains announced, it was announced that Land Securities has written down the value of its shops, offices and other properties by a further £945m alongside its half year results and reported losses of £835m to September. The value of Great Portland Estates’ London shops tumbled by almost a fifth as coronavirus restrictions took hold.

Property owners are facing a £4.5bn rent shortfall by the end of the year as collection rates continue to suffer, amid a government ban on evictions and aggressive rent collection. The government’s moratorium on evictions during the pandemic has resulted in a mass deferral of rent payments, particularly from retailers and leisure companies. The Times reports that Britain is once again at the bottom of the international GDP league table, with the economy 9.7 per cent smaller in the third quarter of this year than it was in the final three months of 2019.

In terms of the new vaccine, real estate will have its own part to play in the roll out. Reports suggest that the Pfizer vaccine will need to be stored at a temperate of minus 70 degrees celsius until the day that it is used, posing huge logistical challenges in preserving the millions of doses that will be needed. The Guardian reports that “Two vast football-pitch-sized facilities equipped with hundreds of large freezers in Kalamazoo, Michigan, and Puurs, Belgium, will be the centres of the huge effort to ship the coronavirus vaccine developed by US drug giant Pfizer and German biotech firm BioNTech, around the world.”

Whilst focus has been mostly on the Covid pandemic, potentially the greater issue remains the fallout from Brexit. We currently have no post-transition period deal agreed and our influence and importance to a new US administration is significantly diluted as we seek enhanced trade from that stable also.

So, what now? From a valuation perspective, the institutional lease is under attack, affecting certainty of income and the ‘copper bottomed’ upwards only cash cow that brought many investors to the UK is changing as never before. The timing could not be worse, give the likely impact that Brexit will have on the attraction of investing in the UK for overseas investors. I have recently negotiated a number of flexible tenancies, with elements of managed services, inclusive costs and tenant flexibility, that put the occupier in the driving seat when re-setting the longevity of the landlord / tenant relationship. Again, we predicted that this was an existing trend that has accelerated. Rents will undoubtedly fall in all but the best of class assets and the entire market will feel the effects.

The commercial real estate world has been through a revolution. In our report from a year ago we wrote that “Both macro-economic and socio-cultural factors are significantly changing just what it is that people require from property”. The importance of wellness in particular has become a distinguishing factor, even before the Covid effect. Those assets that cannot keep up will lie empty or encourage heavy discounts.

Commercial real estate will universally need a rethink from all involved with it – developers, owners, occupiers and beyond to reimagine how the built environment goes forward from here. Those that innovate will be the winners and I for one am looking forward to being part of the rethink.