The COVID crisis is throwing up all kinds of challenges for the real estate industry. Some of these are rapidly accelerating trends that we’d already recognised, but others are entirely new. Over the coming weeks, we will be hosting a series of events bringing together senior industry leaders from specific areas of the industry to share their thoughts on the critical issues that they are dealing with right now.
Thomas Hughes, Partner at Bohill Partners held the first of these last week, gathering 19 leaders from the UK and European retail sector and across real estate investment including Multi, Hammerson, Pradera and Capital & Regional. Whilst we, unsurprisingly, weren’t able to solve all the issues affecting the sector in 90 minutes, we did raise a number of key questions:
Is this a big bump in the road, or does it lead to fundamental change?
There was a split in the group on this – some focused on how COVID-19 is a brutal acceleration of existing trends (particularly around shoppers moving online), whereas others saw it as a key inflection point: some shoppers who would have never previously considered buying online are now being forced into it, and they may well not go back. The big questions that need to be answered are ‘when can we return to normal?‘ and ‘what does the new normal look like?‘ Most are past the initial pressure point of securing temporary liquidity, so the next key issue is to find the formula for re-opening. Over the next 6-12 months, how are consumers going to be able to interact, and will they get comfortable going back into a shop for anything other than the essentials? If customers are only visiting briefly to shop rather than as a pastime, this will have a big knock-on effect, particularly on the F&B outlets and leisure elements in shopping centres, as one of our participants noted.
How does this change your relationships with tenants?
A long standing mantra in the retail property industry is that tenants appreciate loyalty and will repay you in time. But, does that still apply in such an exceptional situation, particularly when some well-funded retailers are simply refusing to pay rent? Relationships between many retailers and their landlords were becoming increasingly strained before the crisis, and this has only exacerbated the problem. And making the decision on who to support becomes an ethical minefield as well as a business one – should you ‘penalise’ a well-run retail business by giving their struggling competitors longer rent holidays or other support? What about a struggling tenant owned by a cash-rich investor – why should you be subsidising their returns? For some tenants, a rent holiday is simply delaying the inevitable – as a landlord, how do you decide whether a retailer is worth supporting? Cynically, you could see a crisis like this as a way to optimise your tenant mix but, when Thomas suggested this as a devil’s advocate, our attendees were unanimously against the idea – it will be hard enough to keep existing tenants in a time like this, let alone new ones. And to do that, the relationship is key – a letter addressed ‘Dear tenant’ that has been sent to every occupier of a particular shopping centre is not the best way to show that you care about individual customers. Similarly, a retailer sending a blanket ‘Dear landlord’ letter is not the best way to approach this situation. This applies double for multinational landlords – different rules and cultural norms in different countries have resulted in vastly different outcomes. Those who have local operations on the ground will find this easier to manage – especially for owners of smaller centres with local rather than international tenants.
How will this affect the relationship between landlords and the government?
This part of the discussion focused much more on the UK market, where business rates are substantially higher than in many other countries – one participant noted that the John Lewis store on Oxford Street pays more tax than Amazon does in the UK. Given the anticipated further slump in valuations and the upcoming rate review next year, this may change (benefiting retail landlords, and effectively putting a brake on more on-trend sectors, particularly logistics), but something may well happen quicker. Governments in a crisis tend to try and stabilise the system rather than to accelerate structural change – this may well lead to more government support for both retailers and retail landlords, although our group expected the government to be more sympathetic towards retailers. Before the crisis started, the Business Secretary included the BRC (whose number one issue is business rate reduction for retail) in weekly meetings – perhaps a clue that support is being considered? However, the unprecedented level of government expenditure will have to be paid for somehow – this may well lead to increased tax burdens on the likes of Amazon and ASOS, but it wouldn’t be much of a surprise if the government also targeted property investors, particularly those from overseas, as an easier target – it affects fewer people and may be easier to manage politically.
How does this affect the sector as an investment opportunity?
The sector certainly has an image problem – a number of investment managers reported that their clients are very interested in seeing value add and opportunistic deals that come out of the crisis for all asset classes other than retail and hospitality. It is hard to know what the true value of these assets are until rent levels on new leases begin to settle (information that we won’t have for some time). Ultimately, potential investors into the sector at the moment need to get comfortable with a lot of risk, and uncertainty that will continue for several months at the very least. One of our more upbeat contributors suggested that it might ‘normalise’ the market quicker than would have happened otherwise given that the retail market was very much in flux anyway. As we’ve seen in past crises, these difficulties tend to create winners and losers – there will surely be some investors who dive into certain retail investments at the right time and do very well. Now, more than ever, it is important to understand the specific dynamics of the catchment area of an asset.
So, in summary, a lot of difficult questions and no easy answers – but some rays of optimism shining through the dark clouds.
What are your views on the future of the sector? Will we see such seismic change in any other areas of the industry?