“Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the world.” – Franklin D. Roosevelt, 32nd US president
The Roosevelt administration created the Federal Housing Authority in the 1930s to help kick-start the economy in the wake of the Great Depression. The president is probably permitted a little bias, but - even with the application of common sense at point of purchase - it is misleading to think of property as a safe investment.
The post-Covid world is demonstrating this, particularly in the commercial property sector, where cashflow is no longer as dependable as once perceived. The travails at Intu, one of Britain's biggest shopping centre owners, are a result of tenants withholding two thirds of their rent. British Land has experienced similar defaults in its retail estate. This is not surprising when Covid is estimated to be costing retailers over £17bn in lost sales.
In the low-rate environment we have experienced in the past decade, lots of investors have chased yields in real estate investment trusts (REITs) and funds, many of which have had borrowings that no longer look sensible given current challenges to rental income. It is often forgotten that REITs are compelled to distribute 90-95% of their income as dividends to shareholders. Those that wish to grow have no choice but to accrue debt, though many are now questioning the prudence of pre-Covid expansion plans.
Intu has been plunged into administration, with debts of £3.7bn. Rival Hammerson, which had collected only 16% of rent due for Q3 at the beginning of July, has tapped £30m of credit. Many more REITs have suspended dividends.
In reality, Covid-19 is accelerating existing structural trends that were already impacting real estate. A decade ago less than 7% of retail was online. At the start of this year it had risen to 20%, and in May it was over 33%. Will people return to shops or prefer to order online?
Retail is not alone in facing challenges. Many of us know of smaller businesses that have decided to dispense with offices altogether, having discovered that working from home is actually feasible. Larger businesses may now be questioning the need for large grade-A offices, especially high-rise.
By introducing Covid-safe hot desking and encouraging staff to work from home just one day a week, many companies could cut their space demands by 20%. That will have repercussions for rents and voids in the office sector.
Tenants are using the opportunity to negotiate rents downwards - we are seeing demands for rents related solely to turnover with lower fixed monthly payments, which increases income volatility for investors. They are requiring shorter terms or more flexible ones, at least.
Contracts are likely to shift to include force majeure clauses that include lockdowns and pandemics. Of course, many are just packing up and leaving. This has catastrophic consequences for the valuation of the asset (and the debt that backs this, which sits predominantly on bank balance sheets). It is difficult to see rental income recovering in the near future, which means dividends - when they return - are likely to be much lower.
This is a global issue. In France we have seen retailer associations asking the government for rent concessions. Deep rental discounts have been granted in Asia.