Covid-19 and real estate investment in the UK
As is universally acknowledged, we are living in unprecedented times and it is not only the UK's signature National Health Service which is bearing the brunt of the virus. Gulf investors who are wondering about the impact of the virus on real estate markets may be interested in our sector by sector analysis and list of practical steps to take.
This is the first in a series of three articles aimed at Gulf-based investors who are interested in, or already invested in, the UK commercial real estate market. In subsequent articles, we will be dealing with the impact on real estate banking arrangements and a real estate insolvency Q&A.
The impact of Covid-19 has been global, resulting in significant changes to financial and property markets, spending, public policies, the workforce and social behaviours. In this article we analyse some of the impacts of Covid-19 on real estate investment in the UK, and flag some key considerations for GCC property investors, portfolio managers and property developers.
Covid-19 has further impacted the retail sector. In an effort to contain the spread of Covid-19, retailers including John Lewis, McDonald's and Arcadia group opted to temporarily close stores - sacrificing sales to do so. Following Boris Johnson's announcement on 23 March 2020, all cinemas, restaurants, bars, gyms, theatres, clubs and shops, other than food stores and pharmacies and other limited exceptions, have closed.
Covid-19 has had a significant impact on the finances of some retailers, prompting updated financial strategies and the reassessment of promised dividends. Next reported that sales declined by 30% between 15-17 March 2020, M&S cut capital spending and Laura Ashley was the first retailer to file for administration, confirming that "the Covid-19 outbreak has had an immediate and significant impact on trading".
Many landlords – particularly those with strong social governance credentials – have been open to conversations with their tenants about rent payments. The moratorium on evicting commercial tenants announced by the Government on 23 March 2020 will give relief to retail tenants whose landlords have not already taken supportive steps.
The uncertainty in the market has also impacted property investment funds, particularly those which are open-ended, with several property funds suspending redemptions by investors. As reported in the FT on 18 March, online investment service Tilney has said "the issue being cited by the funds is the inability to accurately value holdings, not that they are seeing investor redemptions". This a notable difference from the suspension of redemptions by investors following the Brexit referendum in 2016, which were driven more by investor uncertainty.
However, there are several sectors which are seeing increased activity in response to Covid-19. E-commerce is one of them. Amazon is reported to be hiring employees at an accelerating rate for overtime, as consumer shopping habits move further from in-store to online during the lockdown. Supermarkets have seen huge surges in customers, with consumer fears over lockdown leading to panic buying and stockpiling of household basics and non-perishables. Retailers including Tesco and Asda have already initiated hiring sprees to cater for demand outstripping supply with March 2020 seeing record levels of grocery sales. Other sectors anticipated to see uplifts in revenue include healthcare, at-home fitness brands and remote working tech.
It is anticipated that there will be a drop in demand for co-working office space while self-employed workers and small businesses are working from home, following UK Government advice on social distancing and self-isolation. This has already impacted big players in the office rental market; WeWork's bonds traded at a record low of 55 cents on the dollar last week and IWG cancelled its dividend in an effort to mitigate the impact of Covid-19.
As news of the pandemic emerged, corporates have been implementing their business continuity procedures and innovative ways for their businesses to connect and communicate as most non-key worker employees set-up home offices. For many businesses Covid-19 has been (and will continue to be) an experiment in an entire workforce remote working. Should it prove effective, will 'business as usual' post-Covid-19 dramatically change, and will agile working and hot desking become the "new normal" rather than the exception leading to reduced demand for office space?
Build to rent
On 18 March 2020 the Government announced that landlords cannot evict tenants for three months, in an effort to protect individuals who have lost their jobs or whose income has significantly reduced as a result of the virus. In addition, and in order to afford landlords the same protection, the Government has granted residential buy-to-let landlords whose tenants are experiencing financial difficulties due to Covid-19, the ability to apply for a three month mortgage payment holiday. Landlords and lenders are intended to subsequently agree a plan to make deferred payment.
It seems likely that universities will remain closed for the summer term. For the direct let market (where there is a no nominations agreement in place) it seems likely that this will have a significant impact on investors. For leveraged landlords this may cause loan covenant breaches which will need to be waived by lenders. The impact of loss of rent will likely hit investment managers who may look to re-negotiate their promote fees (or otherwise miss out on this incentive all together).
Of all sub-sectors, hotels and leisure has been hit the hardest by the impact of the virus, with the cancellation of thousands of bookings around the world, and the temporary shut down of the global travel industry by governments imposing travel restrictions. It is unclear at this stage when restrictions and social distancing measures will be lifted or eased and therefore some UK hotels are being temporarily re-purposed to house the homeless and provide potential hospital overflow options for additional medical beds.
A number of high profile developers including Taylor Wimpey, Galliard and Barratt announced that they are shutting their construction sites to ensure the health and safety of their staff.
Each building contract should be checked to understand what the relevant contractor's entitlements to extra time and/or loss and expense are in these circumstances. For example, a standard industry form, such as the JCT 2016 Design & Build, provides a contractor with an ability to claim an extension of time if, amongst other things, it can show the works are delayed due to "force majeure". The burden of proof in that instance would be on the contactor to establish that because of Covid-19 the works were delayed, the contractor's failure to perform was due to circumstances outside of its control and that there was nothing that the contractor could reasonably have done to avoid the event or mitigate its effects.
The landscape is changing on a daily basis but investors are building strategies to manage the impact of Covid-19 on both their real estate assets and their investment businesses.
Gulf investors can help themselves to weather the storm, by proactively managing their business risk and by planning ahead now for the weeks ahead:
- Liaise with your insurers to see whether your policies offer any assistance in the wake of current or future Government announcements. Encourage your occupiers to do the same in relation to their own business interruption insurance.
- Urge your occupiers to look into the financial assistance packages being offered by the Government to help support their businesses and job retention, and be open to a dialogue with struggling occupiers. If any rent arrangements are proposed, liaise with your insurers and any lender, and take legal advice on how best to implement them without falling foul of penalty or consumer credit restrictions.
- Review your ongoing construction projects to ensure that you are complying with your health and safety duties and Government guidance. Consider your "force majeure" and delay position in readiness for any labour or materials shortages or further site closures.
- Prepare your "worst case" business continuity plans now, so that your business can continue to keep up with the current pace of change. Consider the location and availability of signatories and remote working contingencies where transactions need to be completed, such as consider using powers of attorney. Check that your video conferencing solutions are cyber-secure and comply with GDPR and other regulatory requirements.
In our daily lives we are all dealing with each new challenge as it arises; and the same applies to the business world. The real estate investment industry is a resilient one – with planning, strategy and good communication we can adapt, find work arounds and successfully navigate these challenging waters together.