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Supermarkets and DIY win as home-bound consumers swap the high street for online

The crisis has accelerated structural changes already underway in how people shop, increasing online retail spending at the expense of the high street. The UK had one of the highest penetrations of online retail spending in the world before the crisis hit, and now that is set to rise even higher. Physical retailers have also been battling with high rates and rising labour costs.

Supermarkets have been the clear ‘winners', both online and offline, and have added significant capacity to meet demand. Sales have rocketed as a result of stockpiling, more meals being eaten at home and many more deliveries as customers vie for online slots weeks in advance. 

The Big Four operators have fared better than the discounters. Their bigger stores are well suited to large and less frequent transactions, while their neighbourhood store networks continue to meet ‘top-up’ needs. We expect supermarket values to hold up well and continued strong demand for the sector, having proved that it is resilient, particularly for long leases with inflation-linked rental uplifts.

Retail warehouse parks may also prove slightly more resilient than expected as lockdown eases.  The size and configuration of stores should make it easier to accommodate changes in trading to ensure social distancing. Typical retail park occupiers such as DIY and home furnishing stores may also benefit from expenditure on ‘nesting’ - as people invest in making their homes more comfortable places to spend work and leisure time. 

Leisure retail and mid-market clothing stores most at risk 

Mid-market apparel stores, which were struggling before the crisis, look to be most vulnerable, particularly where omni-channel retailing was under-developed. Expect to see more chains seek Company Voluntary Arrangements (CVAs) or collapse into administration. Vacancy rates in major high streets and shopping centres will keep rising, putting pressure on rents

Leisure-related retail, such as pubs and restaurants, also looks exposed. A large proportion of this sector is operated by independent traders, who will find it hard to survive a prolonged shutdown. This sector is also likely to be the last to be allowed to re-open as the lockdown eases. Social distancing measures that reduce capacity on re-opening will hurt profitability. 

Nearly all the growth in retail letting over the past few years has been from independent retailers, especially in personal services, such as nail bars and barbers, and restaurants and cafes.  A lack of demand, and an increase in business failures in these sectors will also contribute to rising vacancy rates on the high street.

Physical stores should continue to be in demand, but with fewer, more profitable players 

While retailers with a successful omni-channel business model have probably been more protected during the crisis, strong growth in online sales has not offset losses of trade in store, demonstrating that physical stores are still an important part of the retail offering.  A number of retailers have struggled to operate their online operational models in response to unprecedented online demand, as they are typically not as nimble as the pure play online retailers. 

There are two positives for investing in the retail sector in the medium term. Firstly, competition has been hollowed out in several areas, leaving a small number of profitable players, who should exit the crisis in a good position to capitalise on their market dominance. Secondly, valuers may take the crisis as an opportunity to write down values for retail. The resulting higher yields should reflect market rent corrections and compensate investors for the risk of shorter leases and longer void periods in the sector.

Warehouses see increased demand as supply chains move back home 

The industrial and logistics sector has not been immune to the downturn. Manufacturers have had to adapt production to meet social distancing requirements; supply chains have been heavily disrupted, and the auto and aerospace industries have seen an almost complete shutdown of production. Nevertheless, sectors such as food retailing and healthcare have proved very resilient.

The crisis has highlighted the importance of understanding both tenants’ business models and capitalisation, and at a broader level, the various industrial and logistics subsectors, from last-touch urban logistics to standard warehousing to specialist storage and manufacturing facilities. 

Niche players in segments hard hit by the lockdown, and that were already struggling before the crisis, have been seeking rent deferrals and may take time to recover. But looking ahead, warehouse demand from retailers is likely to increase further as they seek to address any shortcomings of their current fulfilment models exposed by the crisis. We are also likely to see an increase in demand for short-term storage as retailers seek to hold onto unsold spring 2020 stock until spring 2021.

Online retail growth should also drive demand for cross-docked warehousing and urban last-touch facilities, particularly around the largest UK conurbations. There is also some evidence that companies are considering a move away from just-in-time production and will therefore require greater local, and specialist, storage to ensure they have a contingency level of supply.

Some of the trends relating to on-shoring and re-shoring production and reducing supply chains were already in evidence ahead of the crisis, as UK-based producers were preparing for the end of the Brexit transition period. Global supply chain disruption may extend those plans further. 

Overall, demand for warehousing and distribution facilities is likely to increase post-crisis, but the ability to deliver income security and rental growth will be a function of understanding the tenants’ business, their location and the type of asset.

The changing functions of offices   

Office workers have been the least disrupted by the lockdown.  A new generation of video conferencing and file sharing tools has helped shift work from the office to the home. So much so, some organisations are considering a review of Business Continuity Planning (BCP) space for functions such as trading floors. This may result in an increase in supply and a fall in demand in some suburban markets around London.

In the short term, the trend towards reducing space ratios and hot-desking will be reversed to ensure adequate social distancing, but this is unlikely to outlast the pandemi

A longer-term trend may be a reduction in office needs altogether. Morgan Stanley and Barclays have already indicated that they expect to see a reduction in their office space requirements given the success of home working. However, offices are likely to continue to play an important role in facilitating meetings, team working and cross-fertilisation of ideas, as well as developing and supporting the corporate culture.  

Work also plays an important social function, and many workers will be happy to return to the office, even if it is for fewer days per week. Before the crisis, we were already seeing a gradual change in the balance between formal and informal meeting spaces and desk space in conventional offices, and we expect to see this continue.    

Employers are also likely to continue, where possible, to introduce wellness facilities to attract and retain employees. Amenity-rich locations offering attractive live-work-play environments will thrive.

A fork in the road   

There are two paths the industry could take. If the office’s prime purpose becomes bringing people together for specific meetings and collaborations, then there is likely to be a preference for centrally located, easily accessible locations.  

However, if the capacity of public transport is reduced significantly by social distancing for a prolonged period of time, we may see an increase in demand for locations that support car-based commuting or suburban locations that can be accessed easily on foot or by car. However, the resulting increase in carbon emissions would go against ESG goals and mark a dramatic reversal of trends seen over the past 10 years. In the longer term, locations most at risk are probably poorer quality fringe locations within cities, particularly if alternative residential use is a possibility.    

Residential and student housing disrupted, but data centres still in demand   

Investor demand for residential assets is likely to remain robust. However, there have been concerns regarding the UK government’s lack of support for landlords with respect to payment of rents in this crisis.

The challenge for those seeking exposure to the residential sector is the lack of assets of institutional quality. The main route to exposure to the sector is through development of new stock. However, it is difficult to access funding for this in a recessionary environment. 

Student housing had been seen as a relatively resilient sector. In previous recessions, students had opted to remain in tertiary education given the limited employment opportunities.

However, UK universities have become increasingly dependent on overseas students, and many student housing facilities have been targeted at this market. The sector is likely to be disrupted for at least the next academic year, and potentially for much longer as overseas students opt to remain in their home countries.

Data centre demand has remained strong, and there are concerns that insufficient capacity is being added globally. In the listed sector, data centre specialists have proved to be some of the most resilient REITs globally (see chart below). 


Scrutinising tenants’ ability to pay rent

Government policy will remain an important aspect driving the trajectory of the recovery, and also how well landlords are protected from loss of income in the short term. Industry groups are actively lobbying to ensure that the broader implications of loss of income are understood.

The crisis has thrown the spotlight on the importance not only of covenant strength, but more broadly understanding tenants’ business models and balance sheets. This is key to their ability to continue to be able to pay rent. We expect that real estate investors will pay more attention to tenant due diligence and the definition of prime assets will focus more on the security of the income stream than on their location and profile.

Kim Politzer

Kim Politzer

Director of Research