Fund Finance Insights 

Banking Brief:
Making sense of the UK Property market

5 minute read time

The latest webinar in our Banking Brief series reviewed the impact of Covid-19 on the UK property market so far, and looked ahead to what’s in store.

The impact of the coronavirus pandemic on the UK property market has been felt in many different ways: both short-term shock and long-term reassessments. Some sectors immediately came under considerable pressure, with others experiencing spikes in demand from opportunistic investors. At the same time, landlords and tenants, investors and lenders were all working hard to maintain stability and keep the lights on as the global situation grew more volatile.

Clearly, in the short term, the shock of a global health crisis caused everyone in the market to pause and take stock. And, as Jessica Berney, fund manager at Schroder UK Real Estate Fund (SREF), explained, the challenge was unprecedented.

“It’s new territory for everyone: investors, landlords, tenants,” she said. “And while everyone continues to work normally, managing their assets and running refurbs and so on, Covid has added about 400 more tenant conversations about how we can support them.”

To put that in context, that represents about half of SREF’s tenants – and Berney was keen to point out that the crisis has led to a greater level of collaboration between investors, tenants and landlords to navigate through the short and medium term. “They want to understand the real estate implications of the latest developments and how they will play into our strategic approach.”

And, so far at least, activity has continued, with SREF alone doing 98 leasing transactions and rent reviews since the beginning of March, adding 25% to their contracted rent roll, totalling an additional £24m per annum.

The compound impact of Brexit

While there has undoubtedly been disruption, Berney explained that the looming impact of Brexit had actually helped SREF navigate through this unforeseen turn of events. “We’re actually in a good position, thanks to a defensive portfolio, long income, affordable rents, realistic valuations and a limit on speculative developments.”

In addition, there have been lessons on the construction side: “We clearly had a lot to deal with in terms of impact on supply chains,” Berney said. “The biggest lesson focused on what needs to happen for future construction, not only in the final outcome of the building, but also how we get there and addressing new procurement techniques and global supply risks.”

Chain of support

Berney’s reliance on a thematic approach to investment is perhaps illustrative of a wider industry move away from certain sectors and towards others. For Tom Sharman, head of strategy and insight at NatWest Real Estate Finance, the immediate priority once the pandemic hit was to make sure the bank was part of the solution, not the problem.

“While there were clearly immediate impacts, especially with retail tenants struggling to pay rent, we had to ensure we weren’t in the way of letting our customers help their customers. So we offered a range of support measures from capital repayment deferrals to interest roll-ups, covenant waivers and short-term extensions on terms.”

And Sharman reports that, in the teeth of the crisis, around 25% of customers took on some form of support during the initial six-month period. Since then, however, it’s telling that the second round of support measures offered by the bank has seen much less take-up. So does that herald a return to business as usual?

“The biggest lesson focused on what needs to happen for future construction, not only in the final outcome of the building, but also how we get there, new procurement techniques and global supply risks”

Jessica Berney, fund manager, Schroder UK Real Estate Fund

“Certainly, we’ve seen some really effective responses,” Sharman says. “For some that’s meant reorganising their operations, perhaps switching to monthly rents, or agreed deferral plans, and we’re seeing a real improvement in rent collection numbers in Q4 compared with Q3.”

Different trends across sectors

With Brexit still looming in the background, the final months of 2020 and beyond will remain challenging for the real estate industry. But a closer look at the sectoral trends does reveal some interesting signs of opportunity and growth for those prepared with the right strategy.

“There are a range of both short- and longer-term impacts and they will play out in different ways across sectors,” Sharman said. “But generally, the themes show that logistics, where the Covid impact has been largely positive, with a big spike in demand, will remain buoyant; we don’t see Brexit derailing that.

“With offices, short-term Covid risk is neutral, but the longer-term impact of Brexit may be negative. The direct impacts of past pandemics have typically lasted for up to two years, beyond which I would expect to see a robust recovery in the appeal of city-centre offices, which will bring along the associated retail and leisure sites around them.”

A closer look at leisure, which has had a hugely negative outcome from coronavirus so far, may offer an interesting investment for those seeking short-term private-equity-style opportunity. “It’s not for the faint-hearted, and some leisure operators will inevitably fail,” Sharman said. “But if a vaccine does soon become widely available, then there’s no reason why leisure assets and operators can’t return to where they were before; indeed there may be a pent-up demand ready to grow them even further. So for someone with a high-risk appetite, there’s an opportunity there.”

And, as the focus on ESG (environmental, social and governance) increases across the investment landscape, sustainability will continue to influence decisions in the property market, says Berney: “In past recessions, sustainability has been a buzzword that’s faded as other pressures crowd in; but things are very different now. The whole chain has priority: investors, landlords, tenants and lenders. The key this time round is that all parties are aligned, and that improves the viability of sustainable buildings.”

Risk assessment

Berney agreed that variations in investors’ risk appetites would play a major role in the prospects for each sector. In her view, there are some unrealistic assumptions flying around, with prices not reflecting rental growth risks in the industrial sector in particular, and  longer-term headwinds remaining in retail and leisure.

“However, we’re seeing more opportunities, largely thanks to less competition out there. And while that hasn’t moved the prices on more desirable assets, it has on secondary assets,” she said, pointing to SREF’s recent acquisition of an office site in Cambridge as proof that some deals are still being completed.

Ultimately, as Sharman explained, some fundamentals remain unchanged in the face of uncertainty. “Clearly we have no way of knowing how Brexit will play out, or when or if a vaccine will come, so we have to ride with those things.

“For us, the biggest takeaway has been that lenders, landlords and tenants have been able to work together very well to get through the worst of it. And that lays a good foundation for the future once Covid is – hopefully – behind us.”

By Christian Doherty