The coronavirus (COVID-19) pandemic has devastated many UK industries – not least sections of the commercial property market. Lucy Trevelyan explores COVID-19’s lasting legacy for the sector and examines how it can evolve to survive
A year’s worth of on/off lockdowns has seen the traditional high street – already on the endangered species list – now practically on its knees, with 4,500 stores closing in the UK between January and November 2020 alone, leading to the loss of almost 100,000 jobs.
Pubs, restaurants, hotels, and hairdressers have been hit hard, while expensive office space has been gathering tumbleweed as the enforced working-from-home revolution took hold – a trend which sees little signs of easing even if the pandemic abates, as workers, having proved that remote working is feasible, demand more flexibility in future.
“The pandemic has also thrown up challenges in delays to projects either on site or in the planning stage,” says Emma McGlinchey, real estate partner at Aaron and Partners. “Site visits and surveys have been delayed due to restrictions. Decision-making and progressing transactions have been difficult sometimes with clients and other parties working from home. Local authorities have been stretched with planning decisions taking longer to be determined and issued. Staff have been diverted to other teams leaving a lack of resource in important areas.”
Retail and office closures
“It’s not an overstatement to say retail and office markets have been devastated by the pandemic,” says Will Henson, partner and head of commercial property at Slater Heelis. “It’s been a real nail in the coffin for retail. The demise of the high street predates the pandemic; COVID-19 simply sped it up. There’s an appetite nationally for positive change, meaning the high street’s accelerated downturn will be seen as a regeneration opportunity, likely focused on leisure over retail. It’ll spur on some creative thinking.”
“With the changes in consumer purchasing behaviour that have developed over the pandemic, the demise of well-known, high street brands and the reduction in physical footprint of others, property use in the high streets will change,” says Peter Taylor, managing partner at Paris Smith. “People are more supportive of local businesses, so on smaller high streets we may see more non-chain and local or niche businesses.”
“We are definitely likely to see a change on the high street,” McGlinchey says. “Several well-known names have disappeared during the lockdowns. The permanent closure of major stores – such as the Debenhams chain and the Arcadia Group shops – will leave gaps in many shopping areas. Some local councils are putting together task forces to review how to manage gaps created by these and earlier failures such as the BHS chain.”
“The high street will always be a place that people like to go,” she says. “Meeting, learning, doing and eating can all do well on the modernised high street, keeping these spaces important for communities for years. Space will have to be recycled, access has to be easy and visitors need to feel secure and welcome. Further, the high street needs to listen to consumers and respond quickly.
“Local authorities have been pressing ahead with regeneration projects to boost their locality, with areas surrounded by residential areas with a higher balance of independent retailers perhaps emerging as the more resilient.”
Current conditions and price corrections mean investors and new buyers are looking to repurpose assets to other uses
Chris Sullivan, Hollis
Taking Chester city centre as an example, Chester Business Improvement District reports that the city is seeing a dynamic shift in direction over the last year – more than three-quarters of new businesses (76%) are independently owned, while 78% of the closures came from national chains or global brands.
“In the retail property market,” says Chris Sullivan, partner at real estate consultancy Hollis, “current conditions and price corrections mean investors and new buyers are looking to repurpose assets to other uses, such as offices, last-mile logistics warehousing or residential development. We are surveying more retail units and retail portfolios for banks when loans are refinanced, so they have a full picture of the property, as well as in refinancing loan-to-value covenants.”
“Struggling retailers and hospitality groups are turning to CVAs (company voluntary arrangements) as a way of restructuring property portfolios,” Sullivan says, “reducing operating costs and closing failing stores in a cost-effective way. Landlords are currently missing out on protecting their income and insolvency voting rights for tenants going into administration and implementing CVAs on properties they occupy. The answer though could lie in having potential dilapidations schedules pre-determined.”
“Post-COVID, it seems likely that fewer people will be working five days a week in city centres,” says Hugh Angus, commercial property partner at Balfour+Manson, “however, whether there are 20% or 40% fewer people in the city centre, and whether space per head will need to increase, there will be consequences for ancillary services. Lowering rents for restaurants may attract start-ups and challenge established multiples. People working at home may drive demand for neighbourhood services.”
Offices and new models of working
Even with the focus on remote working, movement in offices is forecast to remain the largest sector and likely to remain the core investment of choice, says Tracy Burtwell, sales director at SearchFlow. “The suggestion is that the demand for offices will not diminish even though home working may continue; instead, the way offices are used may change, with central business districts likely to remain resilient.”
A return to some extent is expected in the office markets, Henson says, albeit in a different guise and with variation between businesses. “Organisations that rate culture and collaboration will ultimately see the value in office estate, but will likely hybridise this with home-working. We’re also anticipating a growing demand for smaller, more flexible workspaces for companies downscaling their operations and premise requirements.”
Indeed, in the financial services sector alone, there is a huge shift in office space use. Nationwide has told its 13,000 office-based staff that they can ‘work anywhere’ in the UK as it cuts office space; HSBC plans to move more than 1,200 staff to permanent work-from-home contracts; and Lloyds Banking Group is reportedly aiming for a 20% reduction in its office space within three years.
This trend, says McGlinchey, may create opportunities for smaller regional centres as people want to work closer to, but not necessarily at, home: “The pandemic appears to have accelerated the shift towards a hub-and-spoke model where companies have their headquarters in a major city and satellite offices in the smaller regional towns and cities. Workspace provider IWG saw increased interest in flexible office space outside the big cities and its homeworking packages.”
Flexible office spaces
The flexible working model of many professional service firms will lead to discussions around board tables as to the role of the office, particularly on how it is best configured for staff and to enhance the client experience, says Taylor.
“Offices will have a role as a place to work collaboratively, for learning and development, and to retain the culture of a business. We are social animals and like to spend time with others. That said, the absence of the commute for many will have been a great benefit. This will be a driver for businesses based in the major conurbations to move to regional hubs closer to where staff are living.”
Tenants may want greater flexibility to change their desk or space arrangements at short notice. A lease may therefore not be the most suitable contract
John Szepietowski, Audley Chaucer Solicitors
Landlords and investors with large office block portfolios need to assess how their assets are being used, Sullivan says: “This may mean a sudden burst in shared workspaces in areas of the market that have previously remained very traditional, such as within commuter towns. A clever approach to fit out is going to be vital if landlords want to adapt large, empty floorplates, to compete with more established shared workplace operators.”
Although there could be a rise in the popularity of companies sharing office spaces or renting a desk, rather than taking on a whole building, this trend could throw up issues, says John Szepietowski, partner at Audley Chaucer Solicitors.
“There could be issues with client confidentiality and arranging meetings, especially if there are open-plan offices and lack of security with regards to software and physical file storage.”
There is also an interesting legal dimension, he says: “Leases generally allow for exclusive possession of a defined area of property, which means there can only be one tenant of any one space at a time. This would mean the floorspace itself would have to be defined and then divided up between the different tenants. It would also mean that ‘hot-desking’ between firms and moving around the office may be a legal minefield.”
There is also the issue of term, he adds: “Tenants may want greater flexibility to change their desk or space arrangements at short notice. A lease may therefore not be the most suitable contract, as any variation to it would involve amending the original lease and therefore increased legal costs on both sides.”
A licence is an option, he says, but these do not confer any security of tenure and leaves licensees at risk of being uprooted from their office at short notice. “They are also personal to the individual so cannot be sold or assigned and nor would they survive a change in the freehold ownership. Therefore, these might only be suitable for small office spaces and where there is a strong relationship between the freeholder and prospective licensee.”
A third option, he says, would be for commercial properties to be occupied by tenants at will. “These arrangements can be terminated at any time by either party and may not specify the frequency nor amount of rent paid. While this may seem bizarre in the commercial setting, in the immediate aftermath of the pandemic it could be a risk-free way for tenants to experiment returning to the office, and for landlords to at least secure an income from properties that may otherwise be empty.”
Online purchases have risen to 30% of total retail sales, and e-commerce continues to fuel the need for new logistics and warehouse units to be built and existing ones to be refurbished, bought and sold, says Sullivan. “We are seeing a rise in last-mile logistics hubs in towns and cities, and this is a trend that is likely to stay for the long term.”
As well as a boom in industrial sites as a result of a shift to online shopping during the pandemic, renewable energy sites have also remained robust, McGlinchey says.
“There does not seem to have been any drop off in the number of such sites being progressed due to COVID-19. For such projects, the development timelines are usually years rather than months so the developers can take a longer-term view. Also, climate change isn’t going away any time soon.”
Commercial property disputes
With difficult economic conditions come disputes, with rent payments having been the main root cause for disputes as a result of COVID-19, says Blaser Mills Law partner Jonathan Lilley.
Rent arrears have mostly been caused as a result of the financial struggles businesses have faced due to the pandemic, but there have been cases where tenants have used the situation to their advantage, he says.
“Some have tried to use the pandemic to bring their current lease to an end, which in most cases is not possible unless there is a clear break clause. We are seeing commercial disputes as tenants attempt to withdraw from a lease they are still bound to, or seek to force a landlord into a surrender. In extreme cases we have seen tenants literally clearing out of their premises and sending keys back to the landlord.”
Currently, he says, the restrictions placed on commercial property landlords means they are limited in the ways they can counter disputes relating to rent arrears.
“However, landlords can pursue rent by means of a simple debt collection exercise. It is a quick and effective way of retrieving rent arrears, which does not involve seeking to obtain possession of the premises. Landlords can force the tenant into action which then may lead to recovery of some or all of the arrears, or at least bring the tenant into an affordable repayment programme.”
Unfortunately for landlords, he says, the forfeiture of commercial leases, whether by court action of peaceable re-entry, remains in a moratorium until 30 June 2021 where non-payment of any sums due under the lease are the reasons to forfeit.
“Once these restrictions are lifted, we are likely to see an increase in actions and disputes, and the true impact of the pandemic on commercial property relations.”
Disputes are still likely even when COVID-19 is on the retreat, he says, with tenants likely to try to use break clauses, frustration or ‘force majeure’ to look to end their leases early.
“Disputes around liabilities and obligations are also likely to crop up, especially as high street and office premises have remained vacant for so long. Additionally, as a result of the decrease in demand for office and high street commercial spaces, some landlords may be looking at re-development options for their premises. Landlords who decide to do so may find themselves open to disputes relating to dilapidations, as tenants may argue that there is no need for the property to be repaired if it is going to be re-developed.”
The UK has always had a love affair with commercial property, says Peter Vinden, a chartered quantity surveyor and chief executive at real estate consultancy Gateley Vinden – and he does not see that changing. “I suspect commercial property is going to become fixated on carbon-neutral buildings and there will be a shift to consider the wider impact on the environment. Investors are becoming increasingly aware of these issues and the demand for greener buildings will continue to gather pace in the years ahead.”
It is always difficult, he says, for commercial property clients to decide how to put themselves in the best possible position for the future – particularly given that they are trying to plan and build properties that are likely to be in demand when a property is finally constructed potentially years down the line.
“There is a school of thought that developers need to design and construct with as many potential uses for a building as possible. We have seen a plethora of city centre offices converted to apartment schemes. Large industrial sheds may be in demand now but who knows whether this level of demand will remain consistent for the next five or 10 years. Should these large sheds be designed to allow for splitting up into smaller units in future years? There is no easy answer to this other than perhaps to invest in buildings that may be put to more than one potential use as demand changes in the future.”
Given the UK commercial property sector directly employs more than 1.2m people and contributes over £100bn to the UK’s economy annually, one would have expected the government to do more for the sector than it ostensibly has, says Aubrey Calderwood, managing director of Gateley Capitus, a fiscal incentives consultancy for commercial property.
However, apart from the furlough and business rates relief schemes, which applied to all sectors, there are some recent initiatives, he says, that “would clearly benefit the commercial property industry and provide a stimulus for investment if proactively considered in investment”.
This, he says, includes chancellor Rishi Sunak’s ‘super deduction’, which allows companies to claim tax relief for a limited period on ‘main pool’ and ‘special rate pool’ plant and machinery, which could be a stimulus to commence building works on many types of property.
He explains: “Under the pre-super deduction capital allowances regime, £100,000 of main pool and £100,000 of special rate plant and machinery would give £24,000 of plant and machinery allowances to set against profit before tax in the year the expenditure is incurred, reducing each year thereafter. Under the super deduction regime, it would be an up-front £180,000 allowance in one year.”
Businesses that establish themselves in one of Sunak’s planned Freeports should benefit from more generous tax reliefs, customs benefits, and wider government support, says Calderwood, while businesses should also take advantage of other fiscal incentives while they are still available.
These include: the two-year freeze on corporation tax levels; the Annual Investment Allowance remaining at £1m until 31 December 2021; the Land Remediation Relief regime continuing to offer an incentive of 150% of the cost of remediating contaminated land or buildings; and for the second-hand property investment market, plant and machinery allowances continuing to be available to investors and owner occupiers investing in existing buildings.
“In summary, while there may not be many obvious post-pandemic measures specifically targeted at the property sector, there are some very attractive incentives in existence which could provide additional support and a stimulus for investment over the next few years,” concludes Calderwood.