YEARS OF CHANGE, IN A YEAR TO FORGET
2020 may be a year many wish to forget, but the real estate industry has had to confront years' worth of change in nine months. All sectors have seen change, but some are experiencing structural shifts that will remain long after the crisis ends. It is therefore imperative that we take stock if we are to capitalise on the opportunities that are already emerging in 2021.
It started so promisingly. We had a new majority government that had just signed the Brexit Withdrawal Agreement into law, the source of so much uncertainty in 2019. With a new levelling up agenda, there were high expectations of a wave of regional growth that would be a catalyst for real estate investment outside London. Blackstone's £4.67bn acquisition of iQ's student platform was a signal that UK's "Alternatives" were now a main focus for the world's largest investors.
Instead, COVID-19 threw property valuations into turmoil. Investors were unable to price in risk adequately or conduct site visits, and landlords mostly opted to withhold disposals. Investment volume in Q2 nosedived 52% y-o-y to just £4.7bn. In the Central London office market, just £690m of assets changed hands in the second quarter, the lowest quarterly volume for 18 years. In the listed sector, office and retail REITs are still trading well below January levels, while logistics stocks have recovered from their March lows.
Security of income became the priority. Industry-wide figures show the June quarter day rent collection rate was just 38% versus 79% in 2019, not helped by the government's evictions moratorium. That said, most landlords worked hard to both help tenants and preserve income with payment plans, lease extensions and rent deferrals, and rent collection rates in resilient sectors such as logistics and BTR remained high. BNP Paribas Real Estate’s Q2 & Q3 London office rent collection still reached over 80% 21 days after each quarter day.
Despite the challenges, real estate is still a good source of income. With investment-grade bonds yielding sub-2.0%, equities highly volatile and interest rates close to zero, prime logistics yields have found space to harden to 3.75%, fuelled by rampant demand. Yields for Grade A offices let to secure covenants continue to edge downwards. IPD's 12-month total return was -1.9% in November (its eight month in negative territory), but other markets fared worse; the FTSE All-Share and EPRA listed index recorded -10.3% and -15.3% respectively over the same period. Investors keen to capitalise on this resilience helped volume recover to c. £9.0bn in Q3.
With investors chasing prime and distress now coming forward, we are forecasting growth of 27% in UK investment activity next year, with only 7% and 8% forecast for Germany and France respectively. However, acute uncertainty has accelerated pre-existing trends that will change the market forever. Occupiers now see flexibility as vital, whether than be in lease terms or fit-out. ESG initiatives and the low carbon economy have also been highlighted, particularly with COP26 next year.
These trends have considerable implications for income and capex risk, but they also bring opportunity. The pandemic has shown that landlords who actively engage with tenants and offer high-quality, digitally-connected, flexible space will outperform. BNP Paribas REIM's recent launch of the first Paris Agreement-compliant property fund is in response to growing investor demand for modern, green investments. This will widen the dislocation between prime and secondary performance. It may have been a year to forget, but with change gathering pace, those that do not keep up will be left behind.