Retail and hotels have taken the brunt of lockdowns, while logistics and residential have fared much better. Even when Covid-19 is bought under control, the path of recovery is far from straightforward, writes Stephanie Baxter
With the UK's mammoth Covid-19 vaccination programme well underway, the end of crippling lockdowns is finally in sight, giving hope to parts of the real estate sector that have been heavily impacted.
Retail and hotels have been particularly challenged and adversely impacted by the lockdowns and restrictions, while other sectors such as logistics and residential assets had a great 2020, attracting huge capital flows.
But even if and when Covid-19 is bought under control, the path of recovery is far from straightforward.
PGIM Real Estate head of European investment research Greg Kane says it is striking just how wide the range of plausible outcomes still is: "We're starting the year with an incredible degree of uncertainty, which could lead to very positive outcomes or, as we've experienced in the last few months, there could be setbacks and challenges to overcome."
For Mayfair Capital chief investment officer Tim Munn it is very helpful that the UK got a Brexit deal at the end of 2020, because given where we stand now on Covid-19, a no-deal scenario would have been very bad for the market.
"It means that we're now free to focus on Covid-19 as being the big obstacle," he says. "And while we're in another national lockdown, we're in a better place than we were nine months ago. While infection and mortality rates are higher, we do have a vaccine which is being rolled out. It's a case of allowing that to play through before we can start thinking about getting back to normal, and there may bumps along the road."
From the property market perspective, Munn does not see any real change in the impact of the economy and thinks there is even a bit more stability within the economy than in the first lockdown in spring last year.
However, there could be risks to value still to come in real estate as it tends to lag the wider economy. "When businesses struggle due to the wider economic circumstances, it does take a while to come through. So, the sector is still dealing with the effects of what's happened over the last six to nine months," says Kane.
Polarisation of sectors
There has been a real polarisation in the property market between sectors. Retail and leisure and hospitality have suffered significant declines in value and transaction volume. Retails and hotels in particular have had disrupted cash flow and limited financing options as lenders pull back to reduce their risk exposure, according to Kane.
The short-term outlook for these sectors remains very challenging, adds Munn.
It is "almost a little bit too early" to tell and we need to know a bit more about what the exit from this crisis is going to look like, continues Kane.
The big problem for retail is that in addition to the pandemic, there is also a big structural shift in the business model of retail with the move to online deliveries.
"It's pretty clear there is too much retail space, and we've already started to see retail space being taken out of the market to be converted to other uses," says Kane.
"We know that at some point, both in the UK and elsewhere, the retail sector is going to present itself as a very interesting investment opportunity. The truth is, it's probably not there yet because there's still a long way to go on the adjustment path, and that's also partly because the retailers themselves are not 100% certain what their business models are going to look like in several years' time - so there's a lot of uncertainties all the way through the system."
The types of retail that interest PGIM are those where there is a solid tenant with a reasonable lease term left but also has location and alternative use potential - because it gives some protection against the risks around cash flows.
Other sectors such as industrial logistics and residential have faired very well, with huge demand from investors in Q4 last year, and are expected to continue to do well in 2021.
Demand for logistics has increased faster than was expected as supply chains have adapted to sharp increases in online spending. Residential still delivers steady income, with occupancy supported by job retention programs, according to Kane.
Over the past 12 months, residential property has been reinforced as a very good place for capital, both in the UK and continental Europe, according to Kane, who notes that residential across Europe was almost a third of investment in real estate for the whole of 2020.
The office market is somewhere in between, because while tenants have generally continued to pay rent despite low space utilization, there are question marks over this sector's future.
Munn says: "Ultimately we're supportive that with a recovery, we will see a resurgence in the occupation of the office space. I think everyone's a bit fed-up with being at home.
"So once the vaccine is properly rolled out, I think we will see quite a big sort of recovery in certain sectors, and we expect consumer spending to come back which will benefit the retail and leisure sectors.
Offices after Covid-19
Flexible working was a growing trend even before the pandemic, and it is likely to accelerate after lockdown ends. "Employers are likely to move towards a more hybrid model of working in the future - more work/life balance for employees where there are benefits in terms of different ways of working that can be obtained from both working from home and in the office," says Munn.
But the pandemic has taught us that certain activities are better undertaken within the office space such as physical meetings.
"As real estate investors, we acknowledge that the requirements for offices will change as a result of this, and therefore it's important that investors are exposed to or hold those assets that are best able to meet those requirements."
During the Covid-19 crisis, Mayfair has been examining the offices it holds in its portfolios to see whether those are effectively fit for purpose and fit for the future.
Listed real estate
The significant drop in long-term interest rates means investors are looking at a lower required return on investment than 12 months ago, and so income generating real estate assets generally continue to attract capital.
Pension funds are seeking income like the stable inflation-linked cashflow that property typically provides.
Schemes globally have increased investment in publicly-listed real estate to complement their private allocations to the asset class, while UK pension funds, which have invested in private property for some time, have been slower to invest in the listed sector.
Cohen & Steers EMEA head of institutional sales and client services Marc Haynes says the private real estate market has not corrected as much as it needs to, while public real estate has corrected substantially, which has created a "substantial valuation gap between public and private".
He adds: "We normally see this at the early stage of the cycle, and real estate investment trusts (Reits) have historically posted very best numbers during these early cycle periods when they have massively outperformed equity markets."
"Given the meaningful underperformance we've seen in unlisted real estate relative to broad equities, I think this provides potentially very significant room for the listed real estate market to run."
Valuations of Reits relative to equities, but also to fixed income, are very attractive at historical levels.
Haynes explains that Reits have growing dividends and strong balance sheets, and they should appeal to investors in an environment of pretty low interest rates. "So there's a lot of reason to be positive, broadly for the property market, but also for the listed real estate market in particular over the next couple of years," he days.
That is backed by some of the investor flows that Cohen & Steers is seeing, adds Haynes: "Not so much for the UK, but certainly globally, we are seeing pension fund money looking beyond the weak absolute returns we've seen in Reits in the last year, and either start or add to allocations in public real estate."
Stephanie Baxter is a financial journalist at Rhotic Media