From shops to warehouses: is commercial real estate still worth investing in?

We inter­act with com­mer­cial prop­er­ty every day. From local cof­fee shops to logis­tics ware­hous­es packed full of Ama­zon parcels, com­mer­cial real estate forms an inte­gral part of the UK’s econ­o­my and is regard­ed as the old­est asset class.

Per­haps sur­pris­ing­ly, many peo­ple are exposed to com­mer­cial prop­er­ty invest­ment through funds, insur­ance com­pa­nies and pen­sions. “As soon as you tick the real estate option on an ISA or pen­sion, you’re a prop­er­ty own­er,” explains Adam Cof­fer, man­ag­ing direc­tor of real estate invest­ment firm EPF Group. “It’s not just the realms of cig­ar-chomp­ing barons.”

As coro­n­avirus swept through the UK, shops dropped their shut­ters, offices closed and hos­pi­tal­i­ty venues strug­gled to stay afloat. Almost overnight, reli­able income streams pro­vid­ed by rent sub­sided. 

Many land­lords are now fac­ing the prospect of emp­ty prop­er­ties and long peri­ods with­out rent pay­ments. It’s led some investors to con­sid­er whether the impact is tem­po­rary or if it sig­nals a greater shift in con­fi­dence in the sec­tor.

Repurposing retail

Retail was pro­found­ly affect­ed by COVID-19 as non-essen­tial ven­dors closed on and off over the last year. Dr Andrew Baum, pro­fes­sor of prac­tice at Oxford University’s Future of Real Estate Ini­tia­tive, says: “Retail prop­er­ty was in deep trou­ble years before COVID.” 

The sec­tor had been dam­aged by the 2008 glob­al finan­cial cri­sis and the creep of online shop­ping. How­ev­er, Baum is con­fi­dent there is a long-term space for bricks-and-mor­tar retail, but cau­tions: “There is almost cer­tain­ly too much of it.”

He points to the sig­nif­i­cant changes in high streets dur­ing the last decade and the piv­ot towards ser­vice pro­vi­sion, such as nail bars and yoga stu­dios. “Retail gen­er­al­ly adapts quite well to changes in demand and clear­ly there’s going to be con­tin­ued demand for the sort of things you can­not buy over the inter­net,” he says.

Still, cre­ative solu­tions are required to repur­pose some retail prop­er­ty. This has been sup­port­ed by a relax­ation of the plan­ning laws in July 2020, sim­pli­fy­ing con­ver­sion of retail to restau­rant, office or res­i­den­tial use. The hope is many vacant high street shops will be con­vert­ed to much-need­ed new homes. Gov­ern­ment esti­mates sug­gest 345,000 are need­ed a year in Eng­land alone, which could breathe new life into once-loved retail and com­mer­cial hubs.

How­ev­er, not all retail prop­er­ty lends itself to alter­na­tive use. “Pur­pose-built shop­ping cen­tres are not easy to repur­pose,” says Baum. This is unfor­tu­nate giv­en that data from MSCI, which tracks the val­ue of com­mer­cial real estate owned by finan­cial insti­tu­tions, shows shop­ping cen­tres were hit par­tic­u­lar­ly hard in the last year, forc­ing its largest oper­a­tor, Intu, into admin­is­tra­tion.

No leisure in lockdown

If retail’s decline was well under­way pre-pan­dem­ic, leisure was per­form­ing ade­quate­ly, albeit with mixed for­tunes. Amy Wood, prop­er­ty econ­o­mist at Cap­i­tal Eco­nom­ics, says: “While the leisure sec­tor was ben­e­fit­ing from the trend towards spend­ing on expe­ri­ences, cer­tain types of leisure, such as food and bev­er­age, were strug­gling.”

But there is con­fi­dence that leisure busi­ness­es able to weath­er the COVID-19 storm could trade buoy­ant­ly once allowed. Wood says: “There are already ear­ly signs that house­holds are will­ing to go back to pubs and restau­rants. And as the remain­ing virus restric­tions are removed, there is plen­ty of scope for spend­ing to pick up again.”

Pubs and restau­rants able to reopen safe­ly have wit­nessed strong demand. In Eng­land, CGA Insights com­pared like-for-like sales in sites that reopened on April 12 to that of the equiv­a­lent day in 2019 and they were up 58.6 per cent. Mean­while, Pur­e­Gym logged a mil­lion work­outs across its 240 sites in the first week of April’s reopen­ing.

An opti­mistic out­look is shared by EPF Group’s Cof­fer. “You sim­ply can­not repli­cate the phys­i­cal expe­ri­ence and envi­ron­ment online,” he says. “In attrac­tive loca­tions, such as afflu­ent mar­ket towns, sub­urbs with a strong res­i­den­tial catch­ment, major city cen­tres and tourist des­ti­na­tions, where con­sumers have a com­pelling rea­son to leave their home, we con­tin­ue to see leisure prop­er­ty as a growth area going for­ward.”

Data shows sub­urbs have been more resilient than city cen­tres to COVID changes; what some call the dough­nut effect, as cen­tres were hol­lowed out by office clo­sures and the impact on sur­round­ing retail and leisure. As work­places offer more flex­i­ble work­ing arrange­ments and eval­u­ate the impor­tance of the office to their busi­ness, non-cen­tral loca­tions may con­tin­ue to ben­e­fit. 

The logistics boom

Chang­ing con­sumer habits in response to the pan­dem­ic meant logis­tics was one the few areas of com­mer­cial prop­er­ty that per­formed well over the last year. Jen­net Siebrits, head of research at CBRE UK, says: “Logis­tics ben­e­fit­ed from the mas­sive increase in ecom­merce.” 

Between 2011 and 2019 the val­ue of ecom­merce trade mush­roomed from £23 bil­lion to £58 bil­lion, but this trend accel­er­at­ed dur­ing 2020 with an eye-water­ing increase to £84 bil­lion. “This shift in con­sumer behav­iours has a knock-on effect to real estate with an increase in need for logis­tics ware­hous­es and hubs,” Siebrits adds.

Prop­er­ty firm Knight Frank pre­dicts the expan­sion of ecom­merce could dri­ve demand for 92 mil­lion square feet of fur­ther ware­house space in the next three years. In a sign of the times, etail­er Boohoo recent­ly leased a ware­house pre­vi­ous­ly oper­at­ed by for­mer Top­shop own­er Arca­dia to sup­port its expan­sion. Mean­while, Topshop’s flag­ship shop on Oxford Street is cur­rent­ly emp­ty.

The long-term chal­lenge is the per­ma­nence of this boom, which remains to be seen. Dr Steven Devaney, asso­ciate pro­fes­sor in real estate and plan­ning, Uni­ver­si­ty of Read­ing, says: “Whether demand for logis­tics assets grows post-pan­dem­ic depends on how the econ­o­my rebounds and to what extent shop­pers switch back to phys­i­cal stores.”

While the pan­dem­ic expe­dit­ed some antic­i­pat­ed changes to com­mer­cial real estate, it has also shown the oppor­tu­ni­ties and adapt­abil­i­ty of the sec­tor in response to such a huge chal­lenge. Along­side the growth of dis­tri­b­u­tion cen­tres to sup­port online deliv­er­ies, pub­lic reac­tion to ease­ments ten­ta­tive­ly sug­gests a pent-up demand for expe­ri­ences that can’t be deliv­ered to a doorstep with­in 24 hours. 

As the coun­try pre­pares for the next stage of lock­down lift­ing, investors will mon­i­tor whether COVID-forged con­sumer behav­iour is here to stay.