INVESTMENT BRIEF the Definitive Guide to UK Commercial Property Investment

INVESTMENT BRIEF The definitive guide to UK commercial property investment

Summer 2020

geraldeve.com UK COMMERCIAL PROPERTY OVERVIEW AND OUTLOOK

The economic impacts of the coronavirus-induced social The commercial property sector remains comparatively lockdown from mid-March initially came through on the higher attractive to income investors verses the stock market, where frequency business sentiment and unemployment figures. dividends have been suspended or reduced. Nevertheless, These now also feature in part in the Q1 GDP growth and property yields moved out sharply at the end of Q1, notably for commercial property returns data. Economic output fell 2% Retail and Leisure, where business operations have been hardest quarter-on-quarter, which suggests that GDP growth will be and most directly hit. For 2020 as a whole we expect rents to around -14% for Q2 and -8.3% for 2020 as a whole. fall 4.2% and yields to soften by 60 basis points – driven very much by the beleaguered retail sector. This will cause a 14% fall Many Q1 commercial property investment transactions had in capital values and generate a total return of -10.4% before already occurred or were at an advanced stage so the ostensive stabilising in 2021 without a significant bounceback. drop appears relatively modest. The first quarter also featured some exceptionally large deals – Blackstone bought the £4.7bn iQ student accommodation portfolio and the £500m Hansteen industrial portfolio, and a Qatari investor paid £700m for the Ritz on Piccadilly. Stripping out these exceptional transactions, the investment total was down 45% quarter-on-quarter, which is ominous for the Q2 total deal volume.

All Property investment volumes All Property total return and components Sources: Property Data, Gerald Eve Sources: MSCI, Gerald Eve

£ billion % per year 20 30 45% quarterly drop 18 excluding exceptionals 20 16

14 10 12

10 0

8 -10 6

4 -20 2

0 -30 2011 2017 2013 2012 2021 2019 2015 2016 2018 2010 2007 2020 2009 2005 2006 2008 2014 2022 Q1 2017 Q1 2019 Q1 2016 Q1 2018 Q3 2017 Q2 2017 Q3 2019 Q4 2017 Q3 2016 Q2 2019 Q3 2018 Q2 2016 Q2 2018 Q1 2020 Q1 2020 Q4 2019 Q4 2016 Q4 2018

Income return Yield impact Alternatives Office Leisure Rental growth Total return Industrial Retail

2 INVESTMENT BRIEF Indexed capital values by major property sector Sources: MSCI, Gerald Eve

Index, Q1 2005 = 100 160 The industrial segment has fared better than other property Financial Brexit Coronavirus segments, notably larger logistics and data centres associated crisis referendum pandemic with the increase in online shopping and working. Smaller multi- 140 let units with a greater proportion of direct-trading SME tenants have been more vulnerable. There is a broad cross section of 120 investment buyers with activity focussed on secondary where pricing has slipped 5%-10%. Defaults and voids are forecast to 100 rise from late 2020 but not reach 2009 levels since the modern occupier base is strong and diversified while new supply is tight. 80 A relatively modest 40bps outward yield shift is expected by 60 the year-end. Online retail breaks 10% of total sales 40 Jul 2012 Jul 2016 Jul 2018 Jul 2014 Jul 2010 Jul 2022 Jul 2020 Jul 2006 Jul 2008 Mar 2011 Nov 2011 Mar 2017 Mar 2013 Mar 2021 Mar 2019 Mar 2015 Nov 2017 Nov 2013 Nov 2021 Nov 2019 Nov 2015 Mar 2007 Mar 2009 Mar 2005 Nov 2007 Nov 2009 Nov 2005

Retail Industrial Office Office investment is weak while social distancing limits viewings to a greater extent than its industrial counterparts. The June quarter rent collection is likely to be worse than March, potentially triggering sales in poor performing assets. The impact of the coronavirus on capital values has been felt more Average annual total return, 2020-22 in UK regional markets, with core London assets showing more Sources: MSCI, Gerald Eve resilience. Overseas investors were the most active overall in Q1, %, per year but ongoing travel restrictions suggest that UK-based investors 6 may be able to benefit from less competition later in 2020. 4

-2 Retail property has been hit particularly hard due to the direct lockdown measures on trading units coupled with -4 the accelerated trend to online. Many retailers are suffering -6 significant cashflow difficulties and rent collection has been and is expected to be poor. Government intervention is -8 unlikely to be sufficient to stem the tide of administrations. Hotel

Shopping centres saw a 10.5% fall in capital values in Q1 alone, Leisure SE office All retail All office City office Healthcare Residential with the largest shopping centres most affected. This follows High street All multi-let ROUK office All property All industrial the recovery that never really materialised after the global ROUK multi-let Midtown office West End office London multi-let Retail warehouse Inner SE multi-let Shopping centres financial crisis. The chart shows retail capital values that stalled Outer SE multi-let relative to the other property sectors and that are forecast to Outer London office Distribution warehouse be only 43% of their 2007 pre-crisis peak by the end of 2021. This fundamental shift and very negative sector outlook points to more ‘repurposing’ of retail property to alternative uses in future, especially in London.

UK COMMERCIAL PROPERTY OVERVIEW AND OUTLOOK 3 UK ECONOMY

The much-anticipated Q1 2020 preliminary GDP estimate suggested economic activity fell 2% in Q2, the worst quarter since Q4 2008. This was almost entirely due to a 5.8% monthly decline in GDP in March, caused by measures implemented to try to limit the spread of the coronavirus.

Oxford Economics estimates that GDP was running at roughly 85% of its normal level during the lockdown period at the end of March, but with huge sectoral variation. The hospitality sector has been particularly badly hit, with output at just 20% of its normal level. But at the other extreme, output in the agriculture and public administration sectors has been largely unaffected.

The key transmission channels are temporary closure of firms, either through direct government instruction or because restrictions on movement have reduced demand and it is not financially CLOSED viable to remain open; lower discretionary spending given that opportunities in crowded places have been removed and a rise in precautionary saving; lower working hours due to school closures, self-isolators unable to work from home and a higher incidence of sickness.

Assuming that the lockdown is relaxed according to the timeline set out by the government, activity is likely to have reached a trough in April. There should be a very gradual recovery in May and June as lockdown restrictions are steadily lifted, but GDP will nevertheless likely fall by around 14% in Q2. The GDP growth forecast for 2020 as a whole is -8.3%.

The key drivers of the 2021 economic rebound will be very low inflation from the collapse in the oil price; loose monetary policy with the Bank Rate cut by 65bps to 0.1% and £200bn of quantitative easing; and loose fiscal policy in the form of unprecedented loans, wage guarantees and tax breaks.

GDP is not forecast to return to its Q4 2019 level until the end of 2021. There are significant risks surrounding this outlook, given the myriad possible paths and timelines from this point.

4 INVESTMENT BRIEF UK GDP forecasts Key macroeconomic variables: history and forecast Source: Oxford Economics Source: Oxford Economics

Level, 2019=100 2015 2016 2017 2018 2019 2020 2021 2022 110 Forecast GDP growth 2.4% 1.9% 1.9% 1.3% 1.4% -8.3% 7.8% 3.4% 105 Consumer spending 2.9% 3.8% 2.3% 1.6% 1.1% -10.5% 8.4% 4.5% growth 100 Manufacturing -0.1% 0.2% 2.2% 0.9% -1.5% -5.3% 3.3% 1.5% output growth 95 Services 1.8% 1.7% 0.6% 0.7% 2.1% -2.9% 2.2% 2.5% employment growth 90 10-year bond yield 2.0% 1.3% 1.3% 1.3% 0.9% 0.5% 0.9% 1.2% 85 RPI inflation 1.0% 1.7% 3.6% 3.3% 2.6% 1.2% 1.8% 3.0% 80 2021 2018 2022 2020 2019

May 2020 forecast Q4 2019 level of GDP

UK ECONOMY 5 INDUSTRIAL

• Industrial segment faring better than other property Industrial properties have generally fared better than the segments, notably larger logistics and data centres other major property sectors so far. Occupier operations in sheds are often less densely populated and lend themselves • A broad cross section of buyers with activity more straightforwardly to social distancing. Large logistics focussed on secondary where pricing has slipped and data centre units have been particularly robust in the 5%-10% current set of circumstances.

• Expect defaults and voids to increase from late 2020 Smaller multi-let assets with a greater proportion of SME tenants but not reach 2009 levels have been affected more negatively. Leisure operators and many trade counters dealing directly with the public were initially • A relatively modest 40bps outward yield shift forced to close and many remain so. Off-site construction firms forecast by the year-end and manufacturing – particularly those allied to the automotive industry – have experienced severe business interruptions. • Total return of -3.5% for 2020 before a resumption of Meanwhile suppliers to restaurant, hotel, coffee shop and other positive but relatively moderate returns from 2021 hospitality fields have suffered a near complete drop in traditional demand and need to innovate to generate income. The official quarterly investment transactions data for Q1 only effectively captures the coronavirus-induced lockdown for the Quarterly rent collection in March returned around 65%-70% of last two weeks of March. Many Q1 deals had already taken place MLI rent, but as much as 90%-95% of distribution warehouse rent. at that point or were at an advanced stage. In the investment market there is now a broad cross section All segments nevertheless show a sharp decline, except for of buyers and activity is focussed more at the secondary and Portfolios, which was boosted by Blackstone’s £500m purchase value-add end of the spectrum where pricing has slipped of the Hansteen portfolio in February. around 5-10%. The institutions are typically the most cautious buyers and, at the prime end, a buyer/seller consensus over any discount has not been reached.

Industrial investment by region Sources: Property Data, Gerald Eve

£ billion 5.0

4.5

4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Q4 2017 Q1 2018 Q2 2018 Q3 2018 Q4 2018 Q1 2019 Q2 2019 Q3 2019 Q4 2019 Q1 2020

Multi-regional portfolio Rest of the UK South East London

6 INVESTMENT BRIEF The time to complete deals has lengthened given the increased We expect a slight deterioration of rents year-on-year in 2020, scrutiny over covenant risk or void – buyers will typically except for UK distribution warehouses and London multi-let want to speak with the financial director of the tenant and/or where values should hold. Risks are to the downside but we examine their business plan. The legal process is also longer, in see some positive rental growth again in 2021 in line with the part because the time to get searches back from local councils broader economic recovery while new supply will remain tight. has increased. Yields are moving out across all property segments but the very Cash is critical for both parties. Consequently landlords will in low interest rate environment and underlying strength in the some respects be more flexible with lease terms, but will also industrial occupier market means we expect a relatively modest try to get some cash in sooner by, for example, offering a rent 40bps outward shift for industrial. This will pull total return free as a half rent over double the time period. down to -3.5% for 2020 before a resumption of positive returns from 2021, albeit mostly composed of income return and some Expectations are that the proportion of rent paid will moderate rental growth. deteriorate at the June quarter date. The changes to legislation to make it more difficult to pursue non-payment of rent means that defaults and an increase in voids are likely to be pushed to Industrial total return and components later in 2020 and into 2021. However, this increase is not forecast Sources: MSCI, Gerald Eve to be of a magnitude similar to the 2009 downturn, given the lack of new supply – particularly for multi-let, where the tenant %, per year base is also now stronger and more diversified. 25 Forecast

20 The spread of returns across different industrial segments has narrowed now that yields are no longer compressing. 15

Industrial sectors annual total returns 5 Sources: MSCI, Gerald Eve 0

%, per year -5 30

-10 25 2016 2017 2018 2019 2020 2021 2022

20 Rental growth Income return Yield impact Total return 15

0 The industrial sector has fared better than other property types given the surge in occupational Jun 2017 Jun 2019 Jun 2016 Jun 2018 Sep 2017 Dec 2017 Sep 2019 Mar 2017 Sep 2016 Sep 2018 Dec 2019 Mar 2019 Dec 2016 Dec 2018 Mar 2016 Mar 2018 Mar 2020 demand immediately post-lockdown and the acceleration of internet retail and the home London multi-let annual total return Outer SE multi-let annual total return delivery market. Secondary assets, which were Distribution warehouse annual total return already showing signs of slowing down pre-covid, Inner SE multi-let annual total return have seen a small slippage in pricing, but there is a ROUK multi-let annual total return broad cross-section of buyers, especially for long income distribution and smaller last-mile urban logistics assets. Nick Ogden Partner, Capital Markets

INDUSTRIAL 7 OFFICE

• Investment is weak while social distancing limits Transactional evidence shows an ongoing dichotomy between viewings and the dichotomy persists between buyer buyer and seller pricing expectations. In regional markets, we and seller valuations have seen evidence of value-add funds looking for 15-20% discount on current valuations. In London, similar pricing trends • The June quarter day rent collection is likely to be have occurred albeit less so, for example, Global Gate Capital’s worse than March, potentially triggering sales in poor acquisition of 25 Maddox Street in Mayfair, transacted at performing assets £57 million at the end of March, a discount of £7 million / 10.9% compared to the original bid. • The impact of covid-19 on capital values was felt more in UK regional markets, with core London However, the incentive to sell now at discounted prices is markets showing more resilience small, as vendors believe their buildings are currently protected with appropriate financing and robust occupational terms. • Overseas investors were most active in Q1, however, Additionally, the effect on the leasing market has not fully as travel restrictions remain, UK based investors may presented itself, leading to reliance on backward-looking data be able to benefit from less competition in negotiations.

• Outward yield shift forecast to push total return to -2.5% for 2020 UK office annual total returns and components Source: MSCI

Investment activity in UK offices had an initially strong start to %, per year the year with volumes in January and February totalling £3.3 35 billion, buoyed by robust activity in London. However, as the 30 uncertainty from covid-19 took hold and lockdown measures were implemented, activity in March was hampered with only 25 £1.2bn transacted, a fall of 45% on February. 20

10 UK office investment volumes by region and levels of uncertainty 5 Sources: Property Data, Economic Uncertainty Policy 0

£ billion Index -5 10 600 -10 Post-referendum Brexit Covid-19 9 uncertainty uncertainty 500 8 Jun 2017 Jun 2019 Jun 2015 Jun 2016 Jun 2018 Sep 2017 Dec 2017 Sep 2019 Sep 2015 Mar 2017 Sep 2016 Sep 2018 Dec 2019 Dec 2015 Mar 2019 Dec 2016 Mar 2015 Dec 2018 Mar 2016 Mar 2018 Mar 2020 7 400 6 Income return Equivalent yield impact Capital growth Total return 5 300

4 200 Total return for offices fell to 3.3% in Q1 2020 driven by quarterly 3 outward shifts in equivalent yields in the South East and the 2 100 Rest of the UK. Income returns are more protected, as many 1 occupier sectors within the office segment have comparatively 0 0 healthy cash flows when compared with other sectors in the economy, and, many have been able to maintain productivity Q1 2017 Q1 2019 Q1 2016 Q1 2018 Q3 2017 Q2 2017 Q3 2019 Q4 2017 Q3 2016 Q2 2019 Q3 2018 Q2 2016 Q2 2018 Q1 2020 Q4 2019 through remote working. Q4 2016 Q4 2018

London Rest of the UK Pharmaceutical, tech and law firms are the most resilient, along South East Uncertainty index (RHS) with portions of the finance industry, particularly those invested in other asset classes. However, financial firms holding large The level of uncertainty covid-19 instilled on the UK in Q1 can volumes of debt or loans will begin to struggle, as senior debt be compared to the quarters following the EU referendum vote servicing and loan repayments become increasingly difficult. and the initially-proposed UK exit date in Q1 2019 of March 23rd. Historically, these periods depressed office investment and it is expected that continued covid uncertainty will dampen volumes for the remainder of the year.

8 INVESTMENT BRIEF Despite a large volume of dry powder in the market, the Q1 2020 regional office capital value growth ability to allocate capital will be difficult for overseas investors Source: MSCI as travel restrictions into the UK remain. Increased due diligence has become a key consideration in new acquisitions Annual change, % to anticipate future liabilities associated with the current 4 uncertainty. Well-capitalised UK-based investors may be able to

3 take advantage of this reduction in competition and effectively use pre-existing knowledge of domestic markets to secure 2 assets at a potential discount.

0 Annual total return and components forecast Sources: MSCI, Gerald Eve -1

% -2 25

-3 20

City City 15 Eastern West End Mid Town North East South East North West

South West 10 Inner London East Midlands Outer London Rest of the UK West Midlands

Yorks & Humber 5 Rest of the South East West End & Mid Town 0 Broad UK region Detailed UK regions -5

The most recent capital value growth data from Q1 demonstrates -10 more resilience in London markets when compared with the Rest of the UK and South East. The West End was the only London market -15 2015 2016 2017 2018 2019 2020 2021 2022 2023 to experience a decline, with values falling 0.25% from Q4 2019. There is more variance in regional valuations with positive growth in the East Midlands and the South West. By contrast, Yorkshire and Capital growth Income return Outer London saw marked declines of 2.6% and 2.5% respectively. Yield impact Total return

We expect the forecast -6.5% decline in capital values to be UK office investment by investor type, Q1 2020 driven by harsher pricing falls for secondary assets in 2020. Sources: Property Data, Gerald Eve The outward movement of equivalent yields is forecast to cause a negative yield impact of -6.5%, pushing forecasted total return

2% Private investor 6% Unknown negative to -2.5% for the year.

6% Occupiers

Since the start of the lockdown, transactional

17% UK institutions activity has inevitably decreased, given an 49% Overseas investors inability to inspect and carry out full due diligence. Transaction data during lockdown have indicated core income-led assets let to robust-covenants are

20% UK prop co continuing to trade at, or near, pre-covid pricing, with little discernible discount. However, there is a softening in pricing for value-add opportunities, with Overseas investors were the most acquisitive investor type in uncertainty around marketing voids and the likely Q1, making £2.1 billion of acquisitions, of which £1.2 billion was in pause on rental growth. Willing vendors do however London. The South East saw very little activity with only £369 million remain limited, so discounted sales are scarce. transacted, a third of this volume was captured in CapitaLand’s acquisition of Arlington Business Park for £129.3 million. UK Lloyd Davies institutions were more active in regional markets making £328 Partner, Capital Markets million of acquisitions, amounting to 45% of their total activity.

OFFICE 9 RETAIL

• Retail property has been hit hard due to the impact The volume of retail investment transactions in Q1 was very low, of lockdown measures and the accelerated switch with £837 million traded, only the second time this quarterly to online figure has been below £1billion in the last 10 years. Deals that were negotiated in late February, such as Orion European Real • Annual total return fell further to -10% in Q1 Estate Fund’s £400 million purchase of seven UK retail parks from Hammerson, have subsequently failed to complete. • Retailers suffering significant cashflow difficulties Market valuation uncertainty, the unwillingness of lenders to lend with quarter day rent collection weak and against retail and the severity with which the current crisis has government intervention unlikely to be sufficient to impacted the retail sector suggests that the volume traded in Q2 stem tide of administrations will be even lower.

• Shopping centres saw 10.5% fall in capital values in Sectors that are highly dependent on consumption in social, Q1 alone, with the largest shopping centres most crowded situations like hospitality, retail and recreation have affected been most adversely impacted by covid-19 lockdown measures. Footfall data suggests that shopping centre and high street • Negative outlook likely to lead to more ‘repurposing’ visitor numbers suffered annual falls of over 85% in April. of retail property to alternative uses, especially in London This is reflected in property investment performance, with UK shopping centres, particularly the largest shopping centres, seeing significant falls in capital values and annual total returns With an estimated 69% of stores deemed ‘non-essential’ and of -22.6% in Q1 2020. Landlords of such space have asked therefore forced to close trading (rising to an estimated 83% lenders and bond market investors for ‘standstill’ agreements including voluntary closures), the UK retail sector is generating given the lack of rental income and falls in underlying value very little revenue outside of online channels. This has created a in order to prevent breaching debt covenants. Without such hard stop in cashflow and a more bearish outlook by investors, measures, the future of large retail destinations is brought into particularly for shopping centres and high street retail outlets. question, especially in a post-covid-19 world. This in turn led to a sharp increase in equivalent yields in Q1 and the -5% negative quarterly equivalent yield impact drove UK Retail annual returns down to -10.5% in Q1 2020.

UK retail annual total returns and components Annual UK shopping centre total returns by property size Sources: MSCI, Gerald Eve Sources: MSCI, Gerald Eve

%, per year % per year 15 15

10 10

5 5 0 0 -5 -5 -10 -10 -15

-15 -20

-20 -25 Jun 2017 Jun 2017 Jun 2019 Jun 2019 Jun 2016 Jun 2015 Jun 2018 Jun 2016 Jun 2018 Sep 2017 Sep 2017 Dec 2017 Sep 2019 Dec 2017 Mar 2017 Sep 2019 Sep 2016 Sep 2015 Mar 2017 Sep 2018 Dec 2019 Sep 2016 Sep 2018 Dec 2019 Mar 2019 Dec 2016 Dec 2015 Dec 2018 Mar 2019 Dec 2016 Mar 2016 Mar 2015 Dec 2018 Mar 2018 Mar 2016 Mar 2018 Mar 2020 Mar 2020

Annual income return Annual market rental growth Shopping centres: 0 – 7,000 sq m Annual equivalent yield impact Annual total return Shopping centres: > 50,000 sq m

10 INVESTMENT BRIEF Recent performance data suggests that low yielding and central The internet retail market is one segment of the retail sector that London retail assets have been more insulated against negative continues to grow, with online retail sales accounting for 30.7% of market conditions. However, secondary and tertiary retail all retail sales in April 2020. This has brought the need for last mile properties have seen significant outward yield shifts and the logistics solutions into sharp focus for many retailers with online spread in pricing between prime and tertiary UK retail is now platforms, especially around London, and many are now making at the highest level on record. Whilst it is encouraging that the long term plans to invest in their network capacity. market is correctly pricing assets based on quality (especially when compared to the low excess spreads recorded in 2007) For certain retail assets in and around London, repurposing to such divergence reflects the increased price of risk and is likely industrial and logistics use is now a viable option. Monthly data to push some tertiary retail assets down to ‘site value’ before suggests that equivalent yield spreads between London retail generating investor interest. warehouses and London Industrial are now at 96bps, an all-time high. With further falls expected in retail capital values, this will strengthen the investment case for repurposing retail parks and retail warehouses to logistics uses and could be a trend Retail net initial yield – spread over prime we see more of in 2020. Amazon, for instance, purchased the 9 and tertiary properties acre former Pentavia Retail Park in Mill Hill, North West London, Sources: MSCI, Gerald Eve in May 2020 for £65 million, outbidding several residential

% developers to secure the site for future logistics use. 4.0

3.5 The higher the spread, the higher the return an investor requires from a tertiary retail property over a prime property 3.0 London Retail Warehouse and London Industrial equivalent yield and spread 2.5 Source: MSCI, Gerald Eve

2.0 % bps

1.5 10 100 90 9 80 1.0 70 8 60 The lower the spread, the less investors differentiate 50 between prime and tertiary retail properties 7 40 0.5 30 6 20 10 0 0 5 -10 -20 4 -30 -40

Apr 2011 3 Apr 2017 Apr 2013 Apr 2012 Apr 2019 Apr 2015 Apr 2016 Apr 2018 Apr 2014 Apr 2010 Apr 2007 Apr 2020 Apr 2009

Apr 2006 -50 Apr 2008 -60 2 -70 -80 1 -90 -100 0 -110 -120 We have seen the effects of changing consumer -1 -130 -140 demand within the industrial and logistics -2 -150 market where e-commerce and direct-to- Oct 2011 Apr 2011 Oct 2017 Apr 2017 Oct 2013 Apr 2013 Oct 2012 Apr 2012 Oct 2019 Apr 2019 Oct 2015 Apr 2015 Oct 2016 Apr 2016 Oct 2018 Apr 2018 Oct 2014 Apr 2014 Oct 2010 Apr 2010 Apr 2020 Oct 2009 door distribution has grown further as physical Apr 2009 retail outlets have been forced to close. We are also seeing retailers start to review their London Retail Warehouse London Industrial infrastructure and look to a future of sustained London retail warehouse and industrial yield spread (RHS) e-commerce and direct consumer interaction. This could accelerate long term requirements to meet demand and weakened retail assets around London could suit some of these forward- thinking online retailers. Josh Pater Partner, Industrial and Logistics

RETAIL 11 HOTELS

• The UK hotels industry was instructed to close on March 24th, with only long-term residents, key Change in performance indicators for hotels in London workers and NHS or government contracts allowed to Source: Statista

use services. % 5 • Many hotel operators are pessimistic about the shape of the recovery for the hotel sector and are 0 implementing drastic cost-saving measures. -5 These are in addition to government support packages and involve looking at debt solutions and -10 working with landlords to secure rent relief support. -15

• Many of the franchise hotel operators are ultimately -20 owned by large funds who are reticent to entertain requests for significant rent reductions given their -25

own financial commitments and to avoid setting a -30 precedent for rent requests from other occupiers. Occupancy rate Average daily rates RevPar

• UK hotel capital value growth had been slowing since Feb 2020 early 2018, but a 15bps shift in yields in Q1 resulted March 1–7, 2020 in a 2% quarterly fall in capital values. Q2 is likely to see much sharper falls and with hotels expected to be slower than other sectors to see any benefit of a Hotel total return and components relaxation of lockdown measures, we forecast capital Sources: MSCI, Gerald Eve values to fall by 19% in 2020. % • Restrictions on international travel (including 14 20 day quarantine measures) and public gatherings are 15

likely to have a disproportionately significant impact 10 on airport and conference-centre-linked hotels in 5 the short term. Longer term, travel restrictions and a rise of the ‘staycation’ industry may feed through 0 to increased domestic demand for UK tourist -5 destinations, as has been seen in Germany. -10 -15 • The budget and mid-range domestic market may see a faster rebound than the top end international -20 hotels, where any pickup in activity is often more -25 dependent on international occupancy, although 2015 2016 2017 2018 2019 2020 2021 2022 2023 once lockdown measures are relaxed we are likely to see in-town hotels reduce rates to compete. Rental growth Income return Yield impact Total return

The hotel industry has been hit hard by covid-19 and as one of the sectors likely to see restrictions lifted last under current government plans, the recovery will be longer. Branded hotels, given their potential to withstand a hard-stop in revenue and leverage their covenant strength in the debt market, are likely to be more protected than smaller independent hotels in the short term. Will Kirkpatrick Partner, Alternative Markets

12 INVESTMENT BRIEF LEISURE

• The imposition of lockdown measures to contain the spread of covid-19 has effectively closed down Change in like-for-like sales during COVID-19 the entire UK leisure industry, with most cinemas, Source: Statista

theatres, sports centres, holiday resorts and leisure % parks shut for business. 0

• This has had major implications for leisure operators’ -10 cashflow and revenues and March quarter day rent -20 collection was weak. -30

• The Corporate Insolvency and Governance Bill, -40

which includes a debt enforcement moratorium, and -50 prevents the use of statutory demands and winding up petitions by landlords dated from 1 March and 27 -60 April, will help protect tenants in the short term, but -70

the sector faces significant challenges longer term -80 given social distancing is expected to be in force for All outlet Pubs Bars Restaurants an extended period. Before lockdown, March 9–15 • In turn, landlords are struggling with ongoing Remainder of March operating costs and honouring financial commitments to banks and investors. Whilst payment deferral plans will provide some recovery of unpaid Leisure total return and components rent, such is the scale of the contraction that an Sources: MSCI, Gerald Eve increase in administrations and voids is expected towards the end of 2020. % 15

• Leisure property capital values fell 6.2% on an annual 10 basis in Q1 following a 25bps outward yield movement. We forecast an overall 15% fall in capital values over 5 2020 and for the sector to take longer to recover than 0 other less covid-affected sectors. -5 • The volume of leisure investment transaction in Q1 was weak, with mainly occupiers and private -10

investors committing to purchases. -15

• The outlook for the leisure sector looks bleak in -20 the short term as even if public confidence returns, 2015 2016 2017 2018 2019 2020 2021 2022 2023 social distancing measures are likely to remain in place and greatly reduce capacity. Risks for the Rental growth Income return leisure and hospitality industries are firmly skewed Yield impact Total return to the downside.

• Longer term, the leisure sector could be a beneficiary of a recovery in real wage and consumer spending growth in 2021, but some subsectors, particularly those reliant on tourism and mass gatherings are unlikely to benefit.

LEISURE 13 CORPORATE FINANCE

Property lending slowed 13% in 2019, given prevailing concerns over Brexit and the market uncertainty in the lead up to the general election. Post-election, the market started the year on a stronger footing. However, covid-19 has firmly put the brakes on the lending market.

Caution prevailed and lenders who were already wary of the retail sector saw covid-19 also severely impact the hotel, leisure, student housing and commercial speculative development funding markets. Whilst the construction industry made every effort to return to site after the initial covid-19 lockdown in March, the hold up in the supply of building materials means that development loans are likely to be impacted by construction delays or defaults on construction contracts. This will require lenders to extend loan terms and meet the increased costs brought about by projects overrunning and going over budget.

Defaults on loans are up 36% since March 2019 and increased lending costs and loan defaults are expected in 2020, with the risk driven by an inability to service interest and valuation difficulties. Emphasis has been placed on the rental quarter days and whilst the March rent collection varied from 30% for retail to over 90% for some logistics landlords, the full impact of the lockdown has not yet been felt. Rent collection rates for the June and September quarter days are likely to be worse, and there are concerns on the level of defaults lenders will begin to see.

The change in capital treatment for loans struggling with interest payments due to covid-19 will offer short-term relief. However, in the longer term, some businesses will fail, and the losses of these loans will need to be reflected in lenders’ balance sheets. We have already seen the larger lenders, who are themselves also grappling with the impact of weakening oil prices, significantly raising bad debt provisions. HSBC and Barclays have announced £8.8bn and £4.5 billion respectively to cover bad debts in 2020, the biggest provision for credit losses since the eurozone debt crisis in 2011.

Since the start of April, lenders have adopted tighter underwriting criteria and have increased margins by an estimated 40-70bps on secondary property loans and slightly less for prime. The impact of these margin rises has been offset in part by the reduction in the base rate to 0.1% and the reduction in both LIBOR and 3 and 5 year swap rates. However, many lenders are now imposing ‘floors’ in their interest definitions to protect their position, with floors of between 0.25% - 0.75% being recorded.

We believe that lenders are likely to continue to increase lending costs to recover losses and write-offs, as the underlying decline in credit triggers immediate increased capital costs and tighter underwriting leads to further higher lending margins.

SOLD New debt in 2020 is likely to be driven by refinancing and restructuring rather than to finance new property acquisitions, although some opportunistic debt funds have significant amounts of capital that they are keen to lend at a time of potential market inflection.

14 INVESTMENT BRIEF Annual loan originations by lender type Annual defaulted loans by lender type Source: Cass Commercial Real Estate Lending Survey, May 2020 Source: Cass Commercial Real Estate Lending Survey, May 2020

£ billion £ billion 90 40

80 35

70 30 60 25 50 20 40 15 30 10 20

10 5

0 0 2011 201 1 2013 201 3 1999 2019 201 9 2018 2018 2014 2014 2001 2007 2003 2017 2017 2002 2005 2012 201 2 2006 2015 2015 2008 2008 2004 2000 2016 2016 2010 201 0 2009 200 9

UK banks & building societies North American banks UK banks North American banks German banks Insurance companies German banks Insurers Other international banks Other NBL Other banks Other lenders

Long term commercial property debt cycle Sources: Cass Commercial Real Estate Lending Survey, May 2020

£ billion 350

300

250

200

150

100

0 1991 2011 1997 1993 2017 1987 1992 2013 1999 1995 2012 1996 2019 1989 1998 2015 1994 1990 2016 2018 1988 2014 2001 2010 2007 2003 2002 2009 2005 2006 2008 2004 2000

UK bank debt Other bank debt Insurance debt Non-bank debt CMBS Other secured debt

Debt funds are likely to hone-in on income risk and covenant strength, with many only lending on assets which have some degree of long term covid-19 resilience. Projects which meet this stricter criteria will still see more conservative loan-to-value ratios and cash reserve provisions to cover interest payments. Steven Oliver Director, Gerald Eve Corporate Finance

CORPORATE FINANCE 15 FURTHER INSIGHT

For more information on individual sectors, please see the following publications:

1 2 3 4 5 6

MULTI-LET PRIME LOGISTICS PRIME LOGISTICS The deﬁnitive guide to the UK’s The definitive guide to the The definitive guide to the multi-let industrial property market UK’s distribution property market UK’s distribution property market

Spring 2020 Summer 2019 Q1 2020 Bulletin

27 28 29 30 31 32 33 COMING SOON

27 28 29 30 31 32 33

33 34 35 36 37

geraldeve.com geraldeve.com geraldeve.com geraldeve.com

33 34 35 36 37 Multi-Let Multi-Let Prime Logistics Prime Logistics Bulletin Summer 2020 Summer 2019 Spring 2020 Q1 2020

1 2 3 4 5 6

SOUTH EAST OFFICE LONDON MARKETS INVESTMENT BULLETIN Analysis of the INDUSTRIAL SNAPSHOT London office market Q1 2020

Winter 2019/2020

THE IMMEDIATE AND LONG-TERM IMPLICATIONS OF COVID-19 ON THE I&L SECTOR geraldeve.com geraldeve.com

South East Office London Markets Investment Bulletin Winter 2019 Q1 2020

16 INVESTMENT BRIEF CONTACTS

UK Capital Markets Healthcare Corporate Finance John Rodgers Richard Moir Steven Oliver Partner Partner Tel. +44 (0)20 3745 5892 Tel. +44 (0)20 3486 3467 Tel. +44 (0)20 7333 6281 Mobile +44 (0)7908 622355 Mobile +44 (0)7810 307422 Mobile +44 (0)7771 812249 [email protected] [email protected] [email protected]

Property Asset Management London Offices Portfolios Jennifer Cottle Lloyd Davies Leo Zielinski Partner Partner Partner Tel. +44 (0)203 486 3497 Tel. +44 (0)20 7333 6242 Tel. +44 (0)20 3486 3468 Mobile +44 (0)7919 520700 Mobile +44 (0)7767 311254 Mobile +44 (0)7980 809031 [email protected] [email protected] [email protected]

International Alternatives/Long income Leisure Hettie Cust Richard Lines Daniel Anning Tel. +44 203 486 3484 Partner Partner Mobile +44 (0)7920 267523 Tel. +44 (0)20 7333 6274 Tel. +44 (0)20 7333 6374 [email protected] Mobile +44 (0)7825 721289 Mobile +44 (0)7776 161821 [email protected] [email protected] Research Charles Wilford Steve Sharman Industrial & Logistics Partner Partner Nick Ogden Tel. +44 (0)20 7333 6215 Tel. +44 (0)20 7333 6271 Partner Mobile +44 (0)7774 834113 Mobile +44 (0)7508 008118 Tel. +44 (0)20 3486 3469 [email protected] [email protected] Mobile +44 (0)7825 106681 [email protected] Ben Clarke Valuations Senior Associate Michael Riordan Tel. +44 (0)20 7333 6288 South East Offices Partner [email protected] Guy Freeman Tel. +44 (0)20 7653 6828 Partner Mobile +44 (0)7796 611127 Oliver Al-Rehani Tel. +44 (0)20 3486 3471 [email protected] Senior Analyst Mobile +44 (0)7796 813141 Tel. +44 (0)020 7518 7255 [email protected] Mobile +44 (0)7584 112501 Hotels [email protected] Will Kirkpatrick Regional Investment Partner Callum Robertson Tel. +44 (0)20 7333 6228 Partner Mobile +44 (0)7836 287983 Tel. +44 (0)16 1259 0480 [email protected] Mobile +44 (0)7810 655791 [email protected]

CONTACTS 17 OFFICES

London (West End) Leeds 72 Welbeck Street 1 York Place London W1G 0AY Leeds LS1 2DR Tel. +44 (0)20 7493 3338 Tel. +44 (0)113 204 8419

London (City) Manchester 46 Bow Lane No1 Marsden Street London EC4M 9DL Manchester M2 1HW Tel. +44 (0)20 7489 8900 Tel. +44 (0)161 259 0450

Birmingham Milton Keynes 45 Church Street Avebury House Birmingham B3 2RT 201-249 Avebury Boulevard Tel. +44 (0)121 616 4800 Milton Keynes MK9 1AU Tel. +44 (0)1908 685950 Cardiff 32 Windsor Place West Malling Cardiff CF10 3BZ 35 Kings Hill Avenue Tel. +44 (0)29 2038 8044 West Malling Kent ME19 4DN Glasgow Tel. +44 (0)1732 229420 140 West George Street Glasgow G2 2HG Tel. +44 (0)141 221 6397

Disclaimer & copyright Investment Brief is a short summary of market conditions and is not intended as advice. No responsibility can be accepted for loss or damage caused by reliance on it.

The reproduction of the whole or part of this publication is strictly prohibited without permission from Gerald Eve LLP

06/20