The pandemic has prompted fund managers to renegotiate rents in some cases and accelerated divestment from subsectors already facing longer-term problems.
An estimated £ 6.4bn in rent has gone unpaid following Covid-related business closures, according to the FT, with the ban on evictions of commercial property to remain in effect until March next year.
IA UK Direct Property sector funds reduced their exposure to commercial real estate in 2021, with an average allocation of 5.9% at the end of July against a peak of 8.7% at the end of January, according to FE fundinfo.
Justin Upton, manager of AUM M&G’s £ 1.2 billion real estate portfolio, explained that since December 2019, the fund’s commercial real estate allocation fell from 38.4% to 29.1% in July 2021.
“With retail sales traded and currently in the hands of lawyers, this is expected to drop further to around 21% in line with the fund’s strategy,” he said. “We made strategic sales, which focused on asset risk such as age / location / sustainability and where we had tenant concerns such as strength of engagement, length of lease or vacancy.
“These sales subsequently resulted in our vacancy levels falling to 7.7% in June 2021, well below the peer average of 12.9%. The average term of our leases also extended to 7.7 years.
Likewise, Michael White, UK real estate manager at Canada Life Asset Management (CLAM), said the firm’s retail exposure had fallen due to the “reduction in valuation” and that ‘it had “accelerated the strategy to reduce department store exposure when we are able to do so.”
The terms of repayment of rental debts have largely been left to tenants and landlords, and in some cases have led to bitter legal disputes.
White explained that CLAM has been active in this regard by “negotiating lease adjustments, rent concessions and postponements on a case-by-case basis.”
He added that while this “turned out to be a success”, there remain “some parties who still refuse to discuss the arrears”.
M & G’s Upton also reported a “constant dialogue” with tenants over the past 18 months, negotiating “a variety of payment plans” ranging from deferral packages to free rental packages in exchange for longer terms. and lease extensions.
The result was that M&G Property Portfolio raised “over 90%” of both rental income and service fees for 2020, according to Upton, with the fund distributing 4.7% income.
The coronavirus has caused significant disruption to brick and mortar retail, but the sub-sector also faces the longer-term existential threat posed by the boom in online retail.
As a result, real estate fund managers have actively reallocated capital from brick-and-mortar retail to online competitors, with assets such as warehouses becoming an increasingly attractive investment.
Fund manager and co-head of UK institutional real estate at Columbia Threadneedle James Coke explained in March: “Within the MSCI UK Property Monthly index, net divestment from retail totaled $ 3.6 billion. sterling over the past five years, an average of £ 60million per month.
“As the sales proceeds are redeployed in the industrial sector, its market share – and therefore its contribution to performance – has increased, to the extent that it now represents 37.3% of the index. “
He said that “the migration of online retail,” which has been accelerated by the pandemic, has “had a huge impact on many city centers, but left a nationwide shortage of logistics space, resulting in increases. sustained industrial rents and a corresponding compression of returns in this sector as investors. have accumulated in an asset class considered to be a safe haven ”.
“Far from being blind to this change, proactive managers have reduced their exposure to shopping malls and retail stores and increased their weightings in industry and logistics,” he added.
However, real estate fund managers are not yet focusing on retail from an investment perspective.
White said CLAM still favors “the out-of-town retail format,” but that “core retail,” such as food and DIY, “remains a viable industry” for the fund.
M&G’s Upton added, “Supermarkets and out-of-town retail are proving resilient and both continue to attract retail users in a variety of categories, particularly those that are more focused on convenience.
“Fashion continues to suffer as it battles the continued growth in online shopping and consumer spending which is currently skewed towards experiential spending such as dining and entertainment.”