This year saw a marked change in the economic landscape of many countries. In the UK, both Brexit and the COVID-19 pandemic have affected almost all industries. With the changing requirements for the use of office space, the commercial real estate sector is experiencing major shifts.
Effect of Brexit on Businesses
A few years ago, talks about Brexit affected the commercial property market negatively. Some investors withdrew their investments and several deals fell through. According to the Financial Times, there was an 18% drop in property investments during the second quarter of 2016. This was even markedly lower compared to the same period the previous year, registering a negative 45 year on year. Right after the referendum was signed in June of 2016, many commercial property fund managers revalued their portfolios. Several property funds had no other recourse but to temporarily suspend withdrawals in the face of large redemptions.
As provisions for Brexit became clearer, economic growth returned to normal. The commercial property market rebounded as foreign investors took advantage of the weak pound during this period. With the valuations of properties forecasted to decrease, commercial property investments were expected to continue in the long term. However, there were still approximately 14% of commercial real estate agents who said that their clients were considering relocating some activity from the UK. This was apparently due to the fear of losing access to the EU market, suppliers, and workforce.
Despite the uncertainties, investors were optimistic that Brexit would lead to lower tariffs and better business opportunities in the United Kingdom. During this time, commercial real estate was thriving. Businesses were performing well in the UK, and the demand for commercial premises was high across all sectors.
In June 2019, the Shawbrook Bank released a report on UK commercial property market trends and outlook. The report shows that retail properties had an average yield of 5.7% at the beginning of 2019. This was relatively higher than in other asset classes. The industrial and office sectors likewise showed robust yields of 4.6% and 4.5%, respectively.
Although consumers were cautious of the economic impact of Brexit, consumer confidence became more stable by 2019. Retailers veering towards more experiential and immersive shopping experiences also contributed to the uptick in the retail sector.
In the past couple of years, the services economy also saw higher growth rates than other sectors due to an increased demand for business and professional services. This, in turn, drove the growth of the office sector with a consequent increase in demand for commercial office space. Another factor that impacted the sector is the rise in popularity of serviced office spaces or commercial building fracking.
Early this year, Brexit began its 11-month transition phase, which will last until the end of the year. During this period, the UK will still follow EU rules. If no deal pushes through, the UK will automatically cease current trading arrangements with EU. If it drops out of the single market and customs union, the UK will likely have product delays at ports as they go through customs check. UK goods will probably be more expensive and harder to sell in the EU depending on what tariff agreements will be made.
Challenges Faced by Commercial Real Estate due to COVID-19
While commercial real estate was particularly buoyant the past couple of years, it was severely affected by the COVID-19 pandemic. The retail property sector was particularly hit the hardest as consumers spent less for non-essentials and opted for online over high street shopping. Many shops were forced to close down and some investors were divesting their assets. Since the pandemic erupted, British Land has sold over £400M of its retail properties. Some of its remaining retails will be converted into warehouse and delivery sites to capitalise on the e-commerce boom.
In contrast, the office property sector was generally affected less by the pandemic. Office tenants still managed to pay 97% of the rentals they owed, while retail tenants were only able to settle 62%. While retailers struggled with the flailing economy, the services sector remained in demand.
Still, the commercial property sector has experienced great shifts. Work-from-home arrangements due to lockdowns and quarantines have changed the concept of the office as a self-contained space into a virtual and collaborative space. Even after the pandemic has run its course, the digital transformation of businesses will lead to changes in the use of commercial spaces.
Aside from reducing office size, companies will be looking for office spaces with better controlled environments to ensure the safety of their workforce. Self-contained buildings will be preferred over skyscrapers. To adapt to changing tenant expectations, landlords must employ innovative approaches to enable the safe use of office spaces. Redesigning offices for new health protocols will entail placing measures for social distancing, controlled access, and touchless entry.
As businesses transition into virtual workplaces, tenant and investor demand for retail property will likely decline. This will further be affected as consumers shift from high street shopping to internet shopping. But this decline in demand for retail space will be offset by a surge in demand for logistics property. As such, the industrial warehouse sector is expected to boom in the coming year.
Even before the pandemic, there was already an increase in demand for industrial warehouse properties. This was due to the stockpiling of retailers to cushion for possible high importation fees and trade barriers after Brexit. As retailers adapt to changing consumer behaviour due to both Brexit and the pandemic, we will likely see a continued boost in demand for industrial, logistics, and distribution sites. We can expect the industrial warehouse sector to thrive well and warehouse spaces to be at a premium until Brexit uncertainties clear up.
The Future of Commercial Real Estate
The UK commercial property sector is a resilient market. In spite of the uncertainties due to Brexit and COVID-19, new investment opportunities will lead to more growth in the sector. There’s also the possibility that the UK can be a tax haven for businesses when it leaves the single market. After Brexit, the UK will gain independence in shaping its trade and regulatory policies. With the right tax regime, the UK can be more attractive to investors.
If interest rates remain low, smaller companies will be able to afford the lower rental rates of commercial spaces. And if the shift to virtual offices continues to progress, logistics and warehouse property rentals will bloom. As such, by encouraging investment opportunities in the future, commercial real estate should be able to adapt well and influence the UK’s position in the global market.