Why the pandemic is killing commercial property investment
It’s been a bumpy 24 hours for global stock markets, as surging Covid-19 cases and growing calls for lockdown measures threaten the economic recovery.
But what about commercial property?
With more people working from home, and no real prospect of a mass return to office working, even when we have a vaccine, can this investment sector ever prosper again?
Especially, when the government is thinking about banning new investments into some forms of commercial property funds within ISAs – Individual Savings Accounts.
In this video, I’m talking about commercial property investments. The bad, the ugly, and the, actually, there’s not much good to talk about – but I’ll find something by the end of the video, I promise!
There’s a new survey from The Royal Institution of Chartered Surveyors.
78% of Chartered Surveyors viewed the commercial property market as being in a downturn, up a little from 76% in the second quarter.
Outlook for the year ahead has worsened and demand for retail and office space contracted sharply during the third quarter.
Why? Working and shopping patterns have changed.
We work from home now, if we can. And we shop from home too.
Like many things, the pandemic has served as a catalyst for accelerating existing trends.
The High Street was dying before – online shopping was growing year-on-year. Pandemic further shifted that behaviour, and without City workers in situ, already struggling retailers are screwed.
High-speed Internet means working from home is a possibility like never before. Why suffer the daily commute when you can video conference your colleagues, and have a nicer life instead?
The latest office stats show that a quarter of people worked from home in the week to 18th October.
RICS survey also found clear signs of a pick-up in industrial sites, for example, warehouses for online stores. That makes sense.
We still need to shop; it’s the location of our shopping that has changed. Smart property funds were rotating out of High Street retail and City centre office space long before this pandemic started.
RICS said expectations of a fall in rents for prime office and retail space were the most widespread since records started in 2014, and demand for hotels and student housing was also weak.
RICS economist Tarrant Parsons said:
“The physical retail sector, which was already struggling prior to the latest crisis, is being hit hard by the accelerated switch into online shopping and a drop in footfall associated with social distancing,”
“Likewise, occupier demand across the office sector remains in decline and may continue to come under pressure going forward as businesses reassess their office space requirements following the increased prevalence of remote working.”
These factors are bad news for commercial property investments.
And of course we know that many commercial property funds, at least those with an open ended investment structure, shut their doors (in or out) to investors at the start of the pandemic.
Independent valuers couldn’t give a reliable valuation to property assets, and therefore suspended trading until some certainty returned to the markets. This is called “material valuation uncertainty”.
Those valuation models are more certain now, so some of these closed property funds are starting to reopen for business.
The Financial Conduct Authority (FCA) is consulting on new rules which could introduce a notice period of up to 180 days for investors who want to sell out of open-ended property funds.
That consultation closes next week, and final rules are expected at the start of next year.
If the FCA introduces this notice period, one impact could be effectively banning open ended property funds from ISAs – Individual Savings Accounts.
HM Revenue & Customs opened a consultation yesterday which would allow existing property investments in ISAs to remain, but would ban new investments in such funds, if the FCA rules go ahead.
This is because current ISA rules mean investors have to be able to access their funds or move to another ISA provider within 30 days of making an instruction.
The 180-day notice period for selling open ended property funds is in conflict with that ISA rule.
Under one model being considered by HMRC, existing property funds could be retained in the ISA but investors would be unable to make further investments into the funds.
In another model being considered, investors would be able to continue to add money into those specific property funds already held in the ISA, but investments in new, different, property funds would be prohibited.
The HMRC consultation closes on 13th December 2020.
So, generally bad news for commercial property investments, specifically though for retail and office space – when one sector suffers, another is bound to benefit.
We’re keeping a close eye on the FCA and now HMRC consultations around the 180-day notice period for open-ended funds, and potentially banning these funds from ISAs – more on this to follow as we get further news.
I promised some good news – and the good news is this, commercial property remains a useful tool for diversification in a well-constructed investment portfolio.
A small allocation to commercial property, in a suitably diversified mix of assets (retail, offices, industrial, and good geographical diversification too – not everything in London and the South East) – using a fund with a healthy case balance and largely institutional investors, who don’t rush for the exit when the economy wobbles – these funds can still play a role in your investment portfolios.
Negative correlation with other mainstream asset classes means commercial property funds help to reduce overall portfolio volatility and risk.
With rising equity market volatility, this is a good thing. And depressed property asset pricing means we’re starting to see some attractive yield opportunities in this sector too.
There’s always good news when there’s bad news.