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

Many investors are exposed to the commercial property market, which was hit hard by the coronavirus pandemic, but the sector has shown its adaptabilityu0026nbsp;
Shops are one of the types of commercial real estate people interact with regularly

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.

As soon as you tick the real estate option on an ISA or pension, you’re a property owner. It’s not just the realms of cigar-chomping barons

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.