Capital values across all segments (retail, office, industrial) already fell by 6.1% over the three months from March to May.
By Nick Corbishley, for WOLF STREET:
If you’re a commercial property fund manager in the UK and you think you’ll be able to fetch pre-lockdown prices for properties you need to sell, you’re “smoking dope”, according to Schroder Real Estate fund manager Duncan Owen. Owen believes that valuations of UK commercial property have at least another 10% to fall. His comments come as close to a dozen open-end mutual property funds, with roughly £12 billion in assets, remain suspended after gating en masse in March, leaving hundreds of thousands of retail investors unable to access their money.
These funds are “forced sellers.” They are not selling out of choice but rather out of the need to raise cash as quickly as possible in order to be able to reopen their doors and meet redemption requests. When there are lots of forced sellers in a market — especially big funds that were until recently big buyers that helped drive up prices — it means that prices are now headed down.
Owen, who is head of global real estate at Schroders and jointly manages the Schroder Real Estate Investment Trust, said that while “deal flow has considerably increased” over the past month, the prices being asked by sellers did not reflect the impact of the lockdown and its aftermath.
“Vendors are smoking dope,” he said. “They are asking for [pre-virus] prices and they are not going to sell at those prices.” Owen added that for firms on the lookout for new purchases, there is “no urgency” to buy as “the market will soften,” predicting commercial property had “another 10% to fall and retail maybe another 20%.” The fund has made no bones about the fact it is looking to reinvest after a sharp market correction.
Given the sheer scale of economic carnage the virus crisis has unleashed and the uncertainty that continues to grip financial markets, it’s still too soon to gauge how commercial real estates prices are responding. In fact, this is the official reason why the open-end funds were shuttered in the first place, and remain so: the “material uncertainty” caused by the crisis left valuers unable to accurately value 20% or more of the assets within the property funds. The unofficial reason is that many of the funds’ spooked investors staged a mad dash for the exits.
The retail segment of commercial real estate has been particularly hard hit, as many retailers, including big chains, have stopped paying their rents, cranking up the pressure on already struggling retail landlords. Many landlords have seen their income fall by as much as two-thirds since the crisis began.
Demand for office buildings is also at risk as companies come to terms with the fact that many of their workers can work from home. While new social distancing rules will increase the need for space for those workers who stay on in the office, it’s not clear whether it will make up the difference. In recent days, Lloyds Bank became the latest FTSE 100 company to warn that it would probably “need fewer buildings and different types of spaces” in future.
With rental income from retail properties plunging and demand for office buildings waning, at the exact same time that the market is witnessing a glut of those exact same properties as open-end property funds cash out, the values of those properties are coming under pressure.
In its latest Monthly Index, CBRE reports that capital values across all segments (retail, office and industrial) fell by 6.1% over the three months from March to May.
- Retail sector capital values fell 1.7% in May from April, after a 3.6% in April from March. Shopping Centers reported the largest fall in value (-2.8%); shops in the South East recorded the smallest decrease (-1.4%). Average rental value in the sector fell by 1.6% compared to April — the largest month-on-month decrease in rental values for the sector in the history of the index. The worst performer was shopping centers whose rental values declined, in just one month, by 2.3%.
- Office sector capital values fell by 0.6% in May from April, after having dropped 1.2% in April from March.
- Retail warehouse capital values, despite the unprecedented surge in demand from e-commerce during the lockdown, fell 0.8% in May. Overall, rental yields rose 3bps in May, following a 17bps increase in April.
- Industrial sector capital values fell 0.2% in May.
On Monday, one of the dozen or so gated open-end property funds, BMO Property Growth, announced it had reopened its doors. But there’s an important caveat: Only 28% of the fund’s portfolio was invested in direct property holdings in the UK. Perhaps. Other funds that are more invested in the property sector and that are now forced sellers will have a harder time in this market that has changed. By Nick Corbishley, for WOLF STREET.
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