Q1 2020 – general election bounce in optimism cut short by impact of Covid-19
The decisive general election win for the Conservatives on December 12th marked a notable turning point for a market which had been subdued by Brexit for three years. The greater political certainty provided a change in sentiment and opened an opportunity for investors to return to the market with improved stability.
The lack of stock launched in Q4 continued to constrain the market in early January whilst assets were being prepared for sale, therefore creating a supply/demand imbalance for investors looking to deploy capital. This pick-up in activity meant that assets which remained available at the end of 2019 started to receive a new wave of interest, with transactions including Apollo Court, Hatfield (£14.64m/7.23%) and Ermyn House, Leatherhead (£40m/8.77%).
The weight of capital which had sat on the sidelines through 2019 as a result of the Brexit impasse was starting to be deployed in early Q1, and, the appetite which had previously been focused on core town centre assets had now begun to diversify across the risk spectrum. The total transaction volume for Q1 was £987.93 million over 26 deals. Whilst this represented a 19% decrease on Q4 2019, it was a substantial 125% increase on its respective quarter last year.
Whilst the open-ended retail funds experienced the highest outflows on record in 2019, liquidity of assets was improving and the run on redemptions had eased. Institutions started the year with active requirements and amid historically low interest rates, income-driven institutional investors were actively seeking alternative sources of securing income through active asset management opportunities. Assets which received strong interest included Clarendon and Wellington House in Cambridge, which received bids from over 4 institutions.
We saw a notable rise in overseas investment in early Q1 as the improved certainty combined with the weakening of sterling made south east office investments increasingly attractive on a comparative basis. Overseas investors were focused on the larger lot sizes, accounting for every deal over £50m. These include the acquisition of Arlington Business Park by CapitaLand for £129.25m (Gerald Eve advised), the acquisition of the Cisco HQ at Bedfont Lakes by Fraser’s Property Group for £135m and the acquisition of Building 7 Chiswick Park for £312m by Stanhope with Asian equity backing. A number of high profile transactions remain ongoing, most notably Reading International and White City Place and it will be interesting to note what impact recent events will have on these.
The south east office occupational market continued to perform well, demonstrating good levels of take-up as key south east centres continued to prove attractive to occupiers. The underlying fundamentals in the market proved resilient against a backdrop of low vacancy rates and an acute shortage of supply which has underpinned rental growth projections. It is these fundamentals which will hold the market in good stead as we go through a potentially deep, but hopefully short-lived recession in 2020.
The post-election bounce back experienced across much of January and February was cut short in March as the global economy experienced immense pressure from the impact of the spread of the Coronavirus. Financial markets have since plunged, the pound has dropped to multi-decade lows against the US dollar and the global economy is now entering a deep recession. In the past few weeks there has been a significant change in risk appetite amongst investors, with a narrowing of interest focused solely on ‘flight to quality’ and covenant strength. As real estate markets adjust to the unprecedented ramifications of the outbreak, many investors will be pausing to rewrite business plans and any planned sales are likely to be postponed for the time being.
One of the early impacts to be felt within the industry was the mass suspension of the open-ended retail funds which have all now been suspended until further notice to preserve the value for the shareholders. Whilst the M&G Property Portfolio fund remains suspended since December 2019 in order to raise cash for redemptions, recent suspensions have been the result of ‘material uncertainty’ in valuing assets under FCA rules.
A further impact from COVID-19 has been the sharp spike in the number of office tenants requesting rental payment holidays or monthly payment plans. It is understood that landlords are reviewing this on a case-case basis to assess genuine need, although inevitably this will directly affect borrowers’ abilities to pay lenders. This will significantly increase the risk of some borrowers potential defaulting on or around the June quarter date if we do not see an improvement in the economy. An evolving impact from the lockdown has been that tenants with the ability to work from home have been able to maintain business continuity where possible, notwithstanding the impacts of on each individual business.
For now, the south east office market continues to provide attractive returns relative to bonds and equities. Over the short to medium term we anticipate the deployment of capital to be focused on secure and well positioned assets providing long-dated income streams, as investors move to de-risk their portfolio and limit exposure to market volatility. We expect property companies and private equity investors with large cash weightings to take advantage of potential price adjustment and decreased competition for assets. Investors relying on debt or formal valuations / IC processes wil remain constrained by the ‘material uncertainty clause’, therefore we anticipate institutional and council activity to decrease.
Outlook and Market Insight