Covid-19 could radically transform the commercial property market

City of London

The following article has been reproduced with the kind permission of Insurance Day.

The global Covid-19 pandemic has highlighted the connection between the supply chain and retail. In the UK, for example, large number of consumers purchased items from online retailers for the first time, which will have a further impact on the UK logistics property market. Commercial office space, industrial units and retailers are faced with new risk and opportunities. On the demand side, at least one large commercial property agent reports it has already recorded more than three million sq. ft of new requirements for warehouse space since March 16.

These requirements – which originate from the major supermarkets, online retailers and specialist pharmaceutical third-party logistics providers – are short-term in nature. While for some sectors there is a clear demand for new warehouse space, some occupiers have delayed their acquisitions until greater clarity emerges on the length of the social restrictions in place. With this in mind, will any short-term uptick in demand from certain sectors offset the potential pause in transactions from other more at-risk industries? On the supply side, the UK commercial property market, for example, is very different now from the time of the last global financial crisis in 2008, which will provide some peace of mind for investors and other key industry stakeholders such as insurers. At that time, almost 100 million sq. ft of warehouse space was available, reflecting a vacancy rate of close to 25%. In 2020, supply is reportedly slightly more than 35 million sq. ft and vacancy is 6.5% or less in many parts of the country. There is also just 4.1 million sq. ft of speculative development under construction due for delivery in 2020. Those under way are set to continue, but property agents do not anticipate any new speculative announcements in the short term.

Tenant default

While HM Treasury’s announcement wages will be paid by the state will provide relief to many businesses, the risk of a tenant default remains. What is a great cause of concern, therefore, is more companies hit the rocks as the crisis continues, which in turn leads to more second-hand space returning to the market. It is too early to make a call on such an analysis, which could take at least another year to materialise. It should, however, be pointed out more than 40 million sq. ft of new supply would be required to see vacancy levels rise to 12% – a tipping point for rental growth to stop. However, a question needs to be posed as to whether landlords will be willing or able to offer more flexible lease terms to help tenants in future. This would demand a major shift in thinking, given average lease lengths in 2019 are more than 18 years for build to suit properties and 13 years for the market as a whole. Anecdotal conversations with London EC3 market colleagues and peers have highlighted interesting discussions between landlords and their tenants concerning upcoming rent renewals. It seems some landlords are offering what can only be described as nugatory reductions in their upcoming renewal terms, which could be considered a short-sighted attitude, considering it is unlikely many City of London employees will be working from the office for several months at least. It may be that landlords have yet to adjust their expectations in line with the reality of their tenants’ ability to work from home for a considerable period of time. In this new world of Microsoft Teams or Zoom meetings it is unclear why companies would continue to pay for Grade A City office space when conferencing technology is pulling the rug out from under landlords’ feet.

Unintended consequence

Meanwhile, the longer-term unintended consequence for the market could be the further growth of online grocery shopping, as many consumers who previously did not use such ser[1]vices become more familiar and continue to use it in the future. Should this happen it will clearly have a huge impact on our high streets and the long-term sustain[1]ability of the retailers that continue to trade on them. The pandemic has revealed most, if not all, corporates, insurers, risk managers and investors do not have direct access to data showing the potential impact at the asset level of both direct physical risks and indirect economic impacts as well. Other risks such as cyber and climate exposures also need to be modelled at a more granular level. Retail, travel and hospitality and the financial services industries have been plagued by cyber-attack incidents in recent years. Given the strategic importance of cyber, it needs to be incorporated into the wider enterprise data strategy. Similarly, with climate change risks, investors in commercial property may have been underestimating the risks associated with climate change, including more frequent and intense extreme weather events, and need to rethink their assessment of asset vulnerabilities. The ongoing coronavirus crisis has thrown into sharp relief the need and value of enterprise-wide strategic analysis of perils, which includes pandemics, cyber and climate change

Post Date: 18/05/2020

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