Commercial property stress

September 15, 2020

WHAT’S NEW

When COVID-19 hit, the UK government introduced a ‘rent holiday’ which allowed renters of commercial property (such as restaurants, shops, offices) to not pay their rent and not get evicted until 30 September 2020. There remains considerable uncertainty as to whether this measure will be extended. 30% of landlords are reported to be considering evictions as of October 1 , and there are increased talks of landlords looking to claim full back-rents for the previous few months, a situation that could be untenable for many tenants.

OUR TAKE

With the fourth quarter rents due next week, we will find out shortly in what state this non-residential segment of the market is. As a reminder, last quarter, UK companies British Land and Land Securities reported a relatively healthy 85% collection rate for offices but only around 30% for retail.

We have expressed caution for some time on prospects for high street retail as that segment faces stiff competition from the digitalisation of retail. We are also cautious on prospects for the office segment given the profound changes brought by the move to working from home which COVID-19 has brought. Companies have started reducing their office space, are renegotiating rents, a trend we expect to continue for the foreseeable future.

WHAT’S NEXT

Valuations may look cheap in several parts of real estate markets, but we think the discounts are justified given the negative long-term prospects for the bulk of the sector. Large discounts to book values are telling us that there could be financial distress round the corner, particularly if COVID-19’s second wave leads governments to reinstate social distancing measures which prevent consumer behaviour from normalising. Clearly it is not all doom and gloom within property, as we find pockets of value in the sector, such as student property, elderly homes and parts of industrials - such as logistics - which we expect to benefit from the cyclical recovery.

MARKET REVIEW

EUROPE - European equity indexes had a mixed day on Monday. Brexit developments were in focus again with all living former UK Prime Ministers united in thier criticism of current PM Johnson's Brexit move to break international law and renege on the Brexit deal signed with the EU at the end of 2019.

There is fair bit of attention on European COVID-19 case growth accelerating with France logging over ten thousand new cases while UK recorded more than three thousand for third dayin a row over the weekend. Macroeconomics releases were light with focus on Eurozone industrial production data for July which rose as expected by +4.1%. July's gain comes due to stronger output of capital goods and durable consumer goods, but was still well below lastyear's levels because of the COVID-19 pandemic.

US - US equities were higher in Monday trading with all sectors posting positive returns, following two weeks of back-to-back declines in the S&P 500. Treasuries little changed to a bit weaker with a touch of flattening. Dollar weaker against yen and euro. Sterling rebounding after last week's Brexit-driven weakness. Gold finished up 0.8%. WTI crude oil settled down 0.2%.

Vaccine optimism one of the day's themes on trials extension and as Pfizer CEO said vaccine could be rolled out before end of 2020. On the fiscal support front, Treasury Secretary Mnuchin said he's still open to negotiations with Democrats.

ASIA - Asian equities mixed in quiet Tuesday trade with Nikkei underperforming with Sony a drag amid reports of cut to PS5 production estimate. China markets accumulating gains following activity data firmer-than-expected with main highlight being an unexpected rise in retail sales. Industrial production growth also quickened. In political developments, Nikkei reported newly elected leader of Japan's ruling Liberal Democratic Party, Yoshihide Suga, will retain Taro Aso as finance minister. Suga outlined focus on economic situation rather than calling snap election. Oracle-TikTok US partnership remains under scrutiny as White House debate whether to approve deal.

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