SECTOR SERIES: Real Estate Survival
April 2, 2020
Landlords Grow Rich in their Sleep . . .
So said the 19th century British philosopher, John Stuart Mill. You could add the thoughts of the American steel magnate and philanthropist, Andrew Carnegie: “Ninety percent of all millionaires become so through owning real estate.”
Or do they?
In the extraordinary circumstances created by Coronavirus, it looks increasingly like there are no more sweet dreams for the UK’s property owners, just a nightmare of collapsing valuations and rent strikes by hordes of tenants facing financial Armageddon and even by those blue chip occupiers like the mighty Primark enthusiastically following the old maxim that cash is king in a crisis and refusing to pay their rent.
The sad poster child of this new real estate reality is the embattled Intu, already badly impacted by the revolution overwhelming the retail sector before the virus struck. It has revealed that it had received just 29% of the rent it was due on the Q2 quarter day. After failing to secure rescue finance in the past few weeks, it has now gone cap in hand to the government in full Oliver Twist mode pleading: ‘please, sir, I want some more (money)’.
The drivers of the real estate business model are deceptively simple: it’s all about rental streams, which drive valuations and therefore what level of gearing it’s acceptable for property companies to carry. Location is of course another key determinant.
Previously, many commercial property players looked pityingly at their brethren focussed in the previously fashionable retail sector. Now they too have good reason for sleepless nights. They are caught between the rock of tenants unable or unwilling to pay rent and the hard place of their lenders concerned at tumbling valuations and evaporating rent rolls.
To make matters even worse, the government has legislated to take away landlords’ eviction rights for commercial properties, deliberately neutralising any knee jerk reactions.
What can be done?
Since this crisis broke, we have been advising tenants in a host of sectors to have adult conversations with their landlords about a rent holiday until some sort of normality returns. Now it’s time for property owners to have similarly honest conversations with their lenders about debt covenants and with their shareholders about dividends.
The initial focus on rent strikes in this crisis has been on the most immediately impacted sectors: retail and hospitality. But no property company should be in any doubt that this will spread eventually throughout the economy, with only a very few exceptions. We are in for a major correction at the very least and much worse if the government’s health strategy turns sour.
One reaction and a completely understandable one is to shed assets to raise cash and reduce debt. Good luck with that one. No doubt there will be buyers for quality assets and of course this will be about raising cash not making profits, which is just as well because they won’t be paying premium prices. To use a topical retail phrase, think bargain basement. For less desirable real estate, the analogies are more about vultures and bottom fishers.
By far the best strategy is to hunker down, accommodate (but not capitulate to) your tenants and then get and keep your lenders onside. And start thinking outside the box: we already knew there was too much retail and hospitality capacity in the market, now there may be too much commercial space as well, especially if the WFH solution to Coronavirus turns into a new way for firms to work.
The priority needs to be to explore the world of re-purposing. It must be worth considering residential use or a shift to using your space for the much vaunted ‘experiences’ that visitors now crave. That way property owners and professionals can have a successful future to enjoy rather than just a past to mourn.