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What do the recent high street insolvencies mean for commercial property investors?

04 December 2020

John Richman, Wealth Management Team

An unfortunate reality of recent times has been the influx of news relating to distressed high street retailers, leading to numerous insolvencies. With the long-term effects of COVID-19 likely to remain for some time, there are almost certainly more to come.

Just this week we have heard about Arcadia's administration as well as news that Debenhams is likely to be liquidated following the end of talks with possible bidder JD Sports. Recent store closures as a result of lockdowns have led to an increase in online shopping, putting further strain on the already struggling British high street.

The so-called 'Death of the High Street' has been approaching for some time and has only been accelerated by COVID-19 restrictions, with digital powerhouses such as Amazon coming out on top - as demonstrated by the 80% increase in share price over the past 12 months. As more customers discover the volume of products available online, combined with the ease and speed of service from websites such as Amazon, it is unlikely that the pre-COVID-19 levels of footfall will return for some time, if at all.

The negative impacts of high street insolvencies are clear, resulting in a devastating loss of jobs and having a knock-on effect on creditors of the high street business, such as suppliers and landlords. There is now a huge amount of real estate without the security of long-term paying tenants. Between Arcadia and Debenhams alone, over 520 stores are at risk across the UK.[1]

Landlords are not generally provided with any special privileges when a tenant enters an insolvency process. They are often one of many unsecured creditors that the insolvent business may have, putting them in a long line and often looking to make a minimal recovery of any debts due. Landlords are regularly left out of pocket for rent owed from previous months or even years – something that commercial landlords have historically taken issue with, and particularly so in recent years.

Transport for London (TFL) are one of London's largest landowners, with over 1,000 retail units and 800 railway arches in its property portfolio[2]. They recently provided three months of rent relief to 86% of its tenants in an attempt to minimise the impact of COVID-19 on these businesses.[3] Whilst TFL rent relief undoubtedly helped huge numbers of businesses and allowed them to stay afloat during this time, TFL was perhaps only able to grant such relief due to government support. It was recently announced that TFL are set to receive £1.7 billion from the government to make up for their overall revenue loss, a bailout package that follows a previous support deal of £1.6 billion.[4]

Aside from TFL, a huge part of the UK commercial property market is made up of Real Estate Investment Trusts (REITs). Over 50 REITS are listed on the London Stock Exchange, and represent a market cap of $70 billion - much of the UK's commercial real estate is owned via these structures.[5] REITs provide smaller investors with the opportunity to pool their capital and invest in larger scale income-producing real estate. REITs allow investors exposure to a diversified real estate portfolio and, due to their exemption of corporation tax on rental profits, they must distribute 90% of their net property rental income to investors – which means they regularly offer attractive yields.

Whilst the closed-ended nature of REITs means they remain attractive to investors, the UK commercial property sector as a whole has struggled in recent years. The performance of the FTSE EPRA NAREIT UK Property Index, comprised of UK listed real estate companies and REITs, is unfortunately telling. The performance of the index on a Net Asset Value (NAV) basis is down -15.65% and -9.98% over the last 12 months and 5 years respectively as at the end of November 2020. The iShares UK Property UCITS ETF that follows this index currently has a distribution yield of below 2%, which, in the eyes of many investors, may not provide sufficient income to warrant the relative risk demonstrated by the fall in NAV.[6]

Commercial property investments, including those via REITs, have often looked appealing in the past from an income perspective and may act as a good diversifier within a portfolio. However, the pressure that COVID-19 has placed on the sector, accelerating both the move away from the high street and the trend towards working from home, means that investors must be very selective if looking for investments in this space.

[1] https://www.ft.com/content/52a2cbea-6ad5-11ea-800d-da70cff6e4d3

https://www.ft.com/content/54740cc0-20c8-49eb-b201-50fe4cade93d

[2] https://tfl.gov.uk/info-for/business-and-commercial/commercial-properties?intcmp=52535

[3] https://tfl.gov.uk/info-for/media/press-releases/2020/march/tfl-takes-steps-to-support-tenants

[4] https://www.gov.uk/government/news/government-bailout-to-keep-london-transport-running#:~:text=An%20additional%20%C2%A31.7%20billion,package%20for%20Transport%20for%20London.&text=The%20government%20has%20agreed%20a,up%20to%20%C2%A31.7%20billion.

[5] https://www.lseg.com/markets-products-and-services/our-markets/london-stock-exchange/real-estate-hub/reits-london-stock-exchange

[6] https://www.ishares.com/uk/professional/en/products/251802/ishares-uk-property-ucits-etf?switchLocale=y&siteEntryPassthrough=true#/

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