Astute investors should be active in office property

Until we see the Covid-19 pandemic brought under control – either through a vaccine or a functioning test and trace system – meaningful re-occupation of UK offices is unlikely.

However, despite the near-term gloom, our positive view on the future of offices remains unchanged. Irrespective of weaker short-term demand, there remains a fundamental need for good quality office space to enable companies to create, innovate, collaborate and showcase.

We are convinced office demand will return, as these spaces remain a fundamental part of the overall offering for staff. Indeed the enforced experiment in home working has demonstrated their importance to team building, collaboration and other human-based tasks. Nevertheless, investors need to understand how the traditional role of the office will evolve, in order to capitalise on re-rating opportunities.

Quality will determine future demand

Before the current ‘second wave’ of coronavirus infections, the UK already had the lowest office re-occupancy rates of any Western European country. In lockdown once more, this will persist for the foreseeable future. Many occupiers with imminent lease events may elect not to renew until re-occupation is possible and, instead, look to flexible office leasing models to fulfil any short-term demand.

This will adversely impact short-term income and vacancies for landlords and means more overall pessimism for the sector. Offices already account for a 4.8% reduction in property values across the UK – which have fallen by 7.0% since the beginning of the year*. As a result, the sector is in a state of flux, with asset quality and lease profile determining liquidity and price.

Indeed, when demand starts to return to the sector, occupiers will look to take up less total space, likely leading to an intense focus on the highest quality assets. Location will also become crucial, with occupiers preferring city centres due to accessibility and the presence of nearby amenities. In addition, wellness and ESG have climbed the agenda, and offices will need to provide a positive and sustainable environment for those electing to travel into work.

While quality assets will be key to attracting reluctant commuters into the office, repeated surveys show the optimal solution for most office employees is flexibility – with a mix of office and home-based working preferred. Where landlords can offer high-quality well-located spaces, these will command higher rental premiums. The opposite is true for misaligned spaces and locations.

Preparing for the return to the office

In order to achieve long-term portfolio resilience, it is crucial for investors to be dynamic and adapt to shifting occupier demand – particularly in the face of the unprecedented upheaval brought about by the Covid-19 pandemic. Simply buying properties with long leases to occupiers perceived as financially robust is no longer enough.

The shift towards higher-quality offices will only become apparent once the Coronavirus is under control. Therefore, now is the time to review office holdings to ensure evolving occupier requirements can be met.

Before any real return to normality, investors should use this time wisely to conduct asset management initiatives and adjust office allocations – focusing on assets aligned (or offering the potential to be aligned) to the new working dynamic and offloading misaligned property.

While capital value falls have been moderating, we expect income risk to be increasingly discounted if economic conditions deteriorate further. This is likely to prompt further valuation declines for assets with vacancy and short lease profiles over the coming months. For astute, well-capitalised investors able to accommodate risk in portfolios, this represents a unique opportunity to actively manoeuvre to end up on the right side of change.

*MSCI Monthly Property Index, October 2020

Tim Munn
Chief Investment Officer, Advent Capital Investments Ltd