UK property fund managers are standing by their office allocations in spite of large corporates pledging to downsize their footprint and encourage more employees to permanently adopt remote working after the coronavirus lockdown.
This month, Lloyds told staff in a memo the bank would likely need “fewer buildings and different types of spaces” after the Covid-19 crisis due to changes it had initiated in the way people work.
It is not the only large UK business to signal disruption for office space demand. In April, Barclays chief executive Jes Staley said the “notion of putting 7,000 people in a building may be a thing of the past”. WPP has also signalled its office capacity will be lower on the other side of the coronavirus.
Over in the US, Twitter announced in May staff would be able to work from home “forever” due to the success of remote working during the lockdown. Employees that ditched pricey San Francisco as a result would have to take a pay cut commensurate with living costs in their new location.
Furthermore, Fitch Ratings has warned of lower demand for city centre offices across Europe, but particularly in “expensive and highly centralised” markets like London.
In 2017, it had estimated suburban shared workspaces would steal 25% market share from central London prime offices over a decade. It now expects the coronavirus pandemic could halve the time of such a transition.
See also: BMO property fund reopening raises questions about scarcity of hybrid models
Retail still very much property funds’ most pressing concern
Fundcalibre managing director Darius McDermott (pictured) says property fund managers have indicated to him that rent recollection from office tenants has so far held up. “Where there has been stresses in the last quarter, it’s been on retail.”
In the near term, office tenants have to ride out their leases, McDermott says. “Barclays has got big offices in Canary Wharf. If you’ve got 40 floors and the lease is expiring on the top three floors you could shut those down. But there are contracts and leases in place. That’s also there with retail but the problem with retail is that it could go bust.”
That near-term resilience is good news for the Investment Association UK Direct Property sector, in which all funds are currently suspended due to material uncertainty over valuations on more than 20% of portfolios, a clause that still currently applies to offices.
IA UK Direct Property sector funds with highest allocations to offices
| Fund | Weighting to offices |
| Kames Property Income | 53.21% |
| LF Canlife UK Property | 47.90% |
| Aviva Investors UK Property | 32.29% |
| Royal London Property | 29.70% |
| M&G Property Portfolio | 29.14% |
Source: FE Fundinfo
Nevertheless, McDermott describes the office sector as a medium-term trend to watch. “Retail is very much the focus for today, even if the coronavirus has highlighted potential progression in the working from home culture.”
See also: UK property funds could reopen over summer as valuation uncertainty lifts in some sectors
Markets show no signs of punishing investment trusts with high office exposure
Investment trusts with high office exposure have not taken a harder hit than their peers, says Winterflood Investment Trust research analyst Emma Bird.
There are no property investment trusts focused purely on offices but the Regional Reit has by far the highest exposure to offices, accounting for 80% of the portfolio at the end of March.
“It appears that the fund is performing reasonably well, with 94% of rent due collected as at 18 May, which compares favourably with a number of other investment trusts, particularly those with a considerable retail exposure,” Bird says. The Reit does not publish quarterly net asset values so it is not yet clear the impact the pandemic has had there, she adds.
Property – UK Commercial sector investment trusts with the highest allocation to offices
| Investment trust | Weighting to offices |
| Regional Reit | 79.9% |
| Drum Income Plus Reit | 47% |
| BMO Commercial Property | 41.8% |
| Schroder Real Estate | 39.6% |
| Standard Life Investments Property Income | 32% |
Source: AIC
Bird says the consensus among property fund managers is that the coronavirus outbreak and lockdown will lead to a greater polarisation between prime and secondary assets.
“This means that demand is likely to be increasingly concentrated on workspace that is well-located, high quality, modern, sustainable, environmentally friendly/efficient and which supports flexible working patterns,” she says. “These properties would therefore see greater rental and capital growth prospects, at the detriment of poorer quality office buildings.”
See also: REITs face same uncertainty that prompted raft of property funds suspensions
‘The function of the office will change’
Standard Life Investments Property Income Trust manager Jason Baggaley expects his office allocation to remain broadly similar in spite of the coronavirus lockdown, although he says there is the potential for a “slight reduction”.
Offices currently represent a third of the portfolio with only industrials, which represent 52%, being a larger exposure.
In the immediate term, as offices respond to social distancing, Baggaley says the number of people that can be accommodated in an office will be reduced and the ability to have meetings, make use of amenities, and enjoy social interaction will be reduced. Hot desking is also unlikely to be acceptable.
Aberdeen Standard Investments has undertaken a survey of each office site to understand how the building might operate with social distancing and have provided each tenant with a guide.
Over a longer timeframe, Baggaley reckons the coronavirus will accelerate the trend of more people choosing, and being permitted, to work from home.
“The function of the office will change, from being a place for getting work done, to a place of sharing, interacting, and learning. The office environment is particularly important to create a culture, and help younger members of staff develop. This may lead to a reduction in the size of the HQ office, and will certainly lead to some changes in fit out so that greater collaboration and flexibility of use are enabled.”
See also: UK property funds coy as full fees charged for chunky allocations to ‘idle’ cash
M&G reckons offices are no match for remote working
M&G head of real estate property research Richard Gwilliam sounds upbeat on the outlook for offices, which represents 31% of the suspended M&G Property Portfolio.
“While many of us can maintain productivity and work effectively from home, it simply cannot match the spirit of collaboration, social interaction and in some cases, well-being, which an office environment can provide,” Gwilliam says.
But he expects polarisation in the sector. Offices that cater to collaboration, networking and social appeal will still see demand, but offices in suburbs and third-tier towns will be less competitive, he says. “In our view, well-located offices offering high quality amenities have a bright long-term future and will continue to be important investments within our portfolios.”
Brooks Macdonald manager Niall O’Connor wants to see much more clarity from the office sector before resuming exposure in his multi-asset absolute return fund.
O’Connor ridded his Defensive Capital fund of its limited exposure to the office sector in May, having previously held a small amount through convertible bonds and Reits.
Although Reit prices remain depressed with wide discounts, O’Connor thinks too many tricky questions remain over the future of the office.
“Will we need 40% less space because everyone works from home two days a week? Or will we need 20% more as hot desking won’t be possible, and everyone will need greater separation? Will more people work from satellite offices near their home, and so avoid using the tube, leading to greater uptake of regional office space versus London?”
See also: UK government’s remote working push is no excuse for funds to underperform
London’s dense office footprint will not work well in a socially-distanced world
Office space was looking “quite” expensive going into the crisis, particularly in London, says O’Connor. The Conservative election win in December gave prices renewed impetus, he says.
That view of London is echoed by Fitch Ratings. It has increased its vacancy assumptions in a number of European markets due to remote working and weaker economic conditions. Amsterdam and Helsinki were highlighted as cities likely to be less affected due to their more dispersed office footprints whereas London and Paris sat at the opposite end of the spectrum.
Fitch says funnelling as many workers as possible into a concentrated area of crammed offices and skyscrapers is incompatible with social distancing. But that is the model London had employed before the pandemic with developers building increasingly higher elevations to justify prime land prices. Mass transit and busy lifts only compound the problem, Fitch says.
Fitch still reckons centrally-located offices will re-emerge as places for meetings, collaboration and training. But it also highlights that office leases represent a significant overhead for city centre occupiers. “The crisis has demonstrated that remote working is effective, scalable and even desirable. This makes current prime office valuations harder to justify.”
See also: Darius McDermott: Property should not be a dirty word for investors
