Like the wider economy, every part of the real estate sector has been affected by the pandemic. As retailers depart the high street, shops lose value and warehouses gain. Offices stand empty. A society looking for better quality of life will demand better-quality housing and more sustainable buildings. Phil Hooper, head of real estate finance, and Tom Sharman, head of strategy and insight, real estate finance, explore these issues in the light of Stephen Blackman’s research.

Tom Sharman: From an investment perspective, the retail and leisure sector has been under pressure for some time. The pandemic has accelerated that decline. But if retail is integrated into town centres, owners will need to do something with those assets. Some local authorities have purchased shopping centres, and I can understand why, but the question is what do you use it for? There is potential for some leisure uses, but, realistically, a large amount will need to be repurposed or even replaced. The removal of a significant proportion of retail space will require a step change in the way we think about our town centres.

The challenge is that building costs are roughly the same across the country, but residential values are not. If you have a shopping centre in Maidenhead, for example, you can rebuild. But for some town centres, the cost of knocking down and rebuilding will be higher than many alternative use values.

Work & Play

Phil Hooper: At the moment, many large employers are sending the message that everyone can work at home, but they may be at risk of neglecting the element of well-being. I don’t believe buildings designed today will be brought into operation in an environment where we’re still socially distancing. And if you want to attract good-quality, talented people, you have to provide the right infrastructure, and an office is part of that, although what it looks like, how it feels, will change. There is a feeling at the moment that you can get away with not having any offices, but that won’t keep you operational for long. We think the death of the office market is overplayed; but it’s certainly changing, and we need to adapt.

TS: Surveys suggest employees before the pandemic spent an average of four days a week in the office. Recent surveys suggest the average going forward may be about three. So does that mean you need 25% less office space? My feeling would be no, given the changing way we occupy that space. We’re going to be having lots of meetings away from a desk. For every person in the office you’ll need a bit more space. We expect the total demand for office space to decline by about 10% to 15%, but not across the board; in some areas, you may see a 50% reduction, whereas in others the impact will be minimal. Fringe locations, where the primary appeal was relative cost, but which lack strong transport links and amenities, are likely to be most affected by behavioural change.

Place & Community

PH: We’re starting to build the number of houses we need; supply is increasing; quality is improving too. This takes time, and as a builder you need a lot of money to do it. But the government has underpinned the residential market, both on the build and mortgage side. Initially there was a bit of a panic among builders, but they went into the downturn in a position of strength and were not carrying much debt. Within two or three months they were back building. The mortgage market has been liquid and interest rates are low, so the market has been strong. But we need to see how the pandemic changes employment. Low earners might suffer in terms of employment and job security, affecting their ability to get mortgages.

TS: There’s been talk of an exodus from cities, but my feeling is our megacities will still be the most attractive places for the majority of employers to build office space. When I talk to people in early middle age or older, they’re more comfortable working from home, and not so bothered about going into the city. But people who are 25 to 35 – a core age range for employers – typically want to be in on the action. It’s important we don’t project our own preferences on to the situation, and reflect the fact that younger people still want to live and work in city centres.

Economy & Finance

TS: The role and skill sets of investors are changing. Going back to before the global financial crisis, as a retail investor you might put your money in and employ a managing agent to make sure rent reviews are done and rent collected. What we’re seeing now is the owner might manage that serviced office or use an operator under a management contract. The investor is exposed to the operational performance of the asset. It’s no longer enough to passively collect the rent each quarter and expect to increase it at the next review. You need to manage more proactively and provide the tenant with a service that they value.

PH: And those investors who don’t evolve could feel the full pain of the market.

TS: Many are investing in distribution warehouses at the moment, because you typically get new assets with long income. It’s a hot sector. But this asset might become obsolete over time and will need managing. The underlying demand growth is still massive, but every cycle will get to the point where supply starts to overtake demand. That will happen in logistics.

Health & Meaning

PH: The industry has started to take sustainability seriously and it’s exciting to be part of this. While we haven’t got all the answers to reducing emissions, sustainability is a long way up the agenda, if not the first thing on it. As a lender, we have targets about how we become carbon neutral in the next 10 or 15 years. In the residential sector, for example, we only fund developments with EPC (Energy Performance Certificate) ratings A and B.

TS: Assets that are sustainable will be worth more in future. It makes sense to accept more risk on day one to support these projects, because the return will be better going forward.

PH: It’s like the motor industry: in 20 years it doesn’t matter how much you paid for your diesel car, it won’t be very valuable.

Megatrends: five essentials for the real estate sector

There are opportunities for the leisure sector if local governments buy retail premises for redevelopment, but their commercial viability may be limited.

Office space may decline by 10% to 15%, and the way that businesses occupy that space is also changing.

There will continue to be young, affluent buyers in urban areas for residential properties, with a focus on quality.

Investment in real estate will increasingly demand hands-on management: this means providing shorter, more flexible leases and, in some cases, returns linked to the underlying performance of the asset.

Tenants and planners prefer sustainable developments – a two-pronged incentive for developers to build back green after the crisis.