Summer is over, schools are back and in any other year people would be returning from the beach to the office.

Covid-19 has rendered 2020 different for all sorts of reasons and despite a Government push to get people back at their desk, many continue to work from home. This has big near-term and potentially long-term implications for the economy and the markets.

It remains difficult to say what the long-term impact of the Covid-19 pandemic will be, giving we are still living through it. Yet for businesses reliant on commuter traffic and for investors in commercial property, the slow pace of a return to normal working is a serious problem. This is also true for a UK economy which is heavily weighted towards the services sector.

Office stocks cheap for a reason?

Morgan Stanley says valuations for office-focused real estate stocks look optically cheap in most cases, but it is still concerned that investor appetite to play a recovery via offices could be offset by structural concerns.

The latest IHS Markit/CIPS Services PMI reading of 58.8 (3 Sep) reflected the sharpest increase in activity in five years but was below expectations and really only reflects a recovery from a low base, supported by temporary kickers like the ‘Eat out to help out’ scheme and furlough. A figure over 50 represents expansion and a figure below 50 represents contraction.

The contrarian view

Do you believe the working from home trend won’t last and that people will eventually return to the office?

If so, buy shares in Great Portland Estates and Derwent London while the office-related commercial property sector is unloved.

UK LAGS REST OF EUROPE

Research by Morgan Stanley suggests the UK is lagging other European countries when it comes to people going back to their office.

Its latest AlphaWise ‘Road to Recovery’ survey, conducted in mid-to-late August, showed just 37% of UK office workers returning to working at their normal location compared with 70% across Europe as a whole.

However, one must consider that more people might be returning to offices in September now that children are back at school.

Some UK organisations aren’t contemplating a concerted return to the office until 2021 – including NatWest (NWG) and London Stock Exchange (LSEG).

This reinforces the message from the Bank of England which recently suggested it is impossible for workers to go back in large numbers while the risk of Covid-19 lingers – not least because of a lack of capacity in public transport to accommodate a socially distanced commute.

Greggs & WH Smith – balance sheet situation

Greggs – Net debt of £26.2 million as at 27 June.

WH Smith – As at 4 August the company had cash of approximately £63 million with a revolving credit facility of £200 million and an additional committed bank facility of
£120 million, both of which were undrawn. July cash burn totalled between £15 million and £20 million.

PROPERTY INVESTORS' ISSUES

Rent collection has been affected for owners of office assets– though not as acutely as for landlords of retail property and this has been priced in by investors with most relevant investment vehicles trading at substantial discounts to net asset value.

Based on a survey of its top 50 clients, office landlord Derwent London (DLN) expects 27% occupation for the third quarter of 2020, 47% for the fourth quarter and 65% for the first quarter of 2021.

IS WORK FROM HOME HERE TO STAY?

Writing in July, Schroders’ real estate team argued the current exodus from the office is likely to prove short-term.

‘Taking a longer-term view, we doubt whether the current experiment with remote working will lead to a step change in office demand after the virus. While it will be more common for people to work from home occasionally, we do not expect it to become the norm.

‘The office is the best place to communicate with colleagues, spark new ideas, train staff and meet with clients. Many occupiers including big tech (e.g. Amazon, Apple, Google) have invested heavily in new offices in order to attract and retain staff.

‘We anticipate that the demand for offices in city centres and close to universities will increase once the virus is brought under control, driven by the growth in tech, life sciences, professional services and public administration.’

Investors who buy this argument and want to play an eventual recovery should concentrate on names like Great Portland Estates (GPOR) and Derwent which have the financial strength to weather the current disruption.

Great Portland has a loan-to-value of 15% and recently raised £150 million through a debt issue while Derwent had an LTV of 17.3% and cash and undrawn lending facilities totalling £502 million as at the end of June.

DEPRIVED OF AN ECO-SYSTEM

The picture is starker for the likes of food-to-go specialist Greggs (GRG) and travel shop operator WH Smith (SMWH), the latter also facing a major impact from restrictions on air travel.

These firms have higher fixed costs than property owners, thanks to their large workforces and input costs, and are therefore potentially more vulnerable as they are starved of their usual eco-system of commuters and people in the vicinity of their shops.

The recent decision by sandwich seller Pret to cut 3,000 jobs shows the sector’s pain and the most recent Coffer Peach Business Tracker data says pubs and restaurants experienced sales down 50.4% in July on the same month in 2019. Interestingly trading in the country’s major metropolis London was down by a more significant 58.3%.

Shore Capital analyst Clive Black notes that the wider impact of coronavirus upon consumer behaviour and markets is ‘problematic’ for Greggs, which recently had to close a Leeds distribution depot due to a coronavirus outbreak on site.

Black specifically flags the disruption to trade, ‘particularly in travel hubs and business centres that working from home brings to the British food system’.

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