Performance divergence across commercial property segments reflects structural changes accelerated by the Covid-19 outbreak that have reshaped the CRE sector. Industrials have emerged as the main beneficiaries. Hospitality and retail, with few exceptions, are the most impacted, as rental income has slumped. Both segments face refinancing risk as they approach a debt wall in 2023-24. We expect performance of office assets to remain mixed as per their current performance.

“Operating performance diverges across commercial property segments,” said Florent Albert, director in Scope’s structured finance team and co-author of a report out today. “Industrial has outperformed, with a 6% median income growth and strong fundamentals for further growth. Office is showing a K-shaped performance. Hospitality (-36%) and retail (-20%) strongly underperform. Performance was marred by the weakness of retail outlets and shopping centres despite the resilience of retail warehouses.

“Valuations have generally increased, mainly driven by yield compression as rental growth has dragged. Retail assets are the exception where yields have widened,” added Benjamin Bouchet, a director in Scope’s structured finance team. “The hospitality sector has drastically underperformed, mainly driven by sharp declines in occupancy rates.”

The data points to a negative outlook by valuers for the retail sector, with higher decreases in valuation than in rental income. One percentage point of rental change corresponds to 1.2 percentage points of value change. Market confidence in other sectors is positive, with higher valuation changes than rental changes. Here, one percentage point of rental growth corresponds to two percentage points of value growth.

Change in collateral market value vs. change in colateral income

Source: Scope Ratings, Offering circulars, Quarterly reports

The real estate sector has become more exposed to the ability of sponsors to manage tenant rollovers. The average unexpired lease tenor has reduced by four months on average. The reduction was particularly intense in the office sector (9.4 months). The logistics sector has succeeded in re-letting at higher levels. The office sector has had a mixed outcome, and the retail sector has suffered the most. “Sponsors of retail loans have limited the impacts by signing new leases but at significantly lower rental levels and with a turnover component, which ultimately pressures valuations,” said Shan Jiang, associate director in Scope’s structured finance team.

When it comes to finance, retail and hospitality are approaching a refinancing wall. Lenders’ appetite for refinancing the retail (11 loans) and hospitality underperforming sectors (three loans) will be tested in 2023 and 2024.

“We predict a K-shaped performance between the ‘haves’ and the ‘have-nots’,” said Albert. “The haves will benefit from strong locations, strong tenant covenants, some operational leases to capture growth among in-place occupiers, and environmentally friendly features including strong Energy Performance Certificates. The have nots,” Albert continued, “will lack good transportation links and amenities to support occupiers’ demands or will require significant capital expenditure to deal with environmental considerations.”

Download the report here.