Legal Review: How technology is transforming all areas of commercial property

Developments in technology have disrupted most traditional industries in recent years, with long-established practices becoming redundant in the face of a new, digital way of doing things.

An idea of what St James Edinburgh will look like is coming into focus. Picture: St James Edinburgh

At the heart of these changes is the built environment, but some areas of commercial property seem to be struggling to adapt while others are seeing a boom in values, transactions and yields.

The biggest challenges, and the most visible to the public, are happening in retail.

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Last month Thomas Cook joined the list of famous brands to have disappeared from our high streets following the loss of BHS, Toys R Us, JJB Sports, Blockbuster and Woolworths.

New technology certainly played a part in all of these exits. Woolworths was an early victim of Amazon’s success.

Blockbuster was made obsolete by Netflix while internet fashion providers Boohoo and Asos challenge physical high street stores with their vast product ranges and quick delivery.

The success of online travel specialists Skyscanner and AirBnB undoubtedly played a role in the troubles of Thomas Cook, as consumers opt for clicking a DIY holiday instead of discussing a package deal.

The failures of individual small businesses do not hit the headlines in the same way, but all empty shops contribute to the decline of the traditional high street and have a cumulative effect on the popularity of retail centres.

Richard Rennie of Burness Paull says that challenges in the market are very much regional. “In retail, the high-end, such as Buchanan Street in Glasgow and George Street in Edinburgh, is resilient but in places such as Paisley or Falkirk, it can feel quite dead,” notes Rennie.

“Retailers are being challenged by out-of-town malls and online shopping and while the high streets are evolving in response it isn’t fast enough. Traditional retail isn’t coming back, this isn’t a transitory trend, and the whole sector will have to adapt and change.”

Kenneth Irons of Gillespie Macandrew agrees. However there are exceptions, as he notes: “There are still companies who are looking to grow, there doesn’t seem to be a lack of appetite for coffee shops. Starbucks are building drive-throughs and there are interlopers in that market trying to challenge their dominance.

“For strong, well-located premises you can still get prime rents. The St James Centre in Edinburgh has some punchy rents and it is being seen as a disruptor to Princes Street.

“But it gives rise to opportunity if handled well. There is a suggestion that Princes Street will see a return of independent stores as the rents will be more attractive and it will become a blend of food and leisure, restaurants and bars to entice the footfall.”

Rennie says that the changes in empty rates rules, which were introduced in 2016, have had an effect on commercial property deals. “An empty unit is now costing the landlord so it makes sense to offer shorter leases of say 12 months rather than holding out for ten to 15 years, as no one knows what shops are going to look like in another decade,” says Rennie.

“We are seeing changes to contracts, not just to negotiate the price of rent down but to add greater flexibility, to link rent to turnover and pay monthly in advance rather than annually.

“Company Voluntary Arrangements (CVA) give the opportunity to renegotiate rents but effectively you end up with a two-tier high street, half with rents based on 2019 market conditions and others who are still paying rents which are based on upward reviews carried out some years ago.”

Irons says: “The concern for landlords [of a shopping centre] if they lose a big tenant is that the anchor is gone and other tenants, if leases are coming to expiry dates, can follow and you can go from 90 per cent occupation down to 50 per cent very quickly.

“Trying to get that blend of new-to-market retailers and food and drink is the way to deal with it, but there is no doubt that the market is still under significant pressure. The opportunities lie in the main in Edinburgh and Glasgow and you can see that in the future there will only be ten or 12 major shopping centres in Scotland and all the secondary centres will suffer badly.”

While the retail sector is being hammered by competition from online shopping, the industrial sector is benefiting from it.

Across Scotland demand is high and vacancies are low. Rennie says: “The yields traditionally were 9 or 10 per cent but these have come down as the sector has become popular with investors.

“Consumers are demanding one-hour time slots for delivery so at the top-end you have the Dunfermline Amazon building – the size of 14 football pitches – as a logistics centre but it filters down to ‘last mile’ delivery so smaller depots closer to population centres are also doing well.”

Irons explains: “Hermes and other courier companies are now seeking to take on smaller premises. There is also strong demand for smaller units for trade companies such as Screwfix and Hewson in the right locations.

“The cost of building industrial units relative to returns have historically not been great but speculative builds, particularly of smaller units are now occurring. Investing capital in these, and spreading the risk amongst a number of smaller tenants, is attractive.”

In the office market, premises are changing shape because of the way businesses use technology. Rennie says: “There is a drive for fit-outs including collaboration spaces. It is an idea that started in the creative industries of Silicon Valley but has even filtered all the way down to the somewhat stuffy atmosphere of Edinburgh lawyers.

“The move to agile working has an impact too, it helps staff but in terms of offices you need fewer desks so it is finding a balance between those two influences.”

The arrival of WeWork offices in 80 George Street last month was the global co-working premises provider’s first purchase in Scotland, and despite problems with its parent company it is a business model that is being watched with interest.

The space can house lots of different businesses, from a single person enterprise, to small businesses which may benefit from collaboration with others, to larger companies which can take a core space and expand and contract within the same building depending on projects and staffing requirements.

Irons says: “There is undoubtedly demand for high-end flexible space. But [WeWork] are charging a premium price tag, and how much demand there is will be seen in their first few months.

“It will be interesting to see how the industry reacts but it is an attractive offering to companies with high growth, businesses that want to maintain flexibility but do not want a long-term lease commitment, and also large organisations looking for immediate accommodation.”

The trend for such flexible space and short-term rentals is a knock-on effect of the gig economy.

Edinburgh’s start-ups, young tech industry and contacts with the university make it a key area for such flexibility to flourish.

Specialist co-working spaces, such as Codebase in Argyll House on Lady Lawson Street, which houses coders, hardware engineers and software designers, are likely to increase as university towns in particular are generating the next tranche of entrepreneurs, and the design of commercial offices, and property deals, responds.

As 28 per cent of the commercial property market UK-wide is now invested in alternative sectors, Rennie says that student accommodation, care homes and retirement living which makes up the market has become mainstream as investors look outside the traditional areas.

He says: “It is a case of diversifying and you can find a better yield although again, as these areas have become popular, the yields have come down.

“Alternatives are also seen as shoring yourself up against risk, looking at strategic demographics such as students and an ageing population, when office and retail markets can be more volatile.

“Storage and hotels are very popular, depending on location, and again they used to be classed as alternatives but are now considered mainstream.”

Irons says demand for newer investment vehicles is rising: “In student accommodation, developers are looking for sites not just in Edinburgh but trying to spot a need elsewhere, in Glasgow, Dundee and Stirling.”

He believes that in the next five years a key disruptor of the market will be retirement villages. “The first luxury retirement village in Scotland has just been announced in Newton Mearns [Scotsbridge Holdings’ Hills at Whitecraigs].

“There are a number down south and they are specifically designed and allow both a renting and purchasing model, with security and on-site facilities.

“It is an idea from Australia where such villages have existed for 30 years. They are aimed at the higher end of the market but there will be a point when saturation is reached at that level and so the standard and price will come down. You can expect to see a lot more in the next five years.”

This article first appeared in The Scotsman’s Scottish Legal Review 2019. A digital version can be viewed here.