Adapting to radical uncertainty
Just three months ago, most people around the world had not heard of the coronavirus. The first European cases of the respiratory disease were detected only six weeks ago, on 21 February in France. The wave of contagion which followed has been astonishing.
At the latest grisly count, more than 1.5 million people across more than 200 countries have been infected with coronavirus and there have been more than 90,000 attributed deaths, up from less than 3,500 just one month earlier.
These numbers will sadly be dwarfed by what is still to come. The failure to contain the virus has prompted a worldwide quarantine of around 3 billion people – the breadth and speed of the impact on human life is unmatched in living memory. The draconian restrictions on liberty and freedom of movement to suppress transmission are dystopian, but remain the most realistic strategy to prevent global healthcare systems from collapsing. There is no historical comparable for this emergency: neither the global financial crisis nor any specific terrorist attack quite capture the unique variables in this pandemic. Perhaps one useful framework of reference is the largely unrealised risk of climate change – a slow-arriving existential threat for which the harbinger of what is to come is only perceptible through abstract mathematical modelling.
With this context, this special report attempts to distil what all this means for our industry, the subsectors and the macro economy. First, the economic picture. We begin with an analysis of the unprecedented interventions by governments, central banks and regulators across the US, Europe and the UK in fiscal and monetary stimulus, loosened regulations, and extraordinary state interventions to directly support specific vulnerable sectors (see p4).
Second, we try to make sense of what
this all means for the real estate sector: including investment activity and capital flows (p8). Third, we analyse the vulnerable sectors, how the fundamentals have altered, and the solutions sector specialists are considering (p18). Fourth, we discuss the inevitability of insolvencies and restructuring to come, and the crucial role of lenders. We consider whether government emergency measures to directly support businesses with loans, grants and loosened regulations will be enough to prevent a new wave of insolvencies and bankruptcies (p24). The special report also includes views on the German experience during the first quarter by Blackbird Real Estate (p29), and CREFC Europe CEO Peter Cosmetatos shares his thoughts on impacts on real estate financing markets (p23).
Guarding against complacency
When freedom of movement restrictions are lifted and workers return to factories, offices, shops and restaurants; when airports and schools are reopened, and economies begin their long roads to recovery, we must not move on without heeding the lessons. We are living in an era of radical uncertainty, as coined by former BoE governor Mervyn King. The only viable way to manage this radical uncertainty is through global cooperation. Governments and the private sector must work together internationally on early virus detection. Some nations, like the UK, need to invest in diagnostics while all nations must be better able to rapidly implement contact tracing. Scientists must transparently pool research and underlying data. We would be wise to view Covid-19 not as a once-in-a-century event, but as a precursor to greater challenges to come. The fundamental ongoing risk is in the underestimation of the epidemic’s exponential rate of increase. The future risk is guarding against complacency when this crisis recedes. New science-guided protocols must be implemented to ensure humanity has the best possible chance to swiftly bring to heel not if, but when, a successor coronavirus emerges.
Real estate investors, as owners of physical assets, have a crucial role to play. Logistics providers can reorient supply chains for national frontlines; empty hotels and student accommodation blocks could rapidly be renovated into makeshift hospitals and logistics hubs; retailers can prioritise frontline medical professionals. Global investors can support the build out of a diagnostics capacity through broadened socially responsible investing. Global investors may seek to re-evaluate the boundaries of their socially responsible behaviour to include the nations on which their supply chains are reliant.
We hope you find this special report informative. We are committing to a successor report when governments re-open nations and freedom of movement is restored. We will explore what the aftermath will look like for our sector and we invite you and your colleagues to contribute to that discussion. Above all, we hope you, your family and friends, your colleagues, clients and peers are safe and remain resilient and optimistic.
James Wallace, editor
Monetary and fiscal defences unleashed
Governments and central banks have injected trillions to prevent the coronavirus pandemic becoming a worldwide depression. James Wallace reports
A global recession is now inevitable. What began three months ago as a health crisis is already a massive economic crisis. Governments and central banks worldwide have unleashed many trillions in fiscal and monetary stimulus packages to prevent the economic crisis engulfing the world into a deep depression. We are not there yet. And we may never get there. Fundamentally, the coronavirus crisis represents an exogenous shock to the economy, detached from economic fundamentals. Indeed, governments and central banks have learned the lessons from the global financial crisis (GFC) and have acted decisively.
Here, the extraordinary monetary and fiscal measures implemented by the US, Europe and the UK are summarised and critiqued.
United States
US president Donald Trump signed an historic $2.2 trillion stimulus package at the end of March, in a belated effort to prop up a now struggling US economy paralysed by the coronavirus outbreak. The massive direct aid – three times larger than the $700 billion Troubled Asset Relief Program president Barack Obama signed in 2008 to rescue the financial system – overcame a week-long impasse in Congress. Global markets rallied for three days before the surge cooled. The package will distribute almost $1 trillion in business loans and guarantees to millions of large and small US companies, as well as sending payments of $1,200 to millions of Americans.
By early April, demand for new Small Business Administration loans had overwhelmed the system. Treasury secretary Steven Mnuchin has asked congressional leaders to commit an additional $250 billion to meet surging demand in support of small businesses and households.
It was, however, the Federal Reserve, not the US government, which led the global response to coronavirus. In an emergency meeting at the beginning of March, the Fed surprised markets with a 50 basis points cut in the federal funds rate to a target range of 1-1.25 per cent. Less than two weeks later, it cut rates to effectively zero per cent and immediately restarted daily purchases of Treasury and mortgage-backed securities, to support liquidity.
Initially, the Fed’s revived quantitative easing (QE) programme was capped at $500 billion in Treasury securities and $200 billion in mortgage-backed securities. However, within days, the programme was expanded to unlimited purchases, which prompted Wall Street to rally, but the gains did not last. The Fed also offered up to
$1 trillion of overnight loans a day, in an effort to stave off a new liquidity crunch. The market has noted the unprecedented speed, force and decisiveness that the Fed, in particular, has shown, which has underpinned the stability and strength of the US dollar in these extraordinary times.
‘The US economy and commercial property market fundamentals were on firm footing coming into this unprecedented period,’ says Richard Barkham, CBRE global chief economist and head of Americas research.
The US has rapidly replaced Italy, and China previously, as the epicentre of the coronavirus, and the toll on the world’s largest economy is stunning. In the final week of March, more than 6.6 million Americans filed for unemployment benefits, according to the latest Labor Department data. In the last two weeks of March, 9.9 million Americans applied for benefits, more people than through the two years of the GFC. For the month, the figure tops 10.4 million, and a further 4 to 5 million of claims were expected in the first week of April.
SMEs provide about 61 million US jobs, or 47 per cent of total private sector jobs, according to Moody’s Analytics. The US economy is reliant on a vibrant SME sector, which will bear the brunt of this recession. US policy measures will be judged by SME survival and employment trends.
Capital Economics now forecasts an unprecedented 40 per cent annualised decline in Q2 GDP, with unemployment hitting 12.5 per cent within months. Annual GDP growth is pitched at -5.0 per cent.
These statistics are a remarkable indicator of the coronavirus-triggered economic collapse and coincide with one of its worst quarters ever for Wall Street. All three indexes closed out Q1 in negative territory for the year. The Dow Jones tumbled by 26 per cent, the S&P 500 sunk 23 per cent and the Nasdaq lost 17 per cent. Wall Street is bracing for worse to come.
Europe
The pandemic may well become the most devastating economic shock in the history of the European Union. The severity of the economic pain to come will be uneven across member states but will undoubtedly severely impact Italy and Spain, which are still heavily indebted from the GFC.
European Central Bank (ECB) chief Christine Lagarde has suggested a one-off joint debt issue of ‘coronabonds’. Nine eurozone governments – including France, Italy and Spain – have also called on EU policymakers to back coronabond issuance, which would integrate the eurozone bloc into the tightest fiscal union in its history. But the communitised bond proposal – for which issuance levels required will be in the trillions – is dividing EU members into a North-South divide, straining the solidarity of the European project faithful.
It is a tragic reality that – so far at least – the European nations ravaged most by coronavirus, Italy and Spain, are among the EU-27’s weakest member states which are yet to fully recover from the GFC. Their sovereign debt to GDP ratios are 136 per cent and 97 per cent respectively, which limits – but does preclude – their ability to access capital markets. Coronabonds would therefore provide cheaper access to capital markets, because stronger economies, such as Germany and the Netherlands, would share the liabilities.
But Northern European countries, led by Germany and the Netherlands, as well as Austria and Finland, are unwilling to underwrite borrowing to fund spending in weaker countries and argue other tools can support vulnerable EU member states.
France is the notable Northern European market which backs coronabonds. Backed by Italy and Spain, France wants a common EU fund to help Europe through the crisis. However, Germany’s resistance to issuing coronabonds is starting to soften. France has suggested the fund is limited to a maximum of 10 years and specifically focused on economic recovery.
There is one other weapon in the EU’s armoury, which is to provide member states with emergency access to the European Stability Mechanism (ESM), the eurozone’s €500 billion bailout fund for struggling economies, worth up to 2 per cent of nations’ GPD. Germany is mulling the option, but the Netherlands believes
it is too soon. Eurozone finance ministers are yet to agree on joint stimulus measures. The debate continues.
Fiscal stimulus across Europe has varied by ability to finance and severity of need. Germany will borrow up to €150 billion in addition to a €156 billion supplementary budget and is also reportedly setting up a €500 billion bailout fund to take stakes in critical industries. The net proceeds will finance government grants and loan guarantee schemes to businesses. Spain has announced measures worth €200 billion, Italy has announced €25 billion, France has pledged €45 billion, while Portugal has unveiled a €9.2 billion package. These amounts are all likely to increase.
The ECB has committed to net asset purchases of €1 trillion by the end of the year. The central bank is focused on those most vulnerable to a bond market sell-off – Italy, Greece and Spain. It also loosened self-imposed constraints which capped sovereign bond purchasing thresholds.
At the end of March, the ECB ordered eurozone banks to freeze dividend payments and share buybacks this year, delaying the return of an estimated €30 billion of capital to investors, strengthening efforts to avert a new credit crunch.
GDP will be roughly 25 per cent below its pre-crisis level during the lockdowns, with the scale of devastation varying between countries, says Andrew Kenningham, chief Europe economist at Capital Economics. ‘The risk of a sovereign debt crisis is low, thanks to the ECB’s scaled-up asset purchase programme.’ But Kenningham warns the astronomical cost of the crisis means that governments, businesses and households ‘will all come out of the crisis with significantly impaired balance sheets’.
United Kingdom
The UK government’s fiscal response has been astonishing and, like the US and several European nations, the breadth
and scale is reminiscent of wartime state financing. However, its response has been punctured by prime minister Boris Johnson’s own personal battle with coronoavirus. He remains in intensive care and is stable at the time of writing. Dominic Raab, the foreign secretary, is now leading the UK’s government response.
The headline scheme is a £330 billion guaranteed loan scheme, the Covid-19 Corporate Financing Facility (CCFF), a figure which reflects 15 per cent of UK GDP. Coordinated with the Bank of England (BoE), the CCFF aims to directly support businesses in paying salaries, rents and suppliers during this period of protracted cash flow disruption. A further £20 billion was pledged to extend the business rates holiday for the retail, hospitality and leisure sectors announced in the Budget, which previously committed £12 billion.
The chancellor also announced the state would pay grants covering up to 80 per cent of the salary of workers if companies kept them on their payroll, up to £2,500 a month, to prevent large-scale redundancies following robust virus containment measures which required all cafes, pubs, bars, restaurants, night clubs, gyms, theatres and leisure centres to close.
Subsequently, broadly equivalent support was offered to some self-employed workers. The chancellor also deferred VAT until next June for affected businesses, pledged £7 billion in extra welfare payments for those who do lose their jobs and £1 billion for those struggling to pay their rent. However, critics suggest many businesses in the hospitality or leisure sector will struggle to take advantage of the CCFF as it amounts to increasing leverage at a time when businesses have, in many cases, suspended operations with no indication of resumption, future cash flows, or profitability. The UK government admits it cannot save everyone.
Overall, net government borrowing is estimated to exceed £175 billion, or more than 8 per cent of national income, according to Isabel Stockton, a research economist at the Institute for Fiscal Studies (IFS). ‘This would be more than triple the amount forecast in the Budget last month,’ she says. ‘About 40 per cent of that increase would result from new fiscal measures, and the rest from the economic downturn depressing revenues and adding to government spending. A deficit of over £200 billion in the coming financial year is well within the bounds of possibility.’
In monetary policy, the BoE followed the US’s lead with a 50 bps rate cut, back to the record low of 0.25 per cent, before a cut to 0.1 per cent and its own QE revival comprising bond and securities purchases of up to £200 billion. The BoE’s Financial Policy Committee (FPC) also has reduced the countercyclical capital buffer from 1 to 0 per cent, designed to free up around £190 billion of capital reserves for banks to lend to businesses.
‘The Bank of England has shown that is it going to do all it can to prevent the health crisis from spiralling into a financial crisis,’ says Capital Economics’ Paul Dales, but he warns that the coordinated fiscal and monetary measures will not ‘prevent the economy from falling off a cliff in the coming months’. Capital Economics forecasts quarter-on-quarter UK GDP will collapse by an eye-watering 15 per cent in Q2. However, Dales adds: ‘Their actions so far give us more confidence in our existing view that the economy will rebound reasonably vigorously once the virus has been brought under control.’
BoE will temporarily directly finance UK government spending needs, rather than through gilt auctions, to improve speed. BoE had already started £45 billion monthly gilt auctions through the Debt Management Office (DMO). n
Property markets shuttered
Investment markets slowed to a crawl over Q1 with expectations even lower for Q2 activity. James Wallace looks at market activity ahead
of publication of Q1 data
The coronavirus outbreak has caught real estate markets cold. The abrupt and severe contraction of normal trading has halved deal flow, with only very advanced deals still getting over the line by mid-March. Transactional data for Q1 is likely to show a quarter of three thirds, with the effects of the pandemic disrupting transactional activity exponentially across each sequential month.
Initial estimates imply the retrenchment by the end of the first quarter was back
to levels seen during the global financial crisis (GFC). A period of price discovery will be complicated by severely reduced deal closures. ‘Our early numbers are taking us back to 2008 in volume terms,’ says Mat Oakley, head of commercial research at Savills on the firm’s podcast, ‘and then it
is a question of the pace of the recovery and there are many possible scenarios’.
Investment activity in Q2 is likely to be moribund. The delay before the effectiveness of social distancing mandates throughout Europe can be measured will deepen the investment moratorium in real estate markets.
‘One of the sharpest-ever declines in global demand is looming,’ says Chris Urwin, director of research - real assets,
at Aviva Investors. ‘Real assets have historically performed well in stressed situations relative to other asset classes. Nevertheless, pricing will come under pressure, at least in the short term, though some opportunities may also emerge.’
Markets throughout Europe, and indeed the world, have seen a sharper liquidity collapse than at the height of the GFC. The disruption has been far more severe than initial economic worst-case scenario forecasts, in a reminder that economists are not epidemiologists. JPMorgan projects that a recession will hit US and European economies by July. JPMorgan economists now expect US GDP to shrink by 2 per cent in Q1 and 3 per cent in Q2, while Eurozone GDP could contract by 1.8 per cent and 3.3 per cent over the same periods.
‘As we resign ourselves to the inevitability of a large and broad-based shock, nations’ economic policy responses are key to preventing an even longer downturn,’ JPMorgan wrote in a note to clients. As for the UK, Capital Economics is forecasting a Q2 GDP contraction of 15 per cent, compared to Q1, up from just 5 per cent a week prior. ‘It’s clear we are in the early days of a big recession,’ says Paul Dales, chief UK economist at Capital Economics.
‘Investment activity will track the broader economy, but the additional level of travel restrictions and government quarantines will minimise the ability to run technical due diligence and thus any new sales activity will be pushed back beyond Q2,’ says Richard Divall, EMEA head of cross border capital markets at Colliers International. ‘There will be a recovery,
but “full” recovery will not be until 2021.’
Transactional moratorium
In the near-term, the outlook has been transformed. After a quarterly high in
the final quarter of 2019 of €70 billion, capital flows are expected to now come
to a standstill, as movement is curbed
and the economy spirals into a recession. The data, so far, does not yet show the true impact.
‘Preliminary data indicates that for the first eight weeks of 2020 European activity is off 18 per cent compared to 2019 and in the Americas deal volume is 10 per cent higher,’ according to Simon Mallinson, executive managing director, EMEA & APAC at Real Capital Analytics. ‘In Asia Pacific activity is 50 per cent lower.’ This reflects the time lag of the deal closure lifecycle and the delayed onset of Covid-19 in Europe relative to the Americas and Asia Pacific.
Rental values are expected to come under pressure and yields will increase across the board. Capital Economics predicts eurozone property values to fall by at least 8 per cent in 2020, in an ever-changing picture which will is likely to see future revisions. ‘Investment flows are volatile and always difficult to assess, but as the Continent had effectively closed its borders by mid-March, Q1 is expected to be weak and during Q2, activity is likely to fall to new lows,’ says Amy Wood, property economist at Capital Economics, which predicts a peak to trough 40 per cent reduction in eurozone investment activity, before a recovery. ‘Our central view is that transactions will bear the brunt of the adjustment in this unusual crisis. But we believe it is inevitable that prime yields will also move up against a background of global financial turmoil, stalling rents and growing investor panic,’ Wood adds.
As risk spreads widen, prime property yields will rise by at least 50 basis points in Q2 as investment activity grinds to a halt, predicts Capital Economics. ‘This is a little more severe than the worst quarters of the GFC, though that adjustment continued for almost two years with all-property yields rising by over 100 bps cumulatively, so this shock is milder.’
‘Real estate investment markets have entered a deep freeze period with deals being postponed or abandoned,’ according to Alice Breheny, global head of research at Nuveen Real Estate. As banks reconsider the way forward, liquidity costs have increased, and new funding is drying up due to the abrupt shock to investor confidence in cash flow resilience.
Greater disruption ahead
The timescale for the real estate sector to return to some kind of normalcy in H2 will depend upon how long it takes to beat Covid-19; the speed of access to fiscal and monetary support; and the degree to which the cost of financing governments’ stimulus packages drags on the economic recovery.
‘Due to the rapidly changing landscape, most of the disruption to the real estate capital markets has happened in the last 10 days,’ said Richard Barkham, global chief economist and head of Americas research on a CBRE investors’ conference call on 18 March. ‘The last 10 days saw a meaningful fall off in transaction volume (supply) as measured by deals coming to market and demand (as measured by confidentiality agreements signed).’
More than 50 per cent of CBRE’s capital market professionals have seen sales delayed, according to a snap survey on 17 March. More than 70 per cent expect greater disruption in the coming month. The size of bidding pools is contracting, according to CBRE’s survey. Around 65 per cent of existing deal bidding pools have reduced, while 80 per cent of CBRE’s capital markets professionals expect further shrinkage ahead. In addition, 50 per cent of buyers are seeking to ‘reprice’ deals under contract (asking for a price reduction) and two-thirds of buyers have already asked for 5 per cent price reduction, a discount likely to rise as the global emergency endures.
Impacts will vary by
fund type
Property assets backed by long-dated government or government-sponsored income streams are likely to be most resilient. ‘Long-income assets have historically displayed defensive characteristics during downturns,’ says Aviva Investors’ Chris Urwin. ‘Funds focused on such assets outperformed
on a relative basis during the global financial crisis with investors heavily favouring the secure, long duration cash flows they can offer.
‘At the other end of the spectrum, riskier, growth-focused real estate strategies look more vulnerable in the near term. For developments, there is heightened uncertainty about the timing and costs of projects given the disruption to supply chains and temporary reduction in labour supply. For developments that do complete in the months ahead, leasing activity is likely to be subdued. More generally, investors are likely to discriminate against assets with vacancies or leases nearing expiry.’
Damian Harrington, director, head of EMEA research at Colliers International, says: ‘Long-term core players continue to make moves in safe-haven markets, especially around more defensive assets. Concerns over real estate fund allocations, as broader financial market turmoil ensues, is not likely to lead to a raft of assets put up for sale. On the whole, most investors will simply wait for excess allocations to “burn-off” as investors wait for financial markets to readjust, rather than sell. That said, open-ended funds could present a great buy-side opportunity or be a source of distressed sales.’
History repeating itself
Investors in a11 major UK property funds have been locked from liquidating their holdings. Collectively, around £20 billion worth of real estate assets have been gated after valuers, including CBRE, Knight Frank and JLL, exercised ‘material valuation uncertainty’ contracts clauses. UK open-ended property funds managed by Aberdeen Standard Life, Aviva Investors, BDO Global Asset Management, BlackRock, Columbia Threadneedle Investments, Janus Henderson, Kames Capital and Legal & General, Royal London, St James’s Place and Schroders have all suspended redemptions.
‘History does repeat itself and questions again how appropriate open-ended funds are to gain exposure to illiquid asset such as property,’ says Dzmitry Lipski, head of funds research at Interactive Investor, referring to the last wave of redemption suspensions in the aftermath of the UK’s EU referendum in June 2016.
Capital Economics has attempted to model the valuation downside in all-property UK commercial real estate, predicting a fall of around 10 per cent this year, which is mild compared to the 42 per cent peak-to-trough capital depreciation during the GFC from June 2007 to June 2009, according to IPD. The message, for now at least, is: transactional activity will be harder hit than prices.
Colliers International’s Richard Divall adds to the glass-half full perspective: ‘There will be a recovery, but “full” recovery will not be until 2021. There are pockets of activity in capital markets around the region and investors are open for business to consider opportunities, however, new transactions and marketing campaigns have generally paused, while investors assess the impact Covid-19 is having on their portfolios and in particular on the occupational markets to determine rental and vacancy levels going forward.’
Bayerische Versorgungskammer, Germany’s largest state pension fund, has placed a four- to six-week minimum moratorium on all real estate investment decisions, according to PERE. Colliers’ Divall continues: ‘It is too early to determine the timing of the market recovery, although we can be optimistic that there should be quick recovery as this has not been caused by, for example, financial policy, a real estate bubble bursting or changes in oil prices. However, it is prudent to take a view it will take longer than first anticipated. When government policy changes with remote working, socialising and on travel, there should be a huge spike in GDP in each country, although real estate will take longer to recover.
‘Travel restrictions, remote working, lack of access for site visits is causing delays to transactions, however, there are many investors who do have the ability to proceed on transactions, in particular equity buyers who have local offices in various countries. However, there will be further scrutiny at investment committee for institutional investors and perhaps allow a window for family office capital. Equity buyers will want pricing to reflect the risk they will take.’
‘A key characteristic of real estate is that investors can position themselves to have an information advantage,’ explains Aviva Investors’ Urwin. ‘For instance, by focusing on specific markets where they can build strong relationships with local stakeholders. This characteristic is most valuable in periods of volatility when prices diverge from value, allowing resilient investment options to be identified. While the months ahead are going to be very challenging for all investors, those that have built the deepest market expertise and strongest local relationships should be best positioned for long-term resilience.’
CBRE’s Richard Barkham offers a note of optimism: ‘We believe due to massive fiscal and monetary stimulus, the fact that this is not a banking/financial crisis and the apparently fast bounce back of China,
that there is real reason for optimism
that we will bounce back much sooner than any of the 9/11 or GFC comparable periods we have reviewed.’ In the meantime, opportunistic investors – many of which are flush with unspent capital – will capitalise of market illiquidity and acquire businesses, and real estate, at discounts. The vulture funds are already starting to circle. n
Collapse in investment activity hits two thirds of global markets
The Savills Global Market Sentiment Survey shows sharpest falls in activity in retail and hotels, while pain in offices is more moderate. Occupier demand shift, so far, remains moderate.
Reduced real estate transaction volumes were recorded across almost two-thirds (62 per cent) of global markets, based on a snapshot sentiment survey by Savills of its 24 global country markets research heads. The findings provide the first indication of current market conditions before the global brokerage and data and analytics firms release their anticipated first quarter figures. The survey was conducted between 27 and 31 March 2020.
Savills’ sentiment survey findings show the sharpest falls in activity were seen in retail, with activity reported to be down in 82 per cent of countries surveyed. In the office market, the largest real estate sector, a moderate fall in office transactions has been the most common result, reported in 45 per cent of countries. This is followed by roughly equal numbers stating transaction volumes are either unchanged or are falling severely. Hotels, suffering severe contractions in occupancy levels as global travel is essentially shut down, saw transaction activity fall in 84 per cent of countries. Transactions did continue, particularly those that were in progress before the pandemic took hold.
The impact on capital values is yet to be seen at the same scale, with pricing firm in 51 per cent of all sectors globally. More countries reported office, logistics and residential values as unchanged than they did falling. Retail, a sector already weakened due to structural changes prior to Covid-19, has seen falls in capital values compounded: 82 per cent of markets reported falls. Only in China, Malaysia, Vietnam and Portugal have they remained unchanged.
Logistics is a bright spot, with 57 per cent of markets recording no change, or rises, in transaction activity, against 43 per cent seeing falls. Unsurprisingly, healthcare activity and values are holding firm.
mixed picture on debt
The global picture is mixed when it comes to real estate debt. European and North American countries in particular report tightening of availability and worse terms, most notably in the US and UK. Availability and terms remain favourable in emerging markets such as Indonesia, the Czech Republic, Taiwan and the Middle East.
Demand for real estate from occupiers is changing due to the pandemic. While many companies across the globe are working from home, office space demand has not been impacted as severely. A moderate fall in demand was reported by 70 per cent of countries and just 13 per cent stated a sharp fall. Demand in the residential sectors has also fallen moderately.
The hotel sector has been hit hardest
with 95 per cent of countries reporting sharp falls in demand as international travel and domestic lockdowns prevent visitors. Retail is in a similar situation with 74 per cent of countries seeing sharp falls. Logistics and healthcare have bucked the trend. The logistics market in particular is benefiting from increased demand from food retailers. Healthcare is in demand
at this time.
The impact of this demand change is not yet fully realised in rental values, which were reported unchanged in 51 per cent of countries/sectors. The exceptions are again retail and hotels where 30 per cent and 63 per cent of countries reported rental values to have fallen sharply, respectively.
The change in sentiment has translated
to favourable terms for tenants, especially in retail. Favourable terms for retail tenants were reported in 86 per cent of countries. Just over 50 per cent reported favourable terms for office tenants, and 23 per cent in the logistics sector. n
Deep crisis... and a rebound in 2021?
Real Asset Media’s briefing on the coronavirus crisis found the industry realistic about the shock to markets, but upbeat. Nicol Dynes reports
Contrary to some reports, the real estate market has not fallen off a cliff because of the coronavirus crisis, experts agreed at Real Asset Media’s recent Covid-19: Implications, Scenarios & Outlook for Real Estate
online briefing.
‘Unlike in Asia, investment volumes in Europe so far have not fallen back compared to 2019 or 2018 and notable deals are still being completed, despite the ongoing lockdown in the UK and in most other large European economies,’ said Tom Leahy, director of market analysis, EMEA, at Real Capital Analytics (RCA).
A number of deals that had been in the pipeline have been completed recently.
For example, at the end of March a member of the Qatari royal family bought London’s famous Ritz Hotel for a reported £750-£800 million. In Paris, Aviva bought the Credit du Nord office from the tenant in a sale-and-leaseback deal, while Centrum bought a high street store in Munich’s prime shopping area for a rumoured €250 million.
However, ‘it is likely the case that these and most other completed deals had been worked on well prior to this acute stage of the Covid-19 crisis’, Leahy said. ‘It is only once the current pipeline of deals is complete that we’ll see the real impact
on the market.’
There is no doubt that the number and value of European commercial property transactions in March will be low in comparison to recent years, he said, and the forecast is for a further slowing throughout April as lockdowns remain in place, denting economic and financial activities. RCA, which monitors the market on a daily basis, is already seeing evidence of this, said Leahy: ‘We saw 40 deals in the last ten days, which is way down on the normal rate. What we see is that the number of deals is falling day by day.’
Data shows that the value of deals in Europe in March was €13 billion, compared to €24 billion in the same month last year.
A deep crisis followed by a V-shaped recovery
The crisis will be deep but the recovery could be surprisingly quick. ‘It is important not to get into a the-world-is-ending mode,’ said Hans Vrensen, European head of research & strategy, at AEW Europe. ‘The good economic fundamentals could signal a V-shaped recovery.’
There has been a massive correction in March, with the stock market and oil prices declining steeply. In such a
fast-moving situation it is impossible to predict now how deep the plunge will be, but looking at the market fundamentals and at the policies that are being implemented, there are reasons to be positive, the briefing heard.
‘Markets will recover much more quickly than they did after the Global Financial Crisis, when we saw many consecutive quarters of decline,’ said Andrew Burrell, chief property economist at Capital Economics. ‘We’re quite optimistic, but we also need to be cautious because this situation is unprecedented.’
CRE volumes and trading are correlated to stock market moves, as are the prime capital values of real estate, so the recent rebound in financial markets and any mildly positive trend is to be welcomed, said Vrensen: ‘The financial markets will settle down, and the unprecedented policy response from governments and central banks is such that lower for longer will become almost lower forever.’
Bond yields are likely to stay extremely low or negative, which will make real estate look interesting in investors’ eyes.
‘The policy response has been unprecedented, and there is more government support to come,’ said Burrell.
‘We prepare our clients for the worst-case scenarios, so that they can be surprised by the upside, because the worst-case scenario probably will not materialise,’ said Vrensen. ‘People are being inventive and creative, finding their way around obstacles. I am convinced we will overcome this and we will be stronger once confidence is restored.’
Capital flows will take a hit
The immediate impact of the health crisis will be a sharp drop in transactions, but market players must look beyond the short-term, experts agreed.
‘Volumes will slow substantially in the period ahead, especially if the restrictions on movement last for another six months as some say,’ said RCA’s Leahy. ‘Around 50 per cent of deals in Europe involve a cross-border player, so the restrictions will inevitably have a negative impact.’
RCA’s prediction is that international capital moving into Europe will slow sharply, not just from China but from Singapore and South Korea as well. Gulf money is unlikely to come to the rescue this time, Leahy said, because there is a correlation between outflows from the region and the oil price. The recent plunge in the price of oil is likely to dent any appetite for investments in Europe in the near future.
Looking at how the situation is evolving in China, the first to be hit by coronavirus, can give some idea of what to expect in Europe. According to RCA data, in the first two months of the year deal investment volumes in China fell by 50 per cent. ‘This is the order of magnitude we are likely to see in other markets,’ said Capital Economics’ Burrell. At this stage it is difficult to predict how quickly the economy and the real estate market will respond.
The picture emerging so far from Asia-Pacific is not positive, said Kim Politzer, director, head of research, European real estate, at Fidelity International: ‘We see a quick ramp-up in businesses opening but there is not enough work for them to do, so there is a double dip happening. We need to realise the extent of disruption in the system.’
As offices open again in China things are not quite returning to normal yet. ‘There are positive signs on the supply chain
side, but order books are reduced,’ said Kevin Turpin, regional director of research, CEE, at Colliers International. ‘Ongoing deals are happening, but new ones are being called off and we have seen a price shift starting to come through. It is still early days, but things are shifting.’
The shift to online will
be permanent
The crisis is having a particularly negative impact on the retail sector, but it could also accelerate much-needed change. ‘Retail has been hard-hit, but if the
sector gets fully repriced, then that’s an opportunity to invest in it again, accessing it at a proper level,’ said Politzer. ‘We have been concerned about the slow progress in repricing retail.’
The retail sector could emerge from the coronavirus emergency in very different shape – leaner but also more attractive to investors.
‘We still have too many retailers and too many locations that shouldn’t be there and should be repurposed,’ said Herman Kok, head of research at Meyer Bergman. ‘The crisis will accelerate the repricing and the restructuring of the retail sector.’
Some changes the crisis has brought about will alter the outlook for retail,
for logistics and indeed for society in general over the long-term, Kok added: ‘The emergency has shown that physical presence can be replaced by an online presence. The shift to online will be permanent.’
Another change precipitated by the
forced shutdown of shops and department stores is in the relationship between landlord and tenant. ‘Tenants are struggling as their businesses are being put on hold,’ said Colliers’ Turpin. ‘We’re encouraging communication and cooperation between landlords and occupiers, because sensible compromises are needed rather than legal routes.’
But in fraught situations like now cooperation can be difficult to achieve. ‘There is a conflict between opposing needs and some landlords are taking
legal action against their tenants who haven’t paid the rent,’ said RCA’s Tom Leahy. ‘It would be great to have a collaborative process, but the situation
is so serious that it has become a battle for survival.’
The relationship has to be salvaged for the future, because the crisis will end and things will return to normal, said Kok.
Hoping for a rebound in 2021
It is important to keep positive during
the crisis and focus on the good fundamentals that will underpin the recovery, experts agreed. ‘If we could get to a gradual normalisation from June,
that would allow us to get to a rebound in 2021, which would be a great result,’ said Kok. ‘We can then learn from how we dealt with this crisis.’
There is no doubt that Q2 will be tough, and it is hard to judge what the speed of the recovery is likely to be. ‘We are likely to have the biggest fall in GDP since the Second World War, but things will get back to normal,’ said Capital Economics’ Burrell.
The return to normality is likely to be a slow and gradual process rather than a sudden event. But even in the depth of the crisis it is worth not losing sight of the positives. One is that the current crisis cannot be compared to the GFC because the fundamentals are very different, said AEW’s Vrensen: ‘We don’t have a large amount of space coming through at the wrong time, unlike previously, and this is a saving grace. Also in 2008 there was a lot of leverage in our industry, but we have learnt our lessons and the sector is now
in a better position to withstand a valuation shock.’
Some deals are still highly leveraged, but in general the European market is in a strong position and will be resilient.
‘It is too early to be optimistic but we see positive thinking from our clients, who see the long-term value,’ Vrensen said. ‘We have a large amount of capital still committed to real estate. Having that commitment from our clients means we can find good opportunities with the repricing of assets’.
There are concerns about the denominator effect, as stock market falls have artificially pushed up allocations to real estate, with some indications of an eagerness to sell. In Europe, however, unlike the US, target allocations to real estate have not been met by most institutional investors.
‘Material uncertainty clauses have forced redemptions, rather than clients wanting to get out,’ said Fidelity’s Politzer. ‘The current situation is temporary, and real estate remains a liquid asset class.’ n
‘Physical retail will still have a place’
Greenman CEO Johnnie Wilkinson discusses the German food retail sector’s response to the crisis
Supermarkets are leading the narrow group of essential retailers which have been sanctioned to remain open during the Covid-19 pandemic. Here, Johnnie Wilkinson, CEO of Greenman, the German real estate manager which invests exclusively in food-dominated retail parks and food retail warehouses, discusses how the crisis is impacting the grocery retail sector and how the German government is supporting it.
What is the German government doing to help supermarkets?
The German government has implemented several legislative measures with a combined value of c€1 trillion that are similar to those employed during the 2008/9 financial crisis.
Among these, three are particularly relevant and supportive of both food retail landlords and their tenants:
• a six-month pause on tenants terminating their leases, even if the government has forced them to close;
• a six-month freeze on landlords’ ability to terminate leases if a tenant fails to pay rent; and
• the obligation for tenants to file for insolvency has been waived until the end of September, effectively preventing tenants from seeking lease renegotiations and terminations.
How have the major German supermarkets reacted to Covid-19?
Unlike many other areas of retail, which have been asked to close, most of the large food retailers in Germany remain open. Some of the largest, including EDEKA, REWE, Kaufland, Aldi and NETTO, issued a joint statement on 19 March confirming they would remain open and that their supply chains are sufficiently robust to ensure supermarket shelves remain stocked.
What is Greenman doing to help?
We’ve been trying to support the retailers in a couple of ways. For example, we’re making some of our vacant space available for short term storage of goods and products. We’ve also been looking to facilitate ‘staff swaps’, whereby we help connect staff from retailers that have been forced to close with some of the supermarkets that need extra staff, either because of sickness or to meet the increased demand.
This was a chance for online food delivery to shine. How do you think that is going?
This crisis has highlighted some of the cracks in the online delivery model. Whether there isn’t enough physical delivery capacity to meet the extra demand or the logistical processes have struggled to deal with stock management across warehouse and physical ‘click and collect’ locations, the online delivery model clearly requires a lot more work.
We believe the level of future investment required is going to be difficult to achieve in an industry that already operates on tight margins and has struggled to be profitable. As demonstrated by Amazon’s recent announcements about taking on more physical locations and investment in shops without check-outs, bricks and mortar grocery clearly has an important role to play in the future of the sector.
What’s more, retailers are becoming much more innovative in how they use space at their bricks and mortar stores to generate additional revenue streams and save money. For example, in France Casino has been installing data centres at some of its sites and using the heat they produce to heat the stores.
What about transactions?
There is likely to be a hiatus in transactions while we all adjust to the new restrictions on movement and adapt to new ways of working. However, I’m not convinced that transactions will dry up altogether. I think we will continue to see some deals in the food retail real estate space as many of the assets are on long-term leases to tenants with strong covenants, so relatively attractive from an investor perspective.
It will be interesting to see which assets investors favour as we recover from this pandemic. Ultimately a lot will depend on how long that takes, whether it is three-to-six months, or longer. Assets in sectors underpinned by strong structural fundamentals are more likely to weather the storm than those in areas like fashion retail, which have been hardest hit, or sectors with issues around debt and covenant breaches. But the longer it goes on, the more asset classes will suffer. n
