Covid report demo2

3 EDITORIAL

A localised health crisis has spiralled into global pandemic in just three months. The real estate sector has a part to play

4 MACRO ENVIRONMENT

Governments unleash huge fiscal measures to support economies brought to a standstill

8 INVESTMENT ACTIVITY

The abrupt collapse in transactional activity during Q1 is expected to intensify

10 SENTIMENT SURVEY

Savills research offers an insight into how sectors in different regions are being affected

11 REAL ASSET LIVE

Real Asset Media’s new webinar
briefing finds an industry realistic but still optimistic

15 VULNERABLE SECTORS

The retail sector is on the brink as lockdowns keep customers away and cash flows depleted

20 FINANCE

CREFC’s Europe CEO Peter Cosmetatos says finance sector is in resilient shape but a wave of defaults is possible

21 RESTRUCTURING

It’s a race for survival for struggling firms ahead of access to government schemes

26 THE VIEW FROM GERMANY

Tobias Schultheiß, managing partner of Blackbird Real Estate, explains why Germany remains a safe haven

27 NATIONAL POLICY RESPONSE

Colliers International outlines the unprecedented global government response to the outbreak

30 SECTOR FOCUS: FOOD RETAIL

Greenman’s Johnnie Wilkinson says physical retail will still have a place after this crisis

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.

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.

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

Markets will recover more quickly than they did after the Global Financial Crisis, when we saw many consecutive quar

Retail has been hard-hit, but if the sector gets fully repriced, then that s an opportunity to invest in it again, a

Retail on the brink as social distancing bites

Covid-19 will impact sectors in different ways. Retail and hospitality are dependent on state aid for survival, while the logistics sector faces supply chain reconfigurations. James Wallace examines the emerging sector-specific picture ➠

It remains unknowable how exactly
the impact of the coronavirus will play out. Its impact across societies, economies and sectors is practically impossible to forecast. Models which produce probabilities disguise uncertainty and often, like now, are based on shifting sands, assumptions in constant state of flux. However, beyond the scenario forecasting, we can envisage how, where and why the coronavirus will hit real estate sectors in different ways. In this article, we look at the impact on key sectors.

Retail, leisure and hospitality

Retailers have faced unprecedented disruption in the last decade, as structural and cyclical drivers have imposed a Darwinian environment of ‘survival of the fittest’ on the sector. In the wake of the Covid-19 pandemic, many stores and restaurants have shut indefinitely. More brands will permanently close this year. Net operating income (NOI) will fall drastically over the next month across the retail sector, with short-term rental concessions only granted by cash-stable landlords and reinforced by government protective measures.

The strain across the sectors is uneven: occupiers forced to shut – such as shopping centres, restaurants, pubs, gyms and cinemas – are most severely affected, while essential retailers providing critical products and services – such as supermarkets, pharmaceutical stores,
and food delivery services – are thriving. Consequently, retail parks, anchored by large supermarkets, are comparatively less impacted. ‘Vulture investment will become focused on grocery-led assets and retail parks,’ predicts Alice Breheny, global head of research at Nuveen Real Estate. ‘Retailers that are able to mobilise strong online supply chains will have a much-needed lifeline to their business model and profitability. Companies without an online channel like Primark, for example, are in a more compromised position.’

However, evidence of the impact on valuations will likely be delayed as asset valuations will not take place over the next month and open-ended funds in markets such as the UK have already suspended redemptions. ‘Many retail businesses will be dependent on government support to survive,’ says Chris Urwin, director of research - real assets, at Aviva Investors.

However, the same is true for some landlords, who were vulnerable prior to the Covid-19 pandemic, such as Intu. ‘While non-discretionary retailers such as grocers and pharmacies may be less affected by the severe drop in demand, most retailers are likely to experience a decline in footfall, supply-chain disruptions and difficulties in staffing stores in the months ahead,’ adds Urwin. ‘Many retailers are unlikely to make their rent payments in a timely manner and, absent government support, some could go out of business.’

In the UK, chancellor Rishi Sunak addressed the sector’s vulnerability with a one-year business rates holiday for all retail, leisure and hospitality businesses with a rateable value under £51,000, in addition to up to £330 billion in loans and guarantees, including business interruption loans and cash grants of up to £25,000 (see page 6). ‘This provides a much-needed lifeline in the near term, but the consensus in the market appears to be that more, much more, needs to be done to return the sector back to sustained health over the medium-term,’ says Hemant Kotak, head of UK research at CBRE. ‘Retailers may welcome the chancellor’s financial support as a step in the right direction, but the stock market’s reaction implied it lacked any real potency, given the background of a dramatic fall in footfall, tourism numbers and, since last week, store closures.’

In the Netherlands, footfall in the main central shopping streets of the largest Dutch cities has fallen by around 45-65 per cent since the onset of the crisis. ‘Retailers are depending on support measures from the Dutch government, which can’t head off the impending heavy blow to the retail sector, but it can certainly help mitigate it,’ says Marleen Bosma, head of research and strategic advisory at Bouwinvest. ‘The coronavirus crisis will result in more vacancy and falling rents, but demand may recover quickly provided a deep recession does not take hold.’

However, amid the crisis many brands
are mobilising to address immediate healthcare needs. ‘Luxury brands, brewers, and distillers are converting factories to make hand sanitiser. Designers, like Christian Siriano, are making masks and hospital gowns instead of ball gowns,’ according to Barrie Scardina, Americas leader, retail services, at Cushman & Wakefield.

The hotel sector was hit immediately and severely by the pandemic with room occupancy rates collapsing to unprecedented levels and many operators shutting their doors. ‘Hotel chains with low levels of capital reserves are being particularly hard hit, especially if they are spread over several European markets under lockdown and as alternative sources of income, such as hosting events and restaurants, also dries up,’ says Bosma.

Hotel operators can expect occupancy rates to drop for at least two quarters. ’Risks to staff availability may put a further strain on operators’ capacity to provide a service,’ says Carol Hodgson, senior director, global research, at JLL. Fergus Hicks, real estate strategist at UBS Asset Management, says hotel operators on leases may put pressure on rental payments. Post crisis, further consolidation within the hotel sector is likely, he says.

Most hotels are now closed across Europe, except for some airport locations, while some have converted into hospitals, quarantine facilities, shelters, temporary logistic spaces and work locations, while hotel restaurants are being used to produce food for delivery and staff are being redeployed with delivery companies or in other sectors.

Covid-19 will accelerate structural changes across the retail sector this year, prompting a sharp fall in prime retail rents and increases in yields. ‘An improvement in sentiment and economic conditions in 2021 would reverse some of the decline. That said, the retail sector will still significantly underperform over the next five years,’ says Amy Wood, property economist at Capital Economics.

Hotels are likely to suffer the same fate, as travellers become more selective about travel plans and reconsider non-essential leisure-related trips. This could lead to a resurgence in ‘staycations’, says JLL, as the return to normalcy is protracted. Destinations considered epicentres of the outbreak, such as New York, Italy and Spain, are likely to experience a prolonged downturn both in domestic and international tourism demand.

Logistics

Global supply chain disruption is the pre-eminent concern within the systemically important industrial and logistics sector. Reduced activity at major gateway ports and airports is resulting in falling utilisation rates and idle resources. In the near term, the coronavirus outbreak may accelerate the use of automation and robots in operations and reduce the sector’s reliance on labour. Longer term, the outbreak is likely to prompt a rethink of supply chains across manufacturing companies globally, as companies seek to establish greater supply chain resilience through re-shoring, or near-shoring, as well as through diversifying suppliers and increased local inventory levels to mitigate disruption and risk.

‘This could result in additional regional demand for industrial facilities and associated logistics, but also potentially lead to reduced container flows at major gateway ports and lower warehouse demand in these locations,’ says JLL’s Carol Hodgson. ‘Technology will be key to securing greater supply chain visibility to achieve this.’ Longer term, the reacceleration in online shopping, particularly for groceries, could become permanent, which would also boost logistics space demand.

Nuveen’s Breheny adds: ‘All these measures are likely to come with a price tag, but logistics real estate is set to benefit from increasing demand as a result, apart from big seaports handling long distance global trade. Around Europe, low-cost locations in Eastern Europe, Portugal, Turkey and even North Africa could be possible beneficiaries. This long-term upside has to be balanced with severe short-term risks around factory closures, staff shortages and supply chain disruptions, which are set to lead to bankruptcies of the weakest retailers, 3PLs and manufacturers.’

Prologis says two new structural demand drivers have emerged during this crisis: the need for more inventories as supply chains emphasise resilience over efficiency; and the reacceleration of e-commerce adoption. Logistics operators, and supply chain businesses, have seen incredible volatility – first a slowdown and now the push of product – which underscores the need for flexibility and business continuity planning, says Prologis in its Covid-19 special report.

The outbreak also appears to be a catalyst for changing consumer behaviours that will both accelerate the pace of adoption and raise the ceiling of what can be transacted online. But the volatility signals – such as record US unemployment levels and European business activity surveys, such as purchasing managers’ index (PMI) fell to all-time lows – suggest a recession and that logistics demand could pause or reverse in H2, if not sooner, posing a risk to vacancy rates and rent growth, according to Prologis. ‘We expect that the short-term will be dominated by depressed economic activity and limited capital availability, especially for small- and medium-sized businesses. Fiscal stimulus will help. Logistics real estate demand, occupancies and rent growth all face headwinds.’

In Germany, Realogis-RLI Group, the logistics and industrial property group, claims significant growth in enquiries from food retailers and wholesalers that intend to set up new distribution and shipping hubs, and want to purchase property at short notice. There is also strong demand for rental space for home delivery services. However, global supply chains are also being put to the test, says Umut Ertan, founder of the Realogis-RLI Group.

Offices

Government-mandated homeworking for all but key workers across Europe has left offices empty. The easy decisions come first: occupiers will suspend all lease decisions; landlords will suspend new developments and capital expenditure projects. Even if the sector rebounds in H2, office job losses are inevitable as stalled economic activity will prompt corporates to retrench.

Landlords’ rental cash flows will be protected if their tenants are in long-term leases, and if occupiers’ businesses have similarly resilient cash flows. However, landlords with exposure to short-term leases, which includes the stress untested coworking sector, and companies themselves come under cash flow strain, could see rental shortfalls.

Indeed, a shakeout in the coworking market could well emerge. SoftBank has revoked its offer of $3 billion worth of shares in sector behemoth WeWork, although the Japanese bank remains committed to its $5 billion bailout. In an interview with Forbes magazine, SoftBank founder Masayoshi Son admitted: “We paid too much valuation for WeWork, and we did too much believe in the entrepreneur.” In the London coworking market, Workspace Group reported it had received around 50 per cent of rents due at the end of March. Customer discussions on rent deferrals continuing on a case-by-case basis, the company said.

Many professionals will have a very difficult time working from home, including bankers, traders, medical professionals and those working for public agencies or institutions. While for others, such as lawyers, accountants and consultants, the transition will be relatively frictionless. ‘We are in the middle of the largest test of homeworking in history and corporates are adopting, refining and testing policies, processes and infrastructure to make it work,’ says Marie Puybaraud, global head of research, corporate solutions, at JLL.

In the aftermath of the crisis, companies will need to tightly control fixed costs, thus greater homeworking and lower office space would align some employer and employee interests. ‘Over the medium term, forced working from home may break down cultural resistance in some markets and reduce floorspace per
worker ratios,’ according to UBS’s Fergus Hicks. ‘Serviced office models may be properly tested for first time as their flexibility enables the self-employed and corporates to quickly vacate space they no longer need.’

Much depends, of course, on the severity and duration of the quarantine which may vary widely between European office markets. Rising office vacancies and rental reductions, to varying degrees, are inevitable in the short to medium term. ‘Investors may reassess their underwritings, in particular on future rental growth expectations,’ says Hicks. ‘But even lower interest rates may negate weaker rental growth once the market returns. Valuation levels depend on how valuers factor in lower liquidity (in the short term). We expect a “wait-and-see” approach in the short term but don’t expect vendors to offer discounts.’

Residential

While many of the residential subsectors should be more resilient due to the underlying demand strength and mismatch with supply, there are risks here too. In the student accommodation sector, many students across the UK and Europe opted to return to their family homes after governments closed universities and asked to be released from their rental obligations. If global travel and higher education remains disrupted by late summer, occupancy rates for the 2020-2021 academic year will come under pressure, warns Aviva’s Chris Urwin.

A slowdown in international applications
in the autumn academic year would have implications for purpose-built student accommodation (PBSA) assets in development across Europe. In the build-to-rent (BTR) sector, governments across Europe have promised to support renters, which should support institutional owners. Opportunistic capital will be monitoring PBSA developers and existing asset owners for signs of distress, ready to step in and acquire incomplete schemes and built assets from overleveraged owners caught out by a potential liquidity squeeze.

By contrast, effects on multi-family markets are likely to be more limited
as markets are more driven by demographic mega trend, according to Hicks, although he warns: ‘If unemployment rates rise significantly future rental growth expectations may need to be revised downward.’

Construction

Construction has also crawled to near standstill. Purchasing managers’ index (PMI) levels in the UK, Germany and France have all fallen to the 30s. In Italy, the PMI has contracted to 15.9. A possible consequence in time will be delayed, reduced, or scrapped flagship infrastructure projects. In the UK, the government will have some tough decisions to make regarding the viability of HS2, Crossrail 2, Northern Powerhouse Rail, Midlands Rail Hub and Heathrow’s third runway.

‘Widespread defaults are a real possibility’

Peter Cosmetatos CEO, CREFC Europe, the trade body for the real estate finance sector, offers his view of the crisis

The coronavirus crisis is having an extraordinarily all-encompassing impact on society and the economy, but inevitably the effects on different sectors, businesses and relationships will vary. It is important both to recognise those differences, and to remember how deeply interconnected everything is as policymakers and market participants try to navigate the coming months.

To state the obvious, hotels and non-essential retail are in a very different place from logistics and food retail. Similarly, different real estate owners deal with a ‘normal’ cyclical downturn – or even the GFC – differently. Some proactively manage their financial covenants and their lenders (as well as their occupier customers), with a view to sustaining business relationships and commercial viability over the longer term. Others may take a more zero sum approach, protecting their immediate financial position by shifting as much risk as possible onto tenants or lenders.

My sense is that lenders are analysing their CRE exposures loan by loan, customer by customer, so they can make sure they provide flexibility and support where appropriate. The starting point
for most lenders is likely to be that borrowers and assets that are fundamentally viable should be supported through short-term difficulties. But the extent to which lenders are able to provide flexibility overall will also be affected both by their own funding structure and liability profile, and by applicable accounting rules and prudential capital frameworks.

For banks, recent statements by the UK’s Prudential Regulation Authority and the European Banking Authority helpfully indicated that flexibility shown to borrowers that are fundamentally viable, but under temporary stress because of the crisis, will not lead automatically to impairment charges under IFRS 9, or to increases in prudential capital requirements. That should allow banks to focus on making the right commercial judgments in relation to their CRE borrowers, at least in the near term.

For UK insurers, there seems to be a question mark around whether the availability of the matching adjustment – which ensures that direct CRE lending makes sense in capital terms – might be compromised by disrupted cash flows. Clearly, if disruption is extensive and long-lasting, that might also affect the ability to meet the underlying annuity or other liabilities that CRE lending is intended to fund.

European debt fund lenders seem for the most part to be in a relatively good position, at least in the near term – their use of leverage is relatively modest, and not usually subject to the mark-to-market testing and margin calls that characterise the US repo financing market on which mortgage REITs and debt fund lenders rely.

But this crisis is unlikely to be over quickly, and the challenges (and costs) for lenders may increase. Sorting borrowers for ‘fundamental viability’ may become quite difficult (influenced by government policy and other factors), and widespread defaults (with far-reaching implications for the financial sector) are a real possibility. When many buildings are effectively shuttered, site visits and valuations are difficult (and subject to ‘material uncertainty’ disclosures), and the outlook remains uncertain, the supply of credit will surely be limited, especially from traditional lenders. Even refinancings are hard if you can’t get a proper valuation. Lenders will want to avoid becoming effective economic owners of empty, deteriorating buildings.

The central issue is that the potentially prolonged economic shutdown resulting from this public health crisis is creating a huge amount of economic pain. That pain can be allocated to different constituencies today – households, ordinary businesses, real estate owners or lenders, for example – or it can be allocated to the future, through the intervention of the taxpayer, providing (unprecedented) temporary support to get us all through the crisis.

The financial system today is probably more resilient than it was coming into the GFC, and there are probably bigger risk areas than CRE this time, but it’s important that policymakers understand and think about all the implications of shuttering rent-paying businesses. When the economic costs are borne is at least as important as who ends up having to bear them. The operation of post-GFC expected loss accounting and prudential capital rules needs to be considered carefully in that context. n

Bracing for a wave of insolvencies

The relationship between occupiers, landlords and lenders is coming under strain as cash flows dry up. A race for survival looms before government support taps turn on. James Wallace examines the UK fallout

The synchronised global demand shock has collapsed cash flows as revenues have evaporated, prompting a frantic struggle to preserve cash and limit liabilities. This is forcing occupiers dependent on physical stores for revenue – such as high street retailers, restaurants, pubs, hotels, cinemas and gyms – to reprioritise liability payments in a desperate effort to shore up liquidity. Reduced rental payments, in turn, deplete landlords’ revenues, bringing equivalent cash flow and liquidity preservation moves with owners seeking commercial mortgage and interest holidays, standstills and covenant waivers from lenders.

At the end of the chain, lenders must monitor their balance sheets to ensure compliance with regulatory capital requirements and, more fundamentally, that they remain solvent. This is the
highly visible domino effect which governments and central banks across
the world, mindful of the lessons from
the global financial crisis (GFC), have
sought to mitigate as the Covid-19 pandemic has worsened.

In the UK and Europe, national governments, the Bank of England (BoE) and the European Central Bank (ECB) have already loosened the capital buffer requirements of banks and cancelled 2020 bank stress tests to support lenders’ ability to sustain lending during this economic demand shock.

Government fiscal measures have been sector-specific, as well as broad-based. In the UK, retail, hospitality and leisure businesses have been offered cash grants of up to £25,000 per property and business rates holidays for the 2020 or 2021 tax years.

More broadly, struggling businesses are provided access to the £330 billion government guaranteed loan scheme, underwritten by the BoE. These schemes, designed for investment grade companies and small businesses respectively, are supported by HMRC’s pledge to pay up to 80 per cent of furloughed employees’ wages, up to £2,500 a month. Many of the major real estate brokers have already begun furloughing staff.

However, these emergency direct support measures for businesses during the pandemic will take time before they are accessible, with some confusion and problems already evident. The critical problem for struggling companies – whether tenants or landlords – is the time delays in accessing the schemes.

The government’s broad safety nets – extraordinary as they are – will only be effective for companies with enough cash reserves and access to liquidity to survive before emergency funding is accessible. In the meantime, just days before quarterly rents were due in the UK, the government announced that commercial tenants would be protected from eviction if they could not pay rent because of coronavirus. These measures, which have already received Royal Assent in the Coronavirus Act 2020, ensure a moratorium on tenancy eviction due to missed rental payments for the next three months to the end of June.

The consequence of these legal tenancy protections was predictable. It is a race for survival. Tenants, desperate to preserve cash, have reprioritised liabilities. For struggling tenants, not paying rent is an economic necessity rather than a choice.

missed rental payments

The government encouraged consensual dialogue between occupiers and landlords. The course of behaviour, thus far, is most cleanly viewed before and after the government’s ruling. Overall, the environment is strained, and some failures have already begun to emerge.

Prior to the government eviction protection, several retailers sought rental deferrals, holidays and reductions from landlords. Fashion retailers Superdry, H&M, Next and Footasylum, as well as restaurant chain Carluccio’s, all requested three-month rent deferrals. Two weeks later, Carluccio’s filed for administration. On 6 April, Debenhams filed for administration, its third insolvency process in the last 12 months, which will likely lead to the further rationalisation of its store portfolio.

Subsequent to the government eviction protection, some occupiers were acting unilaterally. Primark, owned by Associated British Foods, refused to pay £33 million in quarterly rent to its landlords after the closure of two thirds of its 189 UK stores. Similarly, JD Sports and Burger King, which operate 390 and 500 UK stores respectively, as well as restaurant chains Tonkotsu and Yo! Sushi, all confirmed they would not pay quarterly rent to landlords, following the government’s eviction moratorium.

Intu Properties, the UK and Spanish shopping centre owner and developer, confirmed it had received just 29 per cent of quarterly rent due on 25 March, compared to 77 per cent received for the same quarter period last year. Likewise, Hammerson had received just 37 per cent of UK rent due as at 27 March, while NewRiver REIT had received 60 per cent of quarterly retail rents by 31 March.

Some landlords have acquiesced to retailers’ obvious struggles, others are less forgiving. British Land, which owns £4.8 billion worth retail assets, confirmed it is prepared to defer tenants’ March quarterly rents and spread repayment over the six quarters from September 2020. But landlords like Intu are not in position of luxury to extend such benevolence. Intu said it has ‘neither the desire or financial capacity’ to waive rents for ‘well capitalised’ brands. Other landlords have chosen to take legal action to recoup unpaid rent.

Criterion Capital has issued a winding-up petition to Caffè Concerto after the restaurant chain reportedly chose to allocate £1.2m to wages for its 700 staff rather than pay a £100,000 rent bill, according to The Caterer. Vietnamese noodle chain Pho and Escape Hunt have been threatened with similar legal action
if they do not pay full rent for the next quarter to Sykes Capital, the landowner
of their Reading sites, according to the Financial Times. ‘The government at no time has said that commercial tenants should receive a rental holiday, yet many, but not all, are choosing to withhold rent. Such action is jeopardising our obligation to meet our commitments to lenders,’ Andrew Sell, head of asset management
at Criterion Capital, told the FT.

Institutional landlords with high liquidity, such as British Land, can shoulder rental deferrals relatively easily, whereas smaller investors with less headroom and stricter covenants often feel the need to push back for self-protection. The alternative
is to simply shift the squeeze onto lenders. If this were to happen at scale, it could create the conditions for a second financial crisis in a little over a decade.

Hammerson’s attempts to improve its own liquidity through the disposal of seven UK retail parks to Orion Capital Managers for £400 million is now in doubt, despite the deal reaching unconditional exchange stage.

Intu’s predicament further exemplifies the interdependency between tenants’ rental income and repayments to lenders, particularly in the case of a major retail landlord that was seriously struggling before the Covid-19 pandemic affected trading. Intu has warned that the impact of reduced rents will ‘require us to seek covenant waivers and we are in constructive discussions with the relevant lenders’. Intu is carrying £4.5 billion of debt, with more than £1 billion due for refinancing by the end of next year, and in February it failed to raise up to £1.5 billion in new equity to stabilise.

Intu’s problem’s largely pre-date Covid-19. Nevertheless, the REIT has confirmed it has been in dialogue with the UK government to secure access to its £330 billion support scheme. This raises the question of where the line for government emergency financial support should be drawn. No doubt Covid-19 has made a bad situation far worse for Intu, but it was already near the brink. While the government has said it is monitoring the impact of the eviction moratorium on rental payments on commercial landlords’ cash flow, chancellor Rishi Sunak also warned: ‘We cannot save everyone.’

New insolvency laws

Tenants and landlords – as well as developers – are now undertaking emergency strategic evaluations of their locations and assets to improve liquidity and strengthen their cash position. ‘Businesses need to understand the changes occurring in the sector including legislation, competition, and international trends,’ says Barrie Scardina, Americas leader, retail services, at Cushman & Wakefield. ‘They need to evaluate liquidity, rationalise store portfolios, and look for savings in the supply chain.’

For many marginal tenants, survival will depend upon the speed of access to direct government support schemes, as well as the leniency of landlords and lenders in the interim. The coordinated steps by the UK government and the BoE to support liquidity, through to direct financing via the CCFF and CBILS schemes, and the reduction of countercyclical capital buffer rate to zero per cent, are supported further by new emergency insolvency laws.

These measures include a three-month temporary suspension of wrongful trading provisions which provides company directors with the confidence to continue trading throughout this pandemic without the threat of personal liability if companies fall into insolvency. It is intended to alleviate anxiety company directors may be facing in relation to ongoing trading decisions.

These temporary loosened director responsibilities, retrospective from 1 March, are designed to support otherwise solvent companies in immediate distress by imposing a moratorium on creditors enforcing debts for between 28 days and three months. This will provide a window for companies undergoing a rescue or restructure process, free from heavy-handed creditor influence. In Germany, the government introduced the temporary suspension of bankruptcy filings until 30 September 2020. In France, similar insolvency law amendments are expected to be defined.

‘The UK government has provided breathing space for directors to make difficult decisions in uncertain times without the risk of personal liability,’ says Mark Fry, partner at management consultant BTG Advisory. ‘Businesses affected by Covid-19 should use this time thoughtfully. Affected companies may need to undertake a short-term analysis of cash and identify ways to enhance liquidity.’

To underscore, the problem for many businesses most affected by the demand shock will be in the realistic time delays before access to government support can be secured. n

Germany still a safe haven for investors

Tobias Schultheiß FRICS/SIOR, managing partner of Blackbird Real Estate, expects market turbulence until the end of the year – but recovery will happen.

For more than two weeks now the contact ban in Germany has forced people to stay at and work from home. Since then, in our numerous calls with investors and developers we are experiencing a lot of uncertainty – statements vary from ‘closing down all investment activities’ to ‘business as usual’. For example, DIC Asset, Exporo and Quadoro Real Estate are still actively looking for new opportunities.

According to GPP spokesman Oliver Schön, Q1 transaction volumes in the top seven investment markets were 55 per cent higher than in the same period the previous year – €7.52 billion compared to €4.86 billion. This result was driven by high demand and investment pressure from institutional buyers. Nevertheless, due to the measures taken by the government to cope with the crisis, real estate investment activity came to more or less a standstill in large parts of Germany. According to Schön, yields are under pressure but how they will react is in question – for example, yields for office buildings depend on the overall economic development as well as the quality of their tenants. For retail properties and hotels, rising yields are expected.

With some of our clients we are discussing whether or not to postpone sales mandates – a mixed-used building with a closed restaurant on the ground floor will not find a buyer these days at a reasonable price. It is also our experience that buyers and sellers don’t want to cancel running deals and are working hard and cooperating together to finalise them – for example, they may be facing problems in finding advisers for technical, environmental due diligence or valuation.

With quarantine, short-time work, negotiations with tenants regarding rent reductions and/or deferment etc, the majority of real estate owners have shifted their focus away from acquisitions and thus we expect a reduction of transaction volumes for Q2 – especially for non-food retail and hotel properties.

Assuming that the current situation will not last too long and the contact ban is loosened hopefully in May, we see strong demand for long-term leased properties with high-quality, bond-like tenants. Value-add and core-plus investors we have talked to expect an increase in investment opportunities.

Nevertheless, getting appropriate debt finance is a major concern for all of our interview partners. Banks are currently focusing on providing sufficient capital to companies in this crisis rather than financing real estate transactions. Cash is king and some (still active) fund managers have agreed with their investors to buy with 100 per cent equity and refinance later. Obviously, their hope is to get some price reduction.

Mid- to long-term real estate will retain its popularity (not only) in Germany: interest rates are at an all-time low and financial markets are too volatile for many investors. On the flip side, we also hear that sales plans are stopped, leading to a further reduction of product. These real estate owners either fear lower prices or cannot sell for example their non-food retail property because the tenant is temporarily out of business.

Nevertheless, crisis or no, there is still a massive oversupply of money to be (re-) invested and thus we do not believe in big price reductions – especially for residential properties. But also office buildings with a solid tenant base: earlier this year we initiated a possible transaction for a fully let, long-term leased office building at an asking price reflecting a gross initial yield of 3.33 per cent and the buying party recently confirmed this pricing.

In 2008/2009, expectations where great in Germany regarding fire sales, but only a few materialised. In my opinion this will also be the case today, although insolvencies may force companies to sell.

So, is Germany still a safe haven for real estate investors? For me the answer is a clear yes, even in these challenging times. Obviously this only applies for acquisitions where the buyer performed a sound due diligence and tackled the underlying risks.

No one can realistically predict when this all ends and the economy can return to ‘normal’. Having survived the collapse of the new economy bubble as well as the financial crisis I am sure that also tomorrow the sun will rise and the real estate market will recover. My guess is this may last until the end of the year. Stay healthy and stay home! n

Unprecedented government
response

Colliers International outlines the measures taken
by governments across EMEA to counteract the
negative economic consequences created by the
Covid-19 pandemic

For more than two weeks now the contact ban in Germany has forced people to stay at and work from home. Since then, in our numerous calls with investors and developers we are experiencing a lot of uncertainty – statements vary from ‘closing down all investment activities’ to ‘business as usual’. For example, DIC Asset, Exporo and Quadoro Real Estate are still actively looking for new opportunities.

According to GPP spokesman Oliver Schön, Q1 transaction volumes in the top seven investment markets were 55 per cent higher than in the same period the previous year – €7.52 billion compared to €4.86 billion. This result was driven by high demand and investment pressure from institutional buyers. Nevertheless, due to the measures taken by the government to cope with the crisis, real estate investment activity came to more or less a standstill in large parts of Germany. According to Schön, yields are under pressure but how they will react is in question – for example, yields for office buildings depend on the overall economic development as well as the quality of their tenants. For retail properties and hotels, rising yields are expected.

With some of our clients we are discussing whether or not to postpone sales mandates – a mixed-used building with a closed restaurant on the ground floor will not find a buyer these days at a reasonable price. It is also our experience that buyers and sellers don’t want to cancel running deals and are working hard and cooperating together to finalise them – for example, they may be facing problems in finding advisers for technical, environmental due diligence or valuation.

With quarantine, short-time work, negotiations with tenants regarding rent reductions and/or deferment etc, the majority of real estate owners have shifted their focus away from acquisitions and thus we expect a reduction of transaction volumes for Q2 – especially for non-food retail and hotel properties.

Assuming that the current situation will not last too long and the contact ban is loosened hopefully in May, we see strong demand for long-term leased properties with high-quality, bond-like tenants. Value-add and core-plus investors we have talked to expect an increase in investment opportunities.

Nevertheless, getting appropriate debt finance is a major concern for all of our interview partners. Banks are currently focusing on providing sufficient capital to companies in this crisis rather than financing real estate transactions. Cash is king and some (still active) fund managers have agreed with their investors to buy with 100 per cent equity and refinance later. Obviously, their hope is to get some price reduction.

Mid- to long-term real estate will retain its popularity (not only) in Germany: interest rates are at an all-time low and financial markets are too volatile for many investors. On the flip side, we also hear that sales plans are stopped, leading to a further reduction of product. These real estate owners either fear lower prices or cannot sell for example their non-food retail property because the tenant is temporarily out of business.

Nevertheless, ing price reflecting a gross initial yield of 3.33 per cent and the buying party recently confirmed this.

In 2008/2009, expectations where great in Germany regarding fire sales, but only a few materialised. In my opinion this will also be the case today, although insolvencies may force companies to sell.

So, is Germany still a safe haven for real estate investors? For me the answer is a clear yes, even in these challenging times. Obviously this only applies for acquisitions where the buyer performed a sound due diligence and tackled the underlying risks.

No one can realistically predict when this ‘normal’. Having survived the collapse of the new economy bubble as well as the financial crisis I am sure that also tomorrow the sun will rise and the real estate market will recover. My guess is this may last until the end of the year. Stay healthy and stay home!

‘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