It is inevitable that the economic fallout from the COVID-10 pandemic will lead to a “big hit to commercial property values” in the UK, according to Capital Economics.
The economic research consultancy has downgraded its forecasts for the UK economy and, as a result, is projecting a 9.4% decline in capital values.
According to its report, “the shock should be short and sharp”, but it has not ruled the advent of a “full-blown crash”.
With greater travel, work and venue restrictions in place and the ramping up of social-distancing advice, UK GDP is forecast to fall as much as 15% quarter on quarter between April and June.
“This is a temporary, if very severe, disruption however, and the economy is expected to recover much of this ground by the end of 2021,” Capital Economics said.
“Property is better in theory placed to weather the disruption than other financial assets, as rents are generally contracted for several years, so much income is secure.
“But the deeper and more prolonged the crisis, the more downward influence new leases, breaks or re-negotiations will exert. And of course, there is a growing risk of existing tenants defaulting. So it is unlikely that rents will be unscathed.”
Capital Economics’ central case now predicts a 50bps rise in real estate yields and a 10% one-off fall in rents during Q2, “given the severity of the slump, though we assume a reversal as the crisis dissipates”.
As a result, total returns in 2020 are expected to end in negative territory (minus 4.8% is the central case), although a rebound in 2021 is expected to deliver a total return of 9.8%
However, Capital Economics admitted that “current uncertainty is huge” and so “a more extreme downside with a weaker recovery cannot be ruled out”.
The report said: “This would push us closer to previous crashes, with values down by more than 25% this year as a result.
“But the GFC market contraction lasted more than two years and this shock should be briefer. And with no debt-fuelled investment boom and supply tight in many markets, some risk factors are absent.
“In addition, further mitigation may come from more aggressive policy measures if the crisis is prolonged.”