Institutional real estate investors are busy digesting the full implications of the COVID-19 pandemic and how the fallout could have long-lasting effects on the asset class.

Although the immediate impact is likely to be a severe drop in transactions, the situation could affect the return profile of the asset class as income streams are threatened.

Retail property – which is already under strain – and hospitality are two sectors that face the most immediate and visible pressure, but it is understood that tenants in other commercial sectors have begun to negotiate on rents.

With social distancing coming into force in an ever-growing number of cities, the co-working revolution looks to be on shaky ground. But the effects on traditional office markets could be just as substantial – if employers learn from this episode that they can operate as efficiently with a smaller office footprint, could there be a structural decline in demand?

A UBS Asset Management paper released today alluded to this. “Serviced office models may be properly tested for the first time as their flexibility enables the self-employed and corporates to quickly vacate space they no longer need,” it said.

“Over the medium term, forced working from home may break down cultural resistance in some markets and reduce floorspace per worker ratios.”

In the meantime, transactions are expected to slow. It is too early for data to show the full picture, but Real Capital Analytics showed that during the first eight weeks of 2020, deal volume in Asia-Pacific was down 50% on last year. For Europe and the Americas, which are further behind in the spread of COVID-19, deal volume was down 18% and up 10%*, respectively.

“Many of the networking events cancelled across the globe (such as MIPIM) have traditionally kicked off the sale processes and it remains to be seen how the curtailment of face-to-face meetings between brokers, buyers and lenders will impact transaction activity,” said Simon Mallinson, executive managing director at RCA, in a note. “We expect any disruption to be recognised in second-quarter numbers in Europe and the Americas.”

The focus of investors and fund managers will be shifting to existing assets since this is where the resources will be needed. The move towards investing in real estate with greater levels of operational risk will be tested by this period.

The return of the denominator effect?

Recent stock-market falls could have artificially pushed up allocations to real estate. For those investors close to their target allocations, this could mean they are overweight real estate.

The most recent annual investment intentions survey by real estate associations PREA, INREV and ANREV showed that the average actual allocation to real estate stands at 10.4%, 100bps below the average target of 11.4%.

This ‘denominator effect’ was seen in 2008 and affected US pension plans especially. The investment industry will be watching to see if there is a replay of the issue.

“The average North American investor was under-target to real estate according to our surveys,” said Greg MacKinnon, director of research at PREA. “At this point, it is largely unknown how property values may have been affected.”

Paul Jayasingha, senior director of investments at Willis Towers Watson, said that, with “the denominator effect from listed equity markets falling so much so quick, it is possible that investors will be overweight unlisted real assets”. This, he said, could bring about “keenness to sell” unlisted open-ended fund holdings.

In the UK, where certain open-ended funds, such as M&G’s £2.5bn (€2.7bn) Property Portfolio, have already suspended redemptions, this could bring about a more widespread liquidity event.

For most institutional real estate investors, the current environment calls for taking stock of existing investments and speaking with fund managers about what actions they are taking.

Asked about how it was responding to the situation, a spokesman for Europe’s largest pension fund investor APG said: “As a pension investor, we are a long-term investor with a highly diversified portfolio. This is also the case within real assets, by type, region and country.”

He said: “Our specialised teams and partners have frequent contact with the above investments and assist them where necessary with advice and assistance.”

Lonneke Löwik, CEO of INREV, said the “last two days have been about making we continue our business as usual”.

“Our members are extremely busy,” she said. “Everybody since last week is very much focusing on keeping everything up and running… the knock-on effect on what that will do to the real estate values and business models is still to be seen.”

* A previous version of this article stated wrongly that US real estate transaction volumes in the first eight weeks of the year were up 10% during the same period in 2019