As global leaders work with medical professionals to control the COVID-19 pandemic, countries have called for self-distancing and in some cases implemented a total lockdown. In the midst of all this, real assets investors, fund managers and advisers have been responding to the unprecedented situation.
Property is the victim not the villain this time – Property has generally been at the centre of the most severe economic downturns in recent decades. But this time it is different, Capital Economics chief property economist Andrew Burrell says. “Although we think the commercial market is likely to experience a sharp jolt in 2020, provided the spread of the virus can be controlled, it should avoid the steep downturns of the past.” Burrell says capital values will correct in 2020 and returns will be negative in most developed markets, though there is reasonable hope that this will be reversed next year. “But while commercial property is not expected to play the same role as in previous slumps, it will also not be immune to any further downside risks that emerge should the economic consequences be worse than we currently expect.”
COVID-19 to hit property values by at least 8% in 2020 – The ever-changing economic effects of COVID-19 mean that the impact on real estate markets is highly uncertain, Burrell says in his eurozone commercial property outlook. It is clear that the sharp contraction in economic activity and deterioration in sentiment over the first half of the year will weigh heavily on rents and put upward pressure on property yields across the board, he adds. “That said, if the virus is brought under control, we expect rental growth to bounce back next year and, aside from retail, yield rises will be more than reversed.” However, a weaker recovery can’t be ruled out, which poses downside risk to the outlook, he says.
Signs of Chinese economic recovery – and lessons for US and Europe – A Prologis research has identified patterns that emerged in China during the Coronavirus outbreak that could play out similarly in European and US industrial real estate markets. For instance, throughout the outbreak in China, logistics operations continued except where strict government lockdowns were mandated and also found that activity was most resilient among Chinese customers focused on end-consumption and city distribution, especially for e-commerce customers, the report says. Despite lockdowns and travel restrictions, lease signing activity in China continued – albeit at a slower pace, it adds. “Logistics real estate in the US and Europe was likely to follow similar patterns and experience an overall softening in activity, Prologis says.
A true test of infrastructure’s resilience – Darryl Murphy, infrastructure MD at Aviva Investors, says while the attention of many people is on the massive price swings in public markets, the defensive nature of UK infrastructure is being tested as never before: some assets are experiencing stress beyond what was seen during the GFC, especially those tied to the transport sector. Murphy says in the short-term issues facing infrastructure investors include GDP risk, disruption in supply chains, social infrastructure demand risk leading to severe pressures on public services and counterparty credit risk. He says despite these risks affecting the transport and social infrastructure sector, some infrastructure sectors like power, utilities and digital have been relatively unaffected by the immediate impact of COVID-19. “With the efforts to address COVID-19 likely to continue over the coming months, infrastructure investors will need to focus their immediate efforts on managing the risks in their portfolios,” Murphy says.
Europe remained resilient in the face of geopolitical headwinds – According to a Knight Frank European Office Outlook 2020 report, Europe remained resilient in the face of geopolitical headwinds in 2019, despite uncertainty dominating the headlines. “Notwithstanding unfolding events with coronavirus, on a return to business as usual basis, we predict continued weight of demand to overall support European yields in 2020,” it says. The report adds that should coronavirus resolve in relatively short order, it expects ”momentum to continue to drive rents and vacancy while being mindful of a downside risk for any locations where the effects of coronavirus becomes more protracted”.
EMEA utilities likely to be more resilient to COVID-19 – The credit quality of European utilities is likely to be more resilient to the effects of COVID-19 than many other sectors, according to S&P Global Ratings analyst. “We currently expect only a limited number of rating downgrades in the sector given the essential service they provide, the regulated or long-term contracted nature of a portion of their activities, and their relatively better access to capital markets,” Pierre Georges says. Nevertheless, the pandemic and recent oil price collapse have triggered a wider economic shock and uncertainties over the timing of a recovery, thereby increasing earnings risks for utilities with large exposure to merchant power activities, Georges adds. “More generally, we see weaker macroeconomic fundamentals affecting ratings on utilities, owing to political and commercial pressure to support weaker customers and suppliers, increased sovereign risk, and in certain cases refinancing challenges,” the credit analyst says.
Effects of COVID-19 will be felt long after it has receded – Seamus O’Doherty, director at Berkeley Research Group, says the impact of construction sites closures are being felt right through the industry and is causing serious financial pressures to an industry which traditionally operates with low margins. He says many market participants are in survival mode during this period of unprecedented shock and are trying to understand what this means to their business, for example: how long will it persist, how will it affect cash-flow, how is the risk and the cost associated with the pandemic allocated under the contracts they have, what support can they get from the government and when can existing funding lines be extended. O’Doherty adds that if previous shocks to the social and economic system are anything to go by, “the effects of the current pandemic will be felt long after it has receded”.
Real estate sectors dependent on discretionary consumer spending to take a hit – The heaviest blows from the economic slowdown in the Dutch real estate industry are likely to fall on sectors most dependent on discretionary consumer spending, including retail – outside of basic daily necessities – hotels and restaurants, according to Bouwinvest research. The Amsterdam-based investment manager says sectors where short-term leases are prevalent, particularly co-working offices, are also likely to be negatively impacted. Sectors like residential and healthcare should be more resilient because of the underlying strong demand trends and mismatch with supply that have been evident for many years, but there are risks here too, it says.
Property owners will need further support to meet their obligations to their lenders – The CEO of the British Property Federation says the UK government’s announcement of a three-month moratorium on the ability to exercise right of forfeiture in relation to non-payment of rent will offer additional reassurance to hard-pressed businesses. Melanie Leech adds that property owners are similarly facing the impacts of coronavirus on their own businesses and will need further support – “for example to meet their obligations to their lenders and to the savers and pensioners who rely on the income they generate - if they are going to help as many businesses as possible come through the next few weeks.”
Some leading European economies are expected to go into recession in 2020 – Global economic growth expectations for 2020 have been adjusted significantly downwards amid the spreading of the COVID-19 virus and oil price decline. Based on this, real estate asset AEW says at least some leading European economies are expected to go into recession in 2020. But, in contrast to the GFC, the current event-driven crisis could prove temporary as economic fundamentals were strong at its outset, possibly signalling a V-shaped recovery, the manager adds. AEW says the long term repercussions on real estate remain uncertain as it is unclear how long exactly this global public health crisis will last. ”Many policymakers are still announcing significant new fiscal and/or monetary stimulus as well as temporary guarantees and tax breaks to limit the impact of the virus on consumers, businesses and banks alike,” AEW adds.
Fallout may be limited thanks to disciplined levels of construction underway – Notwithstanding the tumultuous economic and financial backdrop, DWS remains sanguine about prospects for real estate, particularly on a relative basis. To be sure, a slowdown would dent real estate fundamentals through its negative effects on job creation (office), consumer spending (retail and industrial), and household formation (apartment). “While conditions would vary by market, we believe that vacancy rates could begin to escalate, and rent growth turn negative, toward the end of 2020, the asset manager says. Still, the fallout may be limited thanks to the low level of existing vacancies and the generally disciplined levels of construction underway in most markets. From a capital markets perspective, DWS says the potential consequences are mixed. “There is no doubt that recent volatility could squeeze capital flows into real estate from institutions (which may rebalance portfolios) and listed REITs (whose cost of equity has increased).” Yet lower interest rates could attract capital from levered buyers and yield-seeking investors, the asset manager says.
Current events have led to emergence of two new structural demand drivers – While near-term conditions remain uncertain, a recession is becoming increasingly probable according to Prologis Research report. Logistics real estate demand will be hit, although the depth of the downturn is yet to be seen. The report states that current events have also led to the quick emergence of two new structural demand drivers, namely the need for more inventories as supply chains emphasise resilience over efficiency and the re-acceleration of e-commerce adoption.
Airports likely to be hardest hit infrastructure sector – There are still many unknowns about the impact of the COVID-19 pandemic on the infrastructure sector, but airports are likely to be the hardest hit sector. UBS-AM Real Estate & Private Markets’ latest Outlook Special report states that the impact of the spread of COVID-19 has been more severe than initially expected. “Of most relevance to infrastructure investors is the likely sharp contraction in GDP growth, lower oil prices and stress in the credit markets,” the report says. The sectors most exposed to an economic shock are GDP-correlated assets such as airports, ports and toll roads. The impact on demand-based transportation is more pronounced as countries around the world ramp-up travel bans and advise against non-essential travel, the report says.