The real estate market had been anticipating a ‘sweet spot’ for this year, but coronavirus has changed the outlook, one global investor believes.
At a 2020 outlook briefing on 28 February, UBS Asset Management’s real estate team said the risks to property’s performance were now ‘significant’. Chief investment officer Jonathan Hollick said that travel disruption alone would ‘bring a hiatus in investment activity for six months at least.’
Zachary Gauge, UBS Real Estate & Private Markets (REPM) European research analyst said: ‘When we started this year, things were looking good. Last year’s change in the interest rate environment to a lower-for-longer outlook resulted in a lot of deal flow in the second half of 2019 and decent momentum at the start of 2020.
‘Although economic growth slowed, employment growth ticked along at 1%-2% and on the real estate supply side it is nothing like previous cycles because vacancy is at record low levels. This resulted in a ‘sweet spot’ for property ‘meaning people were comfortable even at record low prime yields.’
UBS’s main case scenario is not that the virus is a ‘black swan’ event that leads to a major recession. ‘We expect delayed decisions, caution, but not job losses as you get in a downturn. Clearly (capital) markets have reacted while real estate is illiquid and you don’t see the effects (as quickly). But risks have increased.’
Gauge added that REPM does not envisage real estate pricing falling ‘because we don’t see sellers offering massive discounts to transact. We see things leveling out at the end of the year or early next.’
Paul Guest, portfolio strategist for UBS’s real estate multi-manager business, pointed out that an unfortunate part of this shock is that some of the most affected markets so far 'were already experiencing problems. HongKong was already in recession and its economy will take another hit; Italy already had economic challenges.’
REPM has 45% of its assets in the US, about 35% in Europe and 20% in Asia. Guest added that the business has 2.5% of its assets in China and 'one asset that is thoroughly closed’ there, due to the virus.
He considered that two key points are how long the outbreak lasts, and insurers’ reaction. ‘Economies could bounce back in one-two years, but if insurers deem it an uninsurable event it will be (more serious).’
Hollick suggested that the virus has the potential to affect the recovery in the UK market. He pointed out that a lot of European as well as Asian capital was looking at the UK property market and doing due dilligence after several years holding back due to political uncertainty around Brexit. ‘But if businesses continue to impose travel bans and staff cannot travel to the UK, there will be an impact.’
He said that UBS staff in its Singapore and Milan offices were working from home.
With respect to the virus, Gauge concluded: ‘The reason that we are not overly concerned about pricing in the medium term is...the fundamentals have not changed. Assuming that (the virus) is contained, it is likely to be short-term and there will be a bounce back because money is still on balance sheets waiting to be deployed.’
Other trends that REPM sees for property include:
- Environmental regulation will increase in the coming years and should be factored into return calculations, possibly putting a floor under yield compression. ‘Embedded ESG costs will strand some assets and make them uninvestible,’ believed Hollick
- Some of the best investment opportunities are: offices outside main city CBDs with the potential to upgrade; central London offices, which ‘missed out on three years of strong growth’ enjoyed by other European cities; and student housing where REPM sees growth ahead in continental Europe
