March 24, 2020

Real Estate After Covid-19

The pandemic has got everything under its grip. Parallels are drawn to the GFC and WWII. So, its impact is bound to be profound and likely not short term. Although little is known about the Covid-19, we’ll attempt an initial assessment on the impact on the property market.

Short term effects

The first sectors to be hit were those associated with tourism. Hotels are officially shut while short-term residential are suffering from massive cancellations. Next in line were leisure properties such as restaurants and bars as well as retail with only essential shops allowed to operate.

In terms of market activity, transactions are postponed as properties and public services cannot be visited. And of course, the economic havoc disrupts rental payments and people pore over force majeure clauses with a fine toothcomb.

Medium Term Effects

As there is no precedent to this pandemic – at least in recent times – the only guidance we have is the China and perhaps the previous Asian epidemics. In Wuhan, the epidemic was contained after about two quarters (it took about nine weeks between the first cases in Wuhan and the Chinese Economy returning to 80% capacity) but we believe Europe and the US may take considerably longer. There are several startling differences, such as response times (remember how in China a hospital was built in a week) and strict population surveillance procedures in place which in the West are sometimes viewed as infringing on civil liberties. The fact that Italy has 4% of the population but twice as many deaths as China is frightening. There are no proven medications against the virus while a vaccine looks something like 18 months out.

GDP forecasts are now looking very grim. According to the IMF the 2020 recession could be as bad as the GFC and most European counties are staring at a c. 5% contraction this year. If the pandemic peaks in the next two weeks, it should hopefully be a ‘U’ shape recovery with most economies rebounding sharply in 2021. Views of course differ widely. The statement of the OECD secretary general that the ‘major economic crisis will burden our societies for years to come’ is telling. While there are stark differences with the GFC – this is not a structural crisis – we should keep sight of the following:

  • The risk of a slower rebound, particularly in countries which were late in taking measures such as the UK and the US
  • Curfews are very costly to maintain in economic terms and without a vaccine, the relaxation thereof may cause subsequent waves of infections
  • Largely ineffective monetary policy as interest rates have been hovering around zero for too long. Stock markets keep sliding despite the stimulus and hopes are now on fiscal stimuli
  • The damage in the supply chain may not be that temporary if the pandemic is prolonged
  • In countries with heavy NPL legacies such as Italy, Greece and Cyprus, the lower income / higher unemployment may lead to another vicious circle of defaults..
  • …while in other countries, such as the US we may see a round of corporate bond defaults

It is true that measures are being taken – monetary, fiscal and regulatory such as the reduction of banks’ capital adequacy ratios but one should be mindful they may not be enough. So, based on the severity of the crisis, we should expect:

  • Significant decline in take up and rents in the commercial property sector
  • The hospitality and short term residential sector may be adversely affected even after lockdowns are lifted in that country if the demand source countries lie behind on the curve
  • It is hard to imagine the residential sector not being battered after a rise in unemployment and the reduction of mortgage finance as liquidity is diverted to ailing industries

The impact on the investment market? Is property a glaring buying opportunity? The answer is not clear. On one hand, property offers considerably higher yields than fixed income and cash. Indeed, property income is more predictably but as things currently stand, all bets are off. On the other hand, equities have dropped by more than 30% which by some accounts may be a buying opportunity (refer to a recent analysis by Goldman Sachs for some interesting insights). Institutions may need jump back in to maintain asset allocations (the ‘denominator effect’). Some of the large private equity funds that 8GCP is working are curtailing new investments as existing ones may need shoring up and pricing remains uncertain. We expect a risk-off play where capital will be channelled from peripheral to core markets, as the crisis is taking the edge off pricing.

Long Term 

We think this pandemic will leave some indelible marks on the industry. For a start, it will accelerate digitalisation, something our laggard sector needs. Space requirements of retailers may decline further, exacerbating the predicament of the retail sector. The global home working experiment will find favour with many but the implications are not yet clear. More demand for flexible officesResidential that can double up us offices (with design and connectivity implications)? Mixed-use residential that offer residents working space?

The impact on Logistics and industrial will be profound for reasons beyond e-commerce expansion. The wildfire-like spread of the crisis across the globe and the disruption of the supply chain may lead to the onshoring of production not least in certain key industries.

Last but not least, we expect to see wellness as a key feature of modern buildings. The quality of the air and in particular particle concentration and humidity as well as the ability of a building to handle such outbreaks will be a highly desirable, if not regulated feature

Tassos Kotzanastassis