Real Capital Analytics saw some positives for real estate in its Q1 2020 European capital markets briefing today. However, going deeper into the firm’s outlook in the light of the coronavirus, the good news was heavily qualified by the bad and the ugly.
RCA’s presentation opened by noting that there is still momentum for real estate. Q4 2019 was the highest-ever quarter for investment volumes after a record year (€350 bn total traded in 2019) and 2020 began well with €64.2 bn transacted in Q1, which is 7% up YOY.
There is still a lot of dry powder in this low rate environment and there is optimism about the fortunes of parts of the asset class in the medium to long term. The spread of property yields over 10-year gilts remain high everywhere and it is unlikely interest rates will go up, RCA’s Tom Leahy said. ‘That is the silver lining for real estate and when the market does come back there will still be an investment case for the asset class.’
Pricing hasn’t changed - yet. ‘Yields to date have pretty much just tracked sideways in major markets’, Leahy reported.
There is no doubt we face recession, but not all recessions are the same for real estate, Leahy pointed out. In 2008 the asset class tanked along with the rest of the world economy; however, the 1970s oil crisis was actually beneficial for real assets, with property prices increasing by 15%.
‘I’m not expecting property prices to increase in 2020 - I’m sure they won’t. But it shows the picture can be more nuanced’, Leahy added.
The logistical challenges posed by the virus may see domestic investors ‘allowed back into their capital cities’ where they’ve been previously outbid by international money suggested RCA Europe MD Simon Mallinson. As lockdowns are eased slightly, those managers who have invested heavily in pan-European teams on the ground ‘may see that investment pay off handsomely if their teams can walk over to view assets rather than get on a plane.’
Markets such as Stockholm, Frankfurt and Paris are in countries with large and sophisticated domestic investor bases, for example. Some 75% of all money spent in April was domestic compared to the long-term average of 45%-50%.
Countries that have so far apparently been able to react to the virus better may recover more strongly. Germany is cited as an example and RCA’s figures show that well over half of all real estate transactions in April took place there compared to a 20% German share of the total traded in Europe in a typical month.
There may be an uptick in sale and leasebacks as cash-hungry retailers and other corporates look to take an advantage of their assets.
The steam in the momentum at the turn of the year is running out fast. The onset of this crisis has been quick and brutal with the EPRA developed Europe real estate index falling from peak to a trough (by 42%) in just 28 days in February/March: in the global financial crisis it took two years to go from peak to trough.
This means public markets - generally held to react six months ahead of private real estate - imply a painful fall in values in the coming months. Of course, public markets often overshoot.
The value of deals completed in March held up well due to some large transactions, but were down in number by 45% compared with March 2019. April looks very slow, Leahy said, and is down on both counts. RCA’s data - which is not yet complete for April - is showing a 50% fall in deals by value compared to 2019.
The proportion of ‘busted’ deals where contracts have been terminated after assets went under offer has spiked to a five-year high, Leahy said.Meanwhile more deals are staying in contract, in RCA’s view indicating ‘that buyers are adopting more of a wait-and-see approach.. maybe lengthening their due dilligence processes..maybe holding off on pushing the button until they have a clearer view on what the world is going to look like’ as countries start to exit lockdown.
There are fewer active buyers, far fewer. The five year quarterly average of 1,000-1,200 has collapsed to 150 according to RCA’s intelligence.
Overall, through this year RCA expects deal volumes to be low, ‘very low in some cases’ and prices to fall ‘when we start to see tenant defaults, debt covenants breached and forced sales.’
In predicting what will come next it is inevitable some of it will be ugly.
Cities in countries that are most dependent on cross border capital are likely to be most vulnerable to a crash in property investment with an associated fall in values. Warsaw would be at the top of this list based on 95% of its buyers being from overseas over the past two years. Italy, Ireland, Finland and Portugal are also at risk for the same reason. There could also be political reasons for capital flow restrictions, said Leahy.
Many cities that have lately seen liquidity well above average are in these countries, such as Dublin, Helsinki and Lisbon, but there are others such as Barcelona, Copenhagen Stuttgart and Utrecht.
Even logistics, the most favoured sector where prices in the UK have risen a further 25% since the last peak in 2007 (compared with a 50% fall from 2007 peak for UK shopping centres), may take something of a hit due to fewer goods moving around, ‘in a world where in the next couple of years we are likely to see depressed output, with low trade volumes and relatively low levels of consumer confidence and rising unemployment.’
The percentage of people working from home will rise. Leahy quoted a Gartner survey of CFOs, with 75% of them expecting some of their workforce will remain remote post the pandemic. In a world where companies will be under cost pressure, reducing their footprint will be one way to save costs as the heads of both Morgan Stanley and Barclays have also stated in recent days.