In 2019, SitusAMC evaluated nearly $1.3 trillion of commercial real estate across the U.S. and Europe. Hugo Raworth, Managing Director of SitusAMC and leader of the firm’s real estate valuation services in Europe, discusses how COVID-19 is impacting cash flow and property values in the European Union (EU), and which asset classes are likely to bear the brunt of the crisis.
How are valuers accounting for the impact of COVID-19 on commercial real estate assets?
With limited transactions outside of super prime assets, valuers have been moving values out based on market sentiment and short-term rental voids. However, the true impact, be it benign or aggressive, will become even more clear over the coming months as the market solidifies around transactional data.
Unlike 2008, this is a health crisis that has led to an income-liquidity crisis, not a capital-liquidity crisis. Pressure on investors and lenders is being driven by tenants’ cash-flow issues, not because of reckless behavior by borrowers nor sponsor or bank capital illiquidity. However, COVID does bear a similarity to 2008 in that both crises have led to market paralysis outside of super prime. No one wants to sell into a market that may recover in a few months’ time and most buyers are taking a wait-and-see attitude. In addition, investment alternatives will also play a big part in the re-pricing effect on real estate, whereby the stock and bond markets aren’t necessarily reflecting good risk-adjusted yields relative to real estate.
The good news is that with valuers now able to undertake inspections, the hope is that we may start to see some market activity, which will enable valuers to point to more market evidence in assessing and tracking values.
What asset classes will be hardest hit by the pandemic?
Before the pandemic, retail had already been experiencing value losses with significant headwinds. That has been exacerbated by COVID-19, as consumers curtail spending and shop online rather than in-store. Coronavirus has pressed the fast-forward button on those challenges, intensifying some of the balance-sheet issues faced by other struggling occupiers.
Other assets are exposed to corporate occupiers with limited maneuverability due to high corporate debt. High corporate debt is not sector-specific, but some areas of the market are more exposed; serviced offices and some hotels have been widely commented on in the press in recent months.
Thirdly, any sector which relies on social interaction will have to adapt at least in the short term; leisure, retail, healthcare, hotels and again, flexible office space. How far and how deep these sectors are hit remains uncertain, but the road to recovery lies in occupiers in these sectors being able to adapt to the new world post-COVID and a swift return to full operational capacity.
What do lower asset values mean for owners and investors in terms of potential mark-to-market losses in their portfolios for the rest of 2020?
Investors and lenders will take write-downs on their assets, but this will be sector-specific and could be limited if some parts of the market recover swiftly. One thing is clear, there is significant weight of capital out there and banks are willing to lend. With real estate still priced attractively compared to other asset classes, it is reasonable we could see this lessen the blow in some sectors, which will of course reduce mark-to-market losses.
Given questions about the security of income, aren’t investors likely to expect a discount in price to reflect the cash-flow risk?
So far, we are only seeing prime assets trade – grocery stores, prime central London offices and the like, or long-leased properties secured to strong tenants. In short, all super-secure, low-risk assets, and so far, no discount in this part of the market.
We have seen some repricing on assets where deals were agreed upon pre-COVID and have transacted now, but these are still limited. It’s clear that the market is expecting some discount even on some of the better-performing sectors such as offices and logistics. However, with most investors anticipating some market improvement over the balance of the year, and with no pressure yet to sell, many fail to see the logic in transacting now at a discount.
Increased national debt across most affected countries will be a significant economic burden for the foreseeable future. What impact will that have on property valuations, if any?
The cost of intervention has been huge across Europe; in the United Kingdom the government is paying 80 percent of wages of all furloughed staff. Any direct impact of increased national debt on values in any country in Europe is and will continue to be difficult to corroborate. However, governments will have to walk a careful path between fiscal responsibility and paying down the debt, whilst not suffocating economic recovery under the burden of high taxation and limited spending.