KEY OBSERVATIONS
27 April 2020
We have a detailed schedule of ongoing, paused and stopped transactions, for the EMEA market, across the sectors. If this would be of interest to you, please do reach out.
Macro Context
- The past week has seen many European countries move into the second phase of the COVID-19 evolution – exiting the lockdown. More than half of the countries Colliers has monitored in terms of government stimulus and strategy, had actively deployed an outlined, phased exit strategy from their national lockdown as of April 27th.
- Countries exiting the lockdown have seen a marked improvement in terms of falling numbers of active cases levelling off. Switzerland, Austria and Germany are the largest markets at the forefront, closely followed by the Nordics (Sweden is an anomaly, given there was no forced lockdown, yet active cases are still rising) with Italy also getting into the recovery quadrant. The Czech Republic, Lithuania, Croatia, Latvia and Lithuania represent a healthy CEE contingent.
- In terms of real estate assets, the vast majority have focussed their initial strategy around re-opening retail in a variety of forms, alongside schools. Very few countries have explicitly set out policies around returning to the office, just as very few have set out distinct guidance for the use of public transport. For those countries that have set out guidance for this, there is a clear capacity cap in terms of their use, to maintain physical distancing.
CAPITAL FLOWS
- Welcomed optimism from Asia with strong enquiries from South Korea, Japan, Hong Kong and Singapore for European Real Estate.
- Middle-East capital flows being affected by oil prices and we have now entered Ramadan until late May 2020.
- European Capital is generally on pause but optimism from German, French and Nordic capital in particular.
- North American capital in general on pause. PE Funds realise distress is not happening yet and are concentrating on the public markets and slices of equity where banks may de-risk their positions or owners who need to recapitalise.
- Investors feel well capitalised, generally have low leverage, are prepared and educated on potential ‘work outs’ and there is expected ‘pent up’ demand / dry powder which will lead to a strong bounceback later in 2020.
Banks/Debt
- UK and EU regulators continue to urge banks to take a flexible approach to problem loans just days before landlord/investor interest payments are due.
- Current view is bank margins will rise between 25 bps and 45 bps dependent on LTV and asset type. Investors adopting use of higher LTVs in their appraisals.
- CMBS & Debt funds feeling the squeeze. Investors considering offering layers of debt: from senior to mezzanine, as banks likely to de-risk their positions.
- Banks will want to do the right thing knowing profiteering will be frowned upon.
- Europe in general has lower LTV’s than the US.
REITS
- A basket of European/UK Listed PropCo/REIT share prices have fallen by an average of 33% year-to-date, which reflects a rebound from the trough in March of around 46% (avg,). There is even broader variance in performance as of the 23rd April, however, with data centres, social housing and logistics providers at or above their share price on Jan 1st 2020. Retail-focused REITS sit at the opposite end of the spectrum alongside serviced offices.
- Intu received only 29% of rents and has threatened to serve ’statutory demands’ to some tenants that have refused to pay their quarterly rent.
- Great Portland Estates collected 62.9% of March Quarter, within seven working days of it being due.
- Land Securities collected 65% of Rent in March Quarter and scraps dividend.
- Both retail and hotel REITS are facing liquidity issues and are trying to raise cash immediately. They are seeking cash infusions through equity issues or convertible preferred issuance to protect them.
Capital Markets Transactions
- Many pre-lockdown transactions have continued although volumes are slowing considerably. Also seeing some strategic acquisitions continuing.
- There is a pause on launching of new product to avoid perception of any distress, and, to reflect reduced levels of demand. Likely to see new launches towards end of summer 2020, dependent on a country’s exit strategies and travel bans.
- There is investor interest from equity buyers, particularly family offices who do not require Investment Committee Approval. However, they want current prices to reward/reflect risk.
- Corporates are starting to undertake sale & leasebacks to raise cash.
- Travel bans will lead to a lack of cross border transactions going forward so domestic buyers will have a window of opportunity.
- Some investors withdrew sales where tenants are paying the rent, to retain income-producing assets, for example, in I&L.
- Investors need to re-assess country’s future economical growth, supply and demand dynamics, future bank margins, construction costs and tenant’s credit worthiness before a full return of Investment Committee Approvals.
Why economies may recover faster from Covid-19 than from the GFC
- The cost of debt is now significantly lower than in 2008/09 and there is no room for central banks to cut rates further to stimulate demand.
- Post GFC banking reforms have resulted in lower levels of borrowing which is likely to prevent any major bank-led or distressed selling. Europe in general has lower LTV’s than the US.
- Real Estate is still an attractive asset class offering yield and there’s a higher level of equity waiting to be deployed compared to 2008/09, as pension funds still have to meet their liabilities and there is a willingness to diversify portfolios globally. INREV recently reported that 2019 was a record year for closed-end fund raising. The problem arises from the inability to physically inspect assets to undergo technical due diligence.
- The largest global economies have already been more active in their stimulus packages than during the GFC and governments have adopted 'whatever it takes' plans. Advanced economies’ national debt levels are subsequently expected to increase by circa 10-15 % of GDP in order to prop up the economy until a rebound in consumer demand occurs after the lockdown.
- Property fundamentals in most property sectors are still landlord favourable with record low office vacancy levels in cities such as Berlin and Paris, lack of affordable residential in most countries, and greater demand for industrial space due to on-line consumption. Rental growth should remain resilient in these property sectors.
- Assuming only a spill-over of deals complete in Q2 and that quarantines are lifted by the summer, this would pave the way for a bounce back in transactions to be completed before year-end, where we see ‘pent up’ demand / dry powder creating a strong bounceback at the end of Q3 and Q4 of 2020.
Property Sectors
General
Evidence of price adjustments on some office transactions: 5-10% reductions are talked about but considerably higher for secondary, retail, hospitality and development.
Re-assessment of tenant’s credit worthiness going forward. Definition of core will be narrowed and different risk premiums will be adopted to each property sectors and risk profile.
Investors wanting to see corporate’s Q2 2020 accounts.
Operational Real Estate, the darling for the past few years, will be re-assessed as an asset class.
Planning / zoning decisions need to be more flexible going forward to allow future uses and alternative uses in distressed product - for example, the high street and hotels being converted into serviced apartments.
Offices
Most cities seeing new occupier deals put on hold, unless well advanced. Some new deals/renegotiations happening on shorter lease terms. Rents are currently stable and seeing outward movements on incentives.
Travel, leisure, oil and gas, and co-working firms to experience distress, but some national governments are stepping in to support specific industries that are most severely impacted.
Offices need to become more resilient in the future from a hygiene and density point of view. Likely occupiers will look into their HQ space requirements with potential satellite offices becoming a new trend.
The return to offices will require social distancing for up to at least 12 months with shift work taking place with smaller teams. Large cities reliant on public transport will take longer to recover to pre COVID-19 office occupancy levels.
Retail
Some retail transactions have proceeded but these are either grocery led or have alternative use plays. Continued interest in such product. Secondary retail is seeing little demand.
Moratorium on eviction of commercial retail leases in some locations. Some landlords – including Grosvenor, British Land, LandSec – offering rent deferrals and direct tenant support. Some major retailers have sought to stop rental payments including H&M, Primark, Deichmann and Adidas. Following a consumer market backlash, Adidas apologised for taking this approach and agreed to pay April rent across its store portfolio. H&M agreed a larger credit line with banks.
Out of town retail parks which consumers can drive to and use ‘click and collect’ formats could recover quicker. These units are larger and so can undertake physical distancing.
Expectation of ‘revenge spending’ once lockdowns ease. However, long term view is high taxes and rise in unemployment will cause an effect on consumption.
I&L
I&L proving resilient – Blackstone closed several I&L transactions on same terms early in lockdown.
All the grocery chains are looking to boost their distribution capacity. Growth in on-line logistics as shopping habits change and China has seen a further boost from senior citizens continuing to use on-line post lockdown.
Emotional ‘chatter’ of bringing supply chains back to Europe, however, land is scarce, as is labour, and the labour market in Europe is more costly than Asia.
Sale and leaseback activity with Next, Topp Tiles and Walmart launching opportunities in the UK to raise cash.
Hotels
As most Government stimulus is helping the hospitality sector and there is lobbying to extend, we are not seeing distress at present but we do expect more distress in the hotel sector to evolve over the next quarter. Most operators are working with skeleton staff to keep operating costs to a minimal however, big brands still have high fixed costs up to £300,000 per month on maintenance and utility contracts as well as IT.
2019 Revenue per available room (RevPAR) levels are not expected to return until the end of 2022 which is a massive challenge for banks.
Domestic business hotels will recover first with longer term pain for top tier luxury hotels as international travel will take longer to recover. Hotels specialising on events and conferences to suffer the most.
Landlord’s disappointed that Travelodge has not paid any of Q1 2020 rent in UK.
Residential
Residential is generally proving resilient. Greater focus on mid-market, affordable / social housing with caution at prime and micro-living ends of the market.
Seeing ‘Build to Sell’ schemes show resilience in markets such as Spain. However, in Sweden, developers change ‘Build to Sell’ schemes to ‘Build to Rent’.
Student Housing
Banks wary of student housing in 2021 - particularly universities which rely on foreign students.
UK student accommodation group Unite warned it could be hurt by virus-enforced travel restrictions reducing numbers of international learners. Their portfolio value falls 2.2% in Q1 due to coronavirus.
Senior Living
Seeing some distress, cost of operations rising short-term.
Development
More scrutiny and caution to development / refurbishment.
Lack of skilled workers as they return to their home countries.
Evidence in London of bank margins increasing 150 bps+ for pure development.
Investment Volumes & GDP
Property Share Prices
Domestics Vs Cross-Border Capital
Yields and Spreads
- Economic forecasts show a sharp correction in Q2 2020. Economy starts to recover in Q3 2020, but doesn’t get back to growth until Q1 2021.
- Investment activity will track the broader economy, but the additional level of travel restrictions and government quarantines will minimise the ability to run technical due diligence and thus any significant new sales activity will be pushed back beyond Q2. There will be a recovery, but ‘full’ recovery will not be until 2021.
European/UK Listed/REIT Share Performance
- A basket of Listed PropCo/REIT share prices show falls of 33% year-to-date (on average), which reflects a rebound from the trough in March of around 46% (avg.).
- There is even broader variance in performance as of 23rd April, however, with data centres, social housing and logistics providers at or above their share price on Jan 1st 2020. Retail-focused REITS sit at the opposite end of the spectrum alongside serviced offices.
- The continued policy of closing borders, even as countries embark on the early stages of exiting the lockdown, will certainly play into the speed of any investment recovery.
- Those countries most dependent on cross-border investment will see a sharper contraction in activity during Q1 and Q2.
PRICING AND INTEREST RATES
- Short-term interest rates continue to adjust to new monetary policy and government intervention.
- This provides some buffer to what had become some very tight yields in some European locations - provided banks are enabled to manage capital ratios and continue to lend against the risk of rising NPLs on their balance sheets. If this cannot be managed, and the cost of debt increases, there will be pressure on yields to soften in some locations.
PRICING AND BOND RATES
- Government bond rates continue to adjust to changing monetary policy action.
- Current yield pricing seems reasonably placed for now, outside of Milan and Russia. Elsewhere a spread of 2%+ in most locations, even if bond rates move further out to a longer term equilibrium rate.
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DISCLAIMER
The analysis and finding reported on this microsite is based primarily on Colliers International data, which may be helpful in anticipating trends in the property sector. However, no warranty is given as to the accuracy of, and no liability for negligence is accepted in relation to, the forecasts, figures or conclusions contained in this report and they must not be relied on for investment or any other purposes. The outbreak of the Novel Coronavirus (COVID-19), declared by the World Health Organisation as a “Global Pandemic” on the 11th March 2020, has impacted market activity in many sectors, creating an unprecedented set of circumstances on which to base a judgement. This report does not constitute and must not be treated as investment or valuation advice or an offer to buy or sell property. Given the unknown future impact that COVID-19 might have on real estate market supply, demand and pricing variables, we recommend that you recognise that our research and analysis is far more prone to market uncertainty, despite our endeavours to maintain our robust and objective reporting.
