Impact of Covid-19 on European real estate

ECONOMIC IMPACT

• Coronavirus pandemic has hit Europe particularly hard. Expect recession in most countries during 2020, possibly with U-shaped recovery in Q4 2020/Q1 2021.
• Approach to containment initially varied considerably between countries but most are now adopting similar messaging. The same is true for policy responses.
• Coronavirus impact may trigger a number of macro risks. Despite additional liquidity measures being provided, solvency now a widespread issue.
• Ability for UK and EU to progress trade agreement talks severely diminished. PM Johnson’s willingness to walk away rather than extend the transition period suggests WTO relationship may ensue.
• Recessions that trigger a credit collapse tend to generate illiquidity, forced sales, investor bifurcation, and tenant insolvencies. Severity of each depends on policy responses and duration of pandemic.

CAPITAL MARKETS IMPACT

• Expect stock market volatility to continue until there is demonstrable containment and flattening of new cases curve.
• Much lower equity prices will leave many investors overweight to real estate. This may curtail investment into real estate in short-term, and could lead to withdrawals from open-ended real estate funds that remain open.
• Economic shocks result in government bond yields falling in safe-haven countries. Germany bonds are now implied to be remain negative until 2022 and not even breach +0.5% within ten year horizon.
• In the short term, real estate could see valuation yields rise. Prime assets will remain relatively resilient and recover first, but secondary assets with no alternative use will be out-of-favour until after fundamentals have recovered.
• Once the crisis has passed, price discovery will begin. Given the generous risk-premium of real estate over bonds, stabilised real estate will seem attractive. Lower interest rates will support pricing for real estate.

REAL ESTATE IMPACT

• Pandemic hitting Italy and Spain particularly hard, and Italy’s healthcare systems is overloaded. Both have large reliance on tourism. But whereas Spain was an economic hotspot, Italy was already beset with challenges.
• Sectors most at risk are Retail, Hotels and Leisure. Speed and magnitude of eventual recovery will depend largely on duration of pandemic.
• Other sectors such as Logistics, Self-Storage and Offices (excluding co-working), will prove more resilient in short term but are not immune.
• Real estate capital flows are slowing considerably. This exposes markets driven by cross-border capital, such as London. Liability-matching assets used as bond substitutes are still transacting.
• Focus on preserving value through asset management. Leveraged investors need to manage liquidity, although debt levels are more manageable than during GFC. Opportunities will emerge but will depend on duration of the pandemic.