Covid-19 and commercial real estate investment risk in Europe

Panellists on last Tuesday’s WBEF webinar were in agreement that the Covid-19 pandemic is already forcing investors to reassess previously held assumptions about the market.

“Resilience has to be redefined with the experience of Covid-19,” believes Martin J Brühl, Chief Investment Officer at Union Investment Real Estate. “We all thought we had resilient portfolios, following all the good measures and sharing of best practice following the Global Financial Crisis. Then we were hit by a global pandemic. There are principles which still hold, but there are also new experiences which we will have to factor in going forward.”

Among those new experiences has been the suspension of the most basic conventions of the owner occupier relationship. Lu Li, Nuveen’s Managing Director and Head of Investment Risk Management for EMEA and APAC explains: “The crisis has brought about some surprises, which we certainly did not include in our thinking when making decisions in the past. When we have a lease agreement, the tenant pays rent – that is a reasonable assumption. As an investment risk officer, I did not expect a situation in which governments would issue legislation allowing tenants not to pay.”

It is the sheer scale of the crisis that has upended such norms; the Covid-19 pandemic has made the extraordinary ordinary. This point is underscored by the key findings of the RICS Global Commercial Property Monitor for Q1. RICS Economist Tarrant Parsons explains: “The forward-looking metrics are probably the most interesting aspect of the results. The latest figures signal one of, if not the, sharpest turnaround in expectations for headline rents and capital values that we’ve ever seen.” 

It is, then, a safe assumption that the market will be permanently altered by the crisis. What is as yet unclear, is what form that change will take. It is unsurprising that a group so practiced in calculations of risk and probability should be wary of making definitive predictions. A shortage of available data only complicates the task of future gazing. Citing the example of the suspended UK house price index, Parsons issues a caution: “There have been so many fewer transactions than normal that any inferences at this stage could be misleading.”

“Visibility for investors is difficult,” agrees Jamie Olley, Principal at Avison Young. “You have to be careful about making bold claims, it’s too early to draw trends, at least until we start to get more people back into the workplace. I’ve had phone calls in the last week that suggest the direction of travel towards greater density of office space will reverse because of social distancing. People may need more space in the short-term. I can’t say that will definitely be the case, but it’s an interesting point to think about.”

There is less immediate cause for optimism in other segments of the market. Among the hardest hit are retail and hospitality. While the crisis seems to have cast an even longer shadow over the already gloomy retail market, Lu Li believes hospitality has the potential to bounce back. She does, though, strike a note of hope, rather than expectation. 

“Looking long-term, if the sector can adapt to changes in regulation and social behaviour, we are all human. We all have a need to play and be entertained. The sector can ride through this, some companies can come back and serve their purpose: to enrich our quality of living.”

There is little doubt that hugely increased public debt will continue to shape the global economy. This points to a further “Japanification” of markets: weak growth combined with persistently low inflation rates. Governments may adopt state interventionist approaches to policy in this area and will face pressure to raise taxes. As they do so, they can be expected to look towards real estate as a source of increased revenue. At the same time, we could expect to see a correction to previous overheating in real estate markets. 

Panellists welcomed government measures to keep employees in work. However, the need for continued clarity on such schemes, as well as guidance on the gradual return to workplaces, was stressed. So too, that landlords’ responsibilities extend beyond rent collection; governments must recognise the contributions made in terms of social, as well as economic value.     

The lasting legacy of Covid-19 for investors remains, to borrow a notorious phrase, a known-unknown. As Martin Brühl says, “We have to distinguish between what are the facts, what we can extrapolate from previous experiences, and what is purely speculation. But I don’t think we can rewind urbanisation, nor can we rewind globalisation.”