You Asked Us: How is the global commercial real estate market holding up?
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11 May 2020
Simon Rubinsohn
Chief Economist, RICS
From a global perspective, what will be the impact of low oil prices?
Simon Rubinsohn: Low oil prices can, at times, be seen as a potential stimulus for economic activity. The latest plunge is largely a reflection of a collapse in demand, as the global economy has over, a period and in stages, gone into lockdown. How this plays out over the medium-term remains to be seen, but I doubt it will be a critical factor in driving any recovery. The ability of governments around the world to effectively navigate policy options will be key.
Sean Ellison: Oil prices are generally fairly sensitive to demand and are likely to recover (to a degree) alongside the global economy. In the near-term, low oil prices increase the risk of deflation in oil-dependent countries, such as those in the Middle East, and those countries that import a large share of oil, such as India. It also hampers infrastructure investment in the energy sector, as returns on investment are substantially reduced. Although a case may be made for renewable energy, the global dearth in demand means the returns on investment in any type of energy infrastructure, renewable or not, are currently very unattractive. This is a good example of why governments need to step up and fill this void in demand.
Would you mind commenting on the fundamental supply-demand characteristic? We have experienced a 10-year boom in commercial real estate in most major markets – particularly in New York City and London. Do we not have significant overhang, made worse by workplace as a service?
SR: I think there are two points here. First is the supply and demand issue. The input from professionals in London to this survey is not suggestive of a significant overhang of good quality office space; the story regarding prime logistics speaks for itself. However, the Covid-19 crisis has changed the game. Listening to professionals working in the sector, it is hard not to conclude that the size of the office and retail estate will diminish over time. The second issue is that owning property has become more operational. This is another trend likely to be exacerbated by the pandemic.
“The Covid-19 crisis has changed the game. It is hard not to conclude that the size of the office and retail estate will diminish over time. ”
Simon Rubinsohn, Chief Economist
RICS
How do you feel a fall in capital values will effect bank lending and the ability to provide accurate valuations for lending purposes? Do you see the market returning to a position of cash is king, similar to the post-08 crisis scenario?
SR: Much depends on the nature of the economic recovery. The more protracted the process, the more challenging the real estate environment. This will be true even with the cost of money close to zero. Lack of transaction activity may impact the accuracy of valuations and encourage greater caution but that will ultimately be a reflection of macro conditions. For the time being at least, credit supply is not generally an issue.
SE: I generally would agree with that, but would add that when accounting for idiosyncratic features of markets, there seems to be clear evidence of a defensive tilt. Core assets in core markets appear to be (relatively) more attractive.
It has been said repeatedly that this isn’t yet a financial crisis, but it may soon become one. Given the situation, this is hard for a lay person to understand? At what point can we say it is a financial crisis?
SE: In a financial crisis, the efficacy of credit transmission is impaired as uncertainty is elevated and risk cannot be priced effectively. In a sense, what some government and central bank actions are doing is providing a floor for markets so that they can better price risk. A characteristic of a financial crisis would be large, high-profile bankruptcies resulting in permanent job losses, rather than transitory job losses – as appears to be the case in several countries currently. As in 2008 and 2009, the health of banks – and other financial organizations that provide credit – would be called in to question. Although the outcome of this crisis remains uncertain, this does not appear to be the case currently.
“A characteristic of a financial crisis would be large, high-profile bankruptcies resulting in permanent job losses. Although the outcome of this crisis remains uncertain, this does not appear to be the case currently. ”
How will investment in education, health and public infrastructure help with the recovery? These are high cost investments and do not provide quick returns?
SR: It is quite right to say that infrastructure investment doesn’t generally provide quick wins, but ultimately it should deliver a bigger “bang for the buck.” And there some projects that can be implemented more rapidly. By contrast, tax cuts can have an immediate impact, but tend to have a much smaller multiplier effects.
SE: To answer this, we need to look at two things: the short and long-term impacts of these investments. Investments in education and health are long-term outcomes. They are investments that will increase economic capacity in the long-term. There is also evidence that they will help to heal some of the ills our economy suffers from in the near-term, such as inequality and structural stagnation.
Listen now: RICS Global Commercial Property Monitor – Q1 results webinar series
The RICS Global Commercial Property Monitor is the leading indicator of conditions in commercial property occupier and investor markets around the world. In these webinars we will present the results of the Q1 survey and assess the probable impact of the Covid-19 pandemic on sentiment over the remainder of the year.
Infrastructure investment also adds to the capacity of the economy in the long-term by increasing productive capacity and lowering costs of transportation, energy etc. It can also provide stimulus in the short-run. A good example of this can be found in New Zealand, where the government is working with industry to identify shovel ready projects to be launched once restrictions are lifted. A very simplified explanation as to why this plan will provide short-term economic benefits is as follows: it will see cash flow to construction companies, who will then need to hire workers to fulfil this demand; these workers will receive a wage, and be able to spend a portion of their income on other products; this will see cash flow to other companies, and so the “virtuous circle” continues.
This is the multiplier effect that Simon touches upon. If the initial investment is both quick and large enough – relative to the size of the economy – it can have a substantial stimulating effect in the short-run. The government is essentially stepping in to provide demand when the private sector is unable to do so. This sort of counter-cyclical stimulus tends to be more effective in the short-run than government spending in normal times, which can ‘crowd-out’ the private sector.
Once the economy is back on its feet, we can start thinking long-term. This is where investments in health, education and infrastructure become important. If done correctly, these can increase the size of the ‘economic-pie’, similar to what we saw in the aftermath of the Second World War.
