The current pandemic has yielded an unprecedented level of uncertainty, raising legitimate concerns on every level, notably, regarding the sanitary measures recommended by health authorities and governing bodies to stem the global spread of the virus, the implementation of adequate policies and ultimately assessing the extent of the ensuing economic crisis.
The real estate sector, which revenues and fundamentals "live, work, shop" are highly correlated to an active and healthy economy, has experienced first-hand the confinement measures. Throughout nine weeks, occupier and capital markets have been at a crossroad, with due diligence processes delayed due to complicated interactions between parties (site visits, drafting of legal documentation, signing of SPAs) and deal closings postponed in some cases, as long as the date of the “de-confinement” remained unknown.
European governments and financial institutions (investors, specialized lenders) have introduced a series of measures, providing stakeholders of the real estate industry e.g. investors, retail brands, office occupiers, co-working spaces as well as hotel operators with a certain flexibility in loan repayment schedules, tax obligations, provisional unemployment and rent payment to allow for business continuity and making necessary adjustments for business survival.
Multiple scenarios are being contemplated - in the event of non-recourse financing, as it is usually the case for corporate lenders, additional collateral can be incorporated to the security package where investors are in turn being encouraged to negotiate tenant incentives with their lessees. As for investment managers and private equity real estate funds with capital commitments from their Limited Partners who have subscribed their funds, time is of the essence...
Retail parks, shopping centres and high street retail units are obvious collateral damage of the ongoing crisis. The closing of "non-essential" businesses could bear immediate consequences for independent retailers who do not have the critical size to either absorb a liquidity shortfall or fit the profile to receive backing from institutional money, hence relying on their retail bank to agree on a prorogation of their loan facility.
Shopping centre and retail park operators have had assets running at <10% of their full capacity, with almost exclusively hypermarkets and supermarkets being open for business, and a large majority of those food anchor premises being owned by their mother companies (Ceetrus, Carrefour, Groupe Casino etc.), hence posing the problem of revenues at a halt for operators whose business model relies on stabilized income streams and recurring cash-flows to service their debt and support operating expenses.
On the other hand, Grade A tenants, encompassing luxury brands and (inter-) national retailers, could in most cases still capitalise on their digital platform and leverage their delivery services to drive online sales and outweigh risks across the board. For strong covenants, rent reductions or delayed rent payment have been amongst the different tenant incentives negotiated between landlords and tenants in order to extend some flexibility and avoid setbacks.
The revenue loss for physical stores has been and continues to be significant considering that retail brands located in the most sought-after luxury arteries of Paris, namely Champs-Elysées, Montaigne, Saint-Honoré and London West End are supporting rent levels ranging between ca. €13,000 - €20,000/sqm ZA per annum.
Nevertheless, a growing number of initiatives have been undertaken on all fronts to safeguard vulnerable businesses such as restaurants / bars, local retail shops and SMEs with an elevated risk exposure. To name a few, crowdfunding campaigns to support local businesses, donations both at private and institutional level and the creation of social organizations such as “Sauvons nos commerces” all exemplify the level of commitment and solidarity we have witnessed in the past weeks, further widening the gap between empathetic, supportive and emotionally intelligent individuals / businesses and…others.
A cultural shift in consumer trends could be emerging post COVID-19, as we are now progressively de-confining the population and learning to live with the virus, eventually forcing retail brands to adapt their business models to a newly disrupted economy and come up with innovative concepts, more efficient distribution channels and improved digital solutions.
Many companies, amid the virus outbreak, have been able to rapidly adapt their entire IT infrastructure by way of investments in technology and cybersecurity to allow their employees to work remotely, which begs the question for a number of office occupiers to re-evaluate their actual needs for office space. As the digital era has been making its way with companies progressively introducing home office solutions and shared desks, this new configuration we are dealing with might be a turning point in the office market with occupiers rationalizing take-up and reducing headcount space / office footprint i.e. leasing dedicated areas for client presentations, important meetings and team gatherings.
This paradigm shift in the way companies operate would not be effective immediately as this is a long and meandering process. However, should office occupiers start to progressively reduce their capacity ratio, which is currently of ca. 10 sqm per employee, by leasing offices with dedicated areas to work, hold meetings or team gatherings, this would already provide employees with an increased flexibility in the way they work and collaborate.
Nonetheless, employees should have the possibility to manage their “WFH” time as there are still many advantages in going to the office i.e. social and intellectual interactions, team building, training of junior staff, avoid a potential burnout and most importantly separate your private life from your professional environment.
Employees would be able to perform their work remotely if they wished and benefit greatly from home office e.g. spend more time with their family, wife, kids or relative affected by an illness and less time commuting. This Modus Operandi would necessarily raise the question of productivity i.e. companies trusting their employees to perform at the same level and would also be subject to a series of functional parameters (data protection, GDPR red flags, phishing etc.).
In any case, managers would still continue to monitor the level of performance of their associates with quantifiable objectives and employees could remain productive whilst spending more quality time with their families.
Finally, this new format would empower business owners and employers to allocate the cost savings of a lower passing rent to the development of their company or review compensation packages. For now, leases in place are still running and offering long-term income streams - but for office buildings with a short remaining term until lease expiry, this could be the opportunity to challenge existing models.
The hospitality industry has recorded significant losses during H1 2020 with historically low occupancy rates and an increasing number of operations being shut down prior to the confinement measures even being announced. At this stage, it is too early to predict long-term effects on the hotel industry, but we could observe a cultural shift leading to a stronger local tourism. Indeed, a temporary decrease of international travelling could surface, at least until fears of contracting the virus have dissipated, or just simply resulting from our guilty conscience coming to the realisation that our nature and environment have caught a break during three months and finally regained their true colours. Therefore, restricted travelling could be the next turn operated by businesses, who had not taken the leap yet and wish to i) restore their ESG image by reducing their carbon footprint and ii) reap the benefits from these cost-effective measures.
Bottom line is, revenues have taken a severe hit and comparing results from H1 2020 using key performance indicators such as RevPAR, ADR, and GOP with H1 2019 results might prove to be a tough sell during the next annual shareholder meeting. Be that as it may, hotel operators with a longstanding history and a solid track-record, especially luxury tourism, will most likely recover on the long run, though we can anticipate that some small players will not be resilient enough to navigate through this crisis.
Residential - the living sector seems to be faring relatively well as no foreseeable amendments to leases or rent reductions have been implemented, and the income profile of this particular asset class is providing investors with stabilized income and increasing capital values. Should there be a slight correction in mature, liquid real estate markets, the reversionary potential could still be captured by investors adopting a capital appreciation strategy betting on long-term upside. Developers might face a decrease in demand for new housing projects as the crisis goes on - however, all in all, the sector should be responding quite well and remain a secure investment offering risk-adjusted returns.
Student housing - Operators forced to shut down student accommodations during COVID-19 could have difficulties making up for loss of revenues on empty beds and increased alternative options for online educations. Further, incoming international students could be having second thoughts and amend their student projects for a more local solution.
Senior housing - At the heart of the virus outbreak, care facilities continue to suffer tragic losses in countless locations calling for increased protective actions. A potential shift in paradigm could appear and result in a decrease in the number of elderlies being sent to medically assisted facilities by their families, favouring domestic solutions. However, to the credit of senior housing operators and care facilities, very strict health and safety measures have been adopted on site to protect elderlies and eradicate a potential virus outbreak, thanks to the support of the medical staff since day one. By all appearances, being in the spotlight has somehow benefitted hospitals and nursing homes, as investor interest in this asset class has surged over the past weeks.
Logistics and supply chain companies have seen overall an increased business activity in home deliveries and distribution channels, however the shutdown of harbours and airport facilities could have long-lasting consequences. Opportunities for potential brownfield restructurings of logistic platforms and light industrial assets or greenfield developments could see the light to respond to a rapidly evolving pattern of online distribution demand in sectors such as food, fashion, health & beauty, home equipment etc.
Rise and shine...
In some instances, opportunistic / value-added investors, who seek to acquire undermanaged assets with an upside potential where they can reposition the property and extract value by unlocking its potential, have engaged in bidding contests with Core investors, as the latter could no longer afford entry yields ranging between 2.50% - 3.00% for prime office or retail assets, and would now dedicate resources to acquire opportunistic assets.
With a new crisis comes new opportunities...acquisition price for plots of land, construction costs and ERVs could become more affordable; and even though an increase of 50-100bps in equivalent yields would impact IRRs and exit strategies for investors who acquired assets with historically low net initial yields, could this momentum eventually set the pace for a new dynamic in the investment market?
The transactional activity is slowly recovering with the recent disposal of a EUR 2 Billion shopping centre portfolio by Unibail-Rodamco Westfield in France, large-scale transactions in the London Office market, acquisition of data centres in Germany and Blackstone announcing mid-April the close of a USD 10 billion equity raising round allocated to a new European Opportunistic Fund despite the current economic upheaval.
Investor confidence is not restored yet, and both institutional funds and lenders are taking precautionary steps as well as carefully carrying out their due diligence when contemplating a transaction to account for a risk premium and market uncertainty as we expect i) upwards pressure on RE yields, ii) slightly decreasing rental values and iii) increasing vacancy rates.
Financial institutions to bailout the economy this time?
Following several years of capital raising efforts, private equity funds have secured a record high $2 trillion of equity commitments from pension funds, insurance companies, sovereign wealth funds and UHNW investors. Dry powder, which is ready to be deployed subject to an appropriate capital allocation strategy, is being devoted to businesses with liquidity shortfalls.
In this specific context, private equity houses are capitalising on their Leveraged Financing platforms by funding loans for SMEs/tenants and provide mezzanine debt to businesses with a reduced risk exposure (...) and the same rule applies for Venture Capital firms monitoring their portfolio of start-ups in need of guidance and financial support who now, more than ever, are urging their investors to resort to their sense of responsibility.
In addition to institutional investors, the banking sector, as instructed by both the ECB and the FED, has been constantly increasing its liquidity reserves over the course of the last 10 years to prepare for a potential recession by running repeated stress-test scenarios. Banks are also participating actively in funding rounds and corporate debt refinancing as illustrated by the recent €500 Mio government backed-loan granted to Fnac-Darty by a banking pool including Crédit Agricole.
Time will tell if the quantitative easing policies, provisional unemployment measures and US stimulus package deal deliver the expected results on global economies. The current situation we are facing is unprecedented and calls for caution, preparedness and an acute sense of accountability.
In all fairness to future generations, we have to seize this opportunity by hitting the reset button, take a hard look in the mirror and come up with a new, better version of ourselves.
July 10, 2020