Market in Minutes: Covid-19 and the consequences

Text: Matthias Pink

The coronavirus pandemic has the financial markets and, increasingly, public life in many parts of the world firmly in its grasp. It is now clear that the spread of Covid-19 can no longer be prevented but merely delayed. The virus will undoubtedly leave its mark on the German property markets. We are already witnessing the first effects in the form of delayed transactions. In view of the inertia in the markets and the low data density, however, most consequences are only likely to become apparent slowly and, in some cases, at a significantly later date. The consequences that will certainly arise and the extent to which they do so depends strongly on the proliferation of the virus going forward. In view of the complex chain of effects, however, this is difficult to predict. Nevertheless, or perhaps for this very reason, we would like to set out a framework for orientation and identify some potential effects in both the short and long term, some of which are based upon our observations in the Asian markets and Italy. This is a snapshot that we may revise at a later date.

Short-term effects

The following effects have already materialised or are expected very shortly:
The earliest affected sector and, according to the current state of affairs also the worst affected, is the hotel sector. Occupancy levels near exhibitions centres in particular have significantly declined and, in view of the ban on events with more than a certain number of participants issued by most federal states, an imminent recovery appears unlikely. With some events merely delayed, a certain catch-up effect can undoubtedly be expected once the coronavirus crisis has been overcome. Nevertheless, even in the event of a ‘mild’ progression, we expect a significant loss of revenues and, without government support, even insolvencies.

The same applies to retail, particularly in tourist locations. Shops as well as food and drink establishments in train stations and airports are also likely to suffer major losses in terms of revenues.

Flexible workspaces are already likely to be witnessing lower occupancy levels, particularly when it comes to their event spaces. However, we would only expect a threat to their existence in the event of a significant increase in the number of those infected and a sustained progression of the pandemic.

In the case of turnover rents, property owners will feel the developments described above directly. Furthermore, we expect rent reductions or requests for respite from occupiers particularly affected.

In the lettings markets, we expect leasing decisions across all sectors to be postponed owing to the uncertainty surrounding economic developments going forward as well as the prevailing travel restrictions. However, this will likely only be measurably reflected in revenues for the second quarter.

Transactions in the investment market are also likely to be delayed owing to potential travel restrictions of the contractual partners as well as the increased uncertainty. The dislocations in the financial markets are having opposing effects in the real estate investment markets. On the one hand, bond yields and interest rates have fallen, increasing the relative attractiveness of property yet further. On the other hand, the stock market slide has increased the weighting of real estate in multi-asset portfolios, potentially above the target level. However, we do not expect this to result in the initiation of property sales in the short term. Rather, investors are likely to wait and see how the markets unfold over the coming months. Meanwhile, risk aversion is even higher than before, producing a stronger core focus in the real estate markets and a corresponding increase in the yield differential between core and other risk categories.

Medium-term effects

There are essentially two scenarios for the remainder of the year. In the more favourable scenario, the number of those infected worldwide peaks over the coming weeks before flattening out. This would result in a U-shaped progression for the economy, with a rapid collapse in economic activity, followed by a brief bottom and a swift recovery including catch-up effects. In this eventuality, the effects on the German real estate markets would be limited. While the short-term effects described above would endure for some time, these would be predominantly of a temporary nature, particularly since the German government has already passed supporting fiscal policy measures and would likely enact further measures if necessary. Nevertheless, even in this scenario, we expect a somewhat higher risk of loss of rent across all commercial use types and particularly in the worst affected segments. Some business models are not sufficiently resilient to withstand even a short slump in demand. Risk premiums on yields would also probably initially hold at a somewhat higher level than in recent times in this scenario. The temporary uncertainty is also likely to have a negative impact on the availability of debt capital. With deals in the investment and lettings markets already being postponed, thus pushing back overall transaction activity, we expect lower take-up and transaction volumes for the current year.

In the second, less favourable scenario, the number of those infected also continues to rise over the coming months but only peaks in the second half of the year. A global recession would then be practically unavoidable. This would likely mean significant declines in demand, take-up and rents across all segments as well as rising vacancy rates. Rising unemployment and/or falling incomes would also have a negative impact on demand in the residential markets in this scenario. In the investment market, transaction volumes would decline with increased risk aversion, growing market risks and debt capital only being available to a limited extent. Declining demand would meet with an increasing willingness to sell and initial yields would soften.

Long-term effects

The coronavirus crisis could have consequences far beyond its conclusion – if indeed it is overcome at all. It is already influencing people’s behaviour and the longer it does so, the greater the probability that these behaviours become habits that will last beyond the pandemic. We believe the pandemic could, in many respects, accelerate the transformation introduced by digitisation in recent years. Many digital technologies have enabled people to conduct interactions online that were previously impossible without human contact. Now, the coronavirus is forcing people to use these options (more intensively), including those who have not used them to date. At a minimum, the virus is providing a greater incentive to avoid human contact in favour of online interaction. In this regard, the coronavirus could act as a digitisation accelerator and almost “fast-forward” processes in the property markets that have been playing out slowly to date. These include, for example, the shift in sales from brick-and-mortar retail to digital retail. Space requirements of brick-and-mortar retailers could decline more quickly than previously expected. There will be no shortage of alternative uses and the coronavirus is unlikely to change that. One such alternative use could be a greater number of flexible workspaces than we have already. In any event, the coronavirus crisis is possibly delivering us the most comprehensive home-office experiment in history. It may be that both employers and employees subsequently declare this experiment a failure. However, we believe the more probable outcome is that entirely (and surprisingly) positive experiences will be gathered. At the same time, however, very few apartments are likely to prove an ideal working environment, shifting local flexible workspaces even higher up the agenda. In this context, video conferencing and other web-based tools for collaboration will probably gain significantly in terms of importance. Together with online shopping, e-learning, e-gaming, etc. this will drive data traffic to new heights and could catapult data centres onto the map of institutional investors.

However, while the coronavirus is likely to fast-forward events in many areas, it may well rewind them in others. It has already exposed the vulnerability of global supply chains when they are dependent on a single nation, in this case China. They are also so dependent since the coronavirus has presented the just-in-time concept that has prevailed for decades with an impossible challenge. Both the roles of China’s extended workbench for the world and the just-in-time concept could be permanently in question as a result of the coronavirus. The threat to the former could see a higher production capacity return to Germany, while the challenge for the latter could produce a strong increase in demand for warehouse space in Germany and elsewhere.