How Soon Can We Bounce Back?

Author: John Scott - Head Of Institutional Investments @ NdG

HOW SOON CAN WE BOUNCE BACK?

At the time of this writing, all major European countries are under lockdown. For over three months, there have been unprecedented restrictions on personal and business activities. And from an economic perspective, the only relevant question is: “How soon and how far can the Eurozone bounce back?”

The COVID crisis is fundamentally different and has rendered useless the economic models which we have historically relied upon for forecasts and analysis.

All economic shocks are different, although most dislocations tend to be attributable to imbalances in either supply or demand. The 2020 COVID crisis, however, is fundamentally different and has rendered useless the economic models which we have historically relied upon for forecasts and analysis.

Eurozone GDP contracted by 3.8% in 1Q20. France, Spain and Italy underperformed while Germany and the Benelux countries proved to be more resilient. According to Capital Economics, however, the $14 trillion euro-economy could contract in 2Q20 a record-breaking 15% … a rate that would be five times greater than the prior record decline in 1Q09.

As a slow-moving asset class, real estate and property market data typically lag by 4 – 8 weeks. Accordingly, 1Q20 – 2Q20 data is unlikely to reveal anything instructive. Going into the current year, Eurozone property valuations had been largely stable. However, this pricing trend may be misleading. Real estate deals generally take months to complete and the most recent metrics are most likely indicative of unsustainable 2019 year-end activity.

Even before the crisis, there were early indications that the Eurozone property markets were showing signs of a slowdown. For example, the number of deals still under contract (€40 billion) was unusually high and surveys suggested that prospective buyers were increasingly cautious. Moreover, the average deal size had risen considerably during 2019, reflecting an increased appetite on the part of cross-border investors for large and high-quality trophy properties.

Since the beginning of the crisis, most real estate deals have been characterized as “frozen.”

Since the beginning of the crisis, most real estate deals have been put on hold and the market has been characterized as “frozen.” Most certainly, pre-COVID underwriting valuations are no longer valid and it is impossible to ascertain with confidence where the markets will find equilibrium.

With regard to the office sector, tenants have remained relatively buoyant. This sector, however, could experience secular pressures resulting from a permanent change in work habits as tele-commuting becomes entrenched and reduces the need for traditional office space. On a more positive note, however, most European office markets are undersupplied and may become even more so due to construction halts attributable to the lockdown. This supply constraint should support rents, especially for new, higher quality stock.

The retail property sector has been under pressure for some time and has suffered from the increasing popularity of on-line shopping. As such, the timing of the COVID crisis could not have been worse. The sector’s outlook will remain at risk, reflecting continued portfolio rationalization amongst the surviving retailers. Prime retail rents have been falling (especially in the shopping center and retail warehouse sectors} and we should see further reductions due to rising vacancy rates across Europe. On balance, retail assets are still very much unloved, except in southern Europe where on-line retail is less established.

The positive fundamentals of the Pan-European logistics sector largely reflect the perceived long-term resilience of the e- commerce industry and their service companies.

On a more positive note, it appears that the logistics sector is experiencing some countercyclical benefits from the crisis. E-commerce rates have increased across Europe, particularly for on-line grocery retailing. This has led to increased demand for logistics space from supermarkets, which have leased new space or renewed leases on older warehouses. The positive fundamentals of the Pan-European logistics sector largely reflect the perceived long-term resilience of the e- commerce industry and their service companies.