Covid-19 has both emphasised and upturned property sector assumptions

The crisis has intensified prior sentiment toward sectors such as logistics and retail, but has forced a major rethink of offices.

Measuring risk

Predictability, which debt providers value most highly, is in short supply in today’s real estate sector. Covid-19 has forced lenders to reconsider underwriting assumptions across all types of property.

In a 29 June research paper, Aviva Investors said a significant drop in infection rates would be needed for European countries to exit this “second phase” of containing the virus, now that intensive lockdowns have eased. For real estate investors underwriting 10-year hold periods, the London-based investment manager said, it was reasonable to assume that these conditions would prevail “for most of that time”.

With most loans in the sector provided for at least five years, underwriting uncertainty is also a challenge for real estate lenders. Across the industry, property people are forecasting the impact covid-19 will have on how real estate is used, traded and financed. In some sectors, such as retail and logistics, the crisis looks set to accelerate existing trends, for better or worse. For others, most obviously offices, prior assumptions have been put into disarray. Here are some thoughts for debt professionals to consider.

A cautious approach to offices will be crucial:

On 1 July, consultancy Knight Frank published the findings of a survey of around 1,000 businesses across Europe. More than half of respondents said they were looking to implement new workspace strategies in response to covid-19. Of concern to office landlords, 40 percent said they would require less space in future. Just 11 percent said they would need more space to accommodate social distancing.

Equity and debt managers, according to sister title PERE’s July/August cover story, will become more conservative in their office underwriting and return assumptions. Executives believe a narrower definition of ‘core’ will be applied during this market correction, and that managers will be required to provide more capital expenditure to ‘covid-proof’ their assets. PERE understands that office lending across the capital stack has now widened by around 150 basis points in the US to factor in rental and occupier uncertainty.

Lenders in Europe are also demonstrating an increased focus on financing assets that are deemed to have defensive characteristics, as Allianz Real Estate’s head of European debt, Roland Fuchs, told us this week.

Retail will become even more problematic:

The sector’s issues pre-date covid-19, but the pandemic will exacerbate them. According to the Aviva paper, experiential retail, which combines leisure and shopping, is unlikely to rebound quickly as people limit social contact. Many shops will play a purely transactional role, with low-engagement retail facing a steeper decline than previously anticipated.

In the longer term, Aviva said it was hopeful for the future of physical retail that prioritises socialising once the crisis has eased and people’s spending power has improved. However, it also predicted that, in more valuable locations, the crisis would hasten the repurposing of retail for uses such as residential and logistics. If lenders were already highly cautious on retail before covid, they will be even more so over the coming years.

The case for logistics looks only more compelling:

This is the sector tipped by many in the property industry as the beneficiary of trends accelerated by the pandemic. Figures published by consultancy Cushman & Wakefield on 3 July hint at the growing role of e-commerce across Europe. The UK’s logistics sector recorded its strongest-ever take-up for a second quarter, with three deals by Amazon bringing volumes to 13.3 million square feet.

According to Aviva, the drivers for logistics activity are deeper than increased online sales. The pandemic, it said, exposed the vulnerability of manufacturers’ offshoring and minimal-inventory strategies. The result is likely to be an acceleration of near-shoring manufacturing, making supply chains more resilient, and even greater demand for shared and on-demand warehousing.

Aviva expects all of this to translate into greater demand for logistics property within Europe. As we learned recently, logistics is one part of the market that lenders can still feel positive about amid all the covid-induced disruption.

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