This article is part of our collection on Property Monthly
Tom Sharman, head of strategy and insight, Real Estate Finance, comments on the latest developments in the commercial property market.
Last updated: 11 Aug 2020 4 min read
At the time of writing, despite a few localised outbreaks, the level of infection in the UK and most of Europe is a fraction of the peak seen in spring. In most regions, shops and restaurants have reopened and lives for many people have returned to at least some semblance of normality.
However, the full impact on the economy is yet to be understood. At the last count, 9.6 million people were still on the government furlough scheme, and we know that some of these people will never return to their previous roles, with significant job losses already announced in the retail and leisure sectors. We have little concept as to where these numbers will eventually end up, but many economic forecasters have predicted that the unemployment rate will more than double from the current low level of under 4%. A loss of jobs on this scale would exceed anything experienced during the global financial crisis, and unemployment would reach a level unseen since the recession of the early 1990s. Those previous recessions coincided with a fall in commercial real estate values of 30% to 40%.
Of course, every recession is unique, triggered by specific events and focused on different parts of the economy. The crashes in 1990 and 2007 came at the end of sustained booms in values and construction, neither of which have occurred to the same extent over the current cycle. But there are aspects of the situation today that are virtually unprecedented, such as the total shuttering of some sectors of the economy, and dramatic ongoing structural changes in retail. So far, the effect on the commercial real estate market has been to drain liquidity from the investment market and to dramatically accelerate the already well-established downward trend in retail values.
The retail sector is undoubtedly the most directly exposed, but other parts of the market will inevitably feel the impact of the retrenchment that is sweeping through that sector
On the other hand, the impact on office, industrial and residential values has so far been little more than a token recognition by valuers that the backdrop has changed. Data from the likes of MSCI, CBRE, Halifax and Nationwide suggest that values across these sectors have perhaps fallen by 3% or 4%. Yet it seems inconceivable that a global economic shock of this scale could have such a marginal effect on real estate values.
The retail sector is undoubtedly the most directly exposed, with many forecasters predicting very significant ongoing value loss, yet other parts of the market will inevitably feel the impact of the retrenchment that is sweeping through that sector. Contraction by retailers, casual dining chains, hotels and airlines will directly impact on a huge range of suppliers and reduce the disposable income of the many thousands who lose their jobs. This fallout will have secondary impacts on residential, office and industrial markets.
The residential sector will surely see lower levels of transactional activity given the expected scale of job losses, and such rises in unemployment have always in the past coincided with a material fall in values. However, the relatively conservative lending that has characterised the mortgage market for the last decade gives some comfort that levels of distress should be far lower than were seen in the early ’90s and at the end of the following decade. The strength of bank balance sheets should also ensure that the mortgage market remains liquid and reduce the risk of financial sector contagion.
The office market will take some direct hits from those sectors of the economy that are contracting, and there are some harder to quantify risks around changing working practices; but the limited development, conservative leverage and moderate growth of recent years suggests that values will deflate rather than collapse. The multi-let industrial sector will see rising business failures, a flattening of the runaway rental growth of recent years and a softening of yields as a result. The logistics sector, meanwhile, is probably more immediately at risk of a new bubble than a burst one.
Things seem certain to get worse before they get better, but there are reasons to feel confident that the real estate sector (outside of retail, at least) will not suffer the devastating losses seen in other major recessions.
Property Monthly, Real Estate
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