The real estate market is often a clear indicator of the economy’s health, and we are starting to see the effects of Covid-19. This pandemic has opened a period of unprecedented uncertainty across the globe, with rising unemployment levels that are skyrocketing in the United States. Authorities in the EU and around the world are working hard to agree on rescue plans to try and avoid a long and deep recession similar to the 1930’s. As a result, most state budgets are under huge pressure, and expected increased deficits will need to be financed, which will likely mean that interest rates remain low for a long period.
Taking a forward-thinking approach, we have compiled our top ten predictions for the real estate market (some short-term, and others long-term) as we pick ourselves up and begin to recover from this global pandemic.
- Real estate transactions: in the short to medium-term, we may see discrepancies between seller and buyer expectations. Sellers will still have the same high expectations, but buyers may no longer be willing to pay the same multiples compared to three months ago. This discrepancy will last until buyers feel a sense of stability within the economy. As a result, real estate investments will inevitably see a drop in Q2 2020.
- Liquidity: stock market volatility that reached new records will most likely continue for a while. Many listed real estate funds have blocked the trading of their shares. Depending on how the situation evolves, this could also happen for redemptions in certain closed-ended funds. More than ever, “cash is king” will remain the rule, and managing and monitoring the treasury position will be critical for market players.
- Financing conditions: interest rate volatility may continue as well. Banks are revisiting their lending offers, we expect to see increased margins to compensate certain borrowers’ increased risk profile. Bank covenants and the ability to generate cash are also expected to be a focus for the lenders. This period of uncertainty could lead to creative new ways of financing and refinancing.
- Investors: we expect investors to review and challenge their investment financial models and profitability assumptions. We also expect ESG to continue to gain traction. In addition to pure real estate investors, it is likely that debt funds, securitization vehicles and other alternative providers of finance become increasingly prevalent as investors take advantage of the opportunities presented to them.
- Fund managers: management companies and AIFMs are responsible for understanding the precise risk position at any given time. Fund managers need to clearly analyze and discuss the current environment with their investors and LPs. This may increase pressure to open the floor for re-negotiating management fees. Governance around Covid-19 issues, as well as increasing operational efficiency, will also be long-standing central themes.
- Valuations: we expect valuations to be more forward-looking than ever, focusing on the ability to generate cash. The location criterion, key for valuation, might have to be revisited in light of new behaviors and ways of using real estate. Auditors may consider including a material uncertainty clause around valuations within their For the specific case of development projects that were halted as a result of lockdown measures, certain price adjustments are expected to occur on existing available stock.
- Technology: we see a focus on understanding and monitoring better real estate investments through digitalization, data analytics, artificial intelligence, and other related tools.
- Tenants: Tenants, like any other market players will certainly consider cost-cutting programs, including revisions to how they use real estate. Some of them might even try to renegotiate rents down.
- Tax: taxes, and more specifically, managing cash tax will be a hot topic in the months to come. Governments and authorities have released measures aimed at “cushioning the blow”. Accessing available business reliefs including tax, state aids and incentives will be high on the agenda.
- Change management will impact organizations. As a result of this pandemic, more people are working from home, and may, to a certain extent, continue to do so after the lockdowns are lifted. Operational models are likely to be challenged and reviewed to ensure continued increased efficiency and business continuity.
What happens to the various asset classes? We also look ahead to give you our views on the future of six asset classes as a result of the Covid-19 pandemic.
- The hospitality business has been severely hit by travel restrictions, and many hotel projects are on hold. The timing for this sector to take off again is uncertain.
- Investors holding retail assets have also felt the immediate effects of this pandemic. As a result of lockdowns in place globally, tenants have closed their “non-essential” shops and are starting to run out of cash. Some rent payments are being missed entirely or delayed.
- Investors with holdings in office buildings may likely be affected by the increased trend of working from home, resulting in less office space being utilized. The impact of this work from home trend for the mid- to long-term is still unclear at present but will be an interesting space to watch. Those who will benefit from this trend will of course be those in technology, digitalization and cyber security.
- Logistics is expected to continue to be amongst the preferred asset classes of investors, mainly due to the resilience of e-commerce. With massive disruptions to global supply chains, certain players will be tempted to revisit their operating models, favoring a more local approach over the current global approach.
- Operational real estate (student housing, care homes, data centers, etc.) is expected to be less affected by the economic cycle and maintains its attractivity as asset class for the time being.
- Residential real estate could be a resilient asset class, depending on tenants’ ability to preserve their economic power and pay rent. Government support could play a role.
In this very challenging environment, it is unclear how and when the economy will rebound. For the mid- to long-term, it is difficult to say the precise, tangible consequences we will see in the real estate sector. Although it is as yet unclear whether real estate will be amongst the first sectors to benefit from a post-crisis lift, we remain optimistic and expect that, together with infrastructure, the real estate sector will continue to be favored by investors.
The KPMG Real Estate team of specialists has developed a multi-disciplinary approach where we combine our expertise, leveraging our global real estate network, to help market players adapt to and manage the current global crisis and its expected consequences. Let’s tackle Covid-19 together.
