The coronavirus pandemic has thrown the financial markets into a fog of confusion and uncertainty. A recent NatWest Trustee and Depositary Services (NWTDS) webinar sought to find some points of light in the darkness, with the help of Simon Rubinsohn, chief economist at the Royal Institution of Chartered Surveyors (RICS), who looked at how the pandemic is affecting commercial real estate.
Rubinsohn drew insights from data that included previously unpublished findings from the RICS Global Commercial Property Monitor for Q2 2020 (PDF, 545 KB), which is based on material provided by more than 2,000 contributors in about 40 countries. The Monitor’s global sentiment indicator for Q2 was unsurprisingly downbeat, across the board, but in Europe and the UK in particular – although sentiment appeared slightly less negative in Switzerland and Germany.
But Rubinsohn also pointed out nuances in this and other datasets indicating market resilience, including data from Real Capital Analytics showing strong interest in new property developments. Share price information highlighted the differences in performance between different sectors of the market, suggesting that logistics and residential specialists are relative winners, compared with office, conglomerate and retail specialists, which endured difficult conditions in the spring.
He then shared data on respondents’ expectations for capital and rental values over the next 12 months. The only sector showing positive expectations for both rent and capital values, it appears, was prime logistics. Expectations for prime office and data centres were flat, those for most other sectors were negative; and the outlook for hotels and secondary retail was particularly grim. “No one’s expecting a turnaround – at this point anyway – in hotels or secondary retail,” said Rubinsohn. “I would be very surprised if our Q3 survey … shows a different picture.”
Office politics
The RICS data also showed respondents expressing caution about current office market valuations in different markets; and Rubinsohn quoted data from Capital Economics that shows the number of markets where it perceives overvaluations in offices has shrunk dramatically during the past year.
Ian Harcourt, head of institutional banking in Luxembourg for RBS International, and the webinar host, pointed to data from the Jones Lang LaSalle Office Property Clock, which shows rents slowing in 13 out of 24 markets, falling in nine; and only rising in Zurich and Geneva – in line with the relatively positive sentiment in Switzerland identified in the RICS data.
“I think [multifamily housing] is likely to be seen as potentially a positive sector. There are risks around it, but I think it’s better placed than many; and I suspect that investor appetite will remain relatively firm for that sector”
Simon Rubinsohn, chief economist, Royal Institution of Chartered Surveyors
Respondents to the RICS Monitor had also been asked to what extent they expected to scale back their firm’s office footprint over the next two years. In Europe, between 30% and 35% of respondents in most markets anticipated reductions of between 5% and 10%.
Overall, said Rubinsohn, the expectation was for office footprints to be reduced by about 12% on average. “Which is not dramatic, but will have a material impact [on] the demand/supply equation; and what it means in terms of pricing and rents,” he said. “We’ve had a retail sector structural change, and now we seem to be having a structural change in offices.”
Meanwhile, 89% of respondents to the RICS Monitor thought it was likely greater emphasis would be placed on health and well-being in the workplace in future, but only about one in three thought tenants would be willing or able to pay for enhancements to offices for this purpose. Rubinsohn said it was inevitable this question would produce many negative responses during a period of deep economic strain.
Managing change
Rubinsohn suggested these datasets showed how structural changes in the commercial real estate market were being accelerated by the pandemic, certainly in retail and offices and perhaps also in hotels, which may be adversely affected by changes in business travel. “Perhaps the outcome might be a somewhat smaller, but better specified stock of real estate,” he concluded.
He then took questions from Harcourt and webinar attendees. The first question concerned the possible shift of office space from city centres to secondary locations. Rubinsohn pointed to data from the RICS Monitor suggesting that a large majority of respondents expected to see businesses move some offices to suburban locations, thereby reducing real estate costs and the need for mass commuting – although he also acknowledged that some employers may be sceptical about the benefits of either more homeworking or of relocating office space outside central business districts.
Another webinar attendee asked whether the anticipated reduction in office footprints might lead to a repurposing of marginal locations or a reduction in rents. Rubinsohn said research from RICS and elsewhere suggested both were possible: Capital Economics has suggested that a combination of reduced occupancy and lower rental values will mean income returns on an average office portfolio may fall by 20% by 2025. This would result in repurposing some office buildings.
Risks and opportunities
Harcourt asked Rubinsohn a question about the Red Book-defined material uncertainty clause (MUC), which was invoked on 17 March as the lockdown began. It imposes extra requirements for valuers when producing a property valuation report. The MUC has been lifted only gradually in some sectors.
Rubinsohn reflected that the MUC was designed with short-lived economic shocks in mind, rather than a long-term crisis like the current pandemic. “So this has been a real challenge,” he said, suggesting that valuers were also hampered by a lack of activity in some sectors.
He was also asked about threats and opportunities related to public or private sector multifamily housing as an area for investment. He said that while RICS research suggested a slightly negative outlook for multifamily over the next 12 months, he felt more positive about the sector personally.
“I think it’s likely to be seen as potentially a positive sector,” he said. “There are risks around it, but I think it’s better placed than many; and I suspect that investor appetite will remain relatively firm for that sector.” He thought this would remain the case even if policymakers altered the tax treatments of these investments.
Considering the insights Rubinsohn drew from all the data, it seems clear that amid the confusion, and even in the sectors and countries hit hardest by the pandemic, opportunities to prosper in commercial real estate will appear during the next few years, as the longer-term effects of the current emergency slowly come into focus.