Predicting the course of the next six months in real estate (or any sector for that matter) is clearly challenging given the number of unknowns that still exist around Covid-19. Its mutation path, the subsequent effect on immunity and the likely success of any vaccination programme remain largely unknown. There is a spectrum of opinions on whether measures across the world have been proportionate or not, however for those countries that opted for lock down, the economic impact has been undeniably huge.
With many countries starting to ease out of lockdown and as we look ahead to the second half of the year, the dialogue is naturally moving towards what the short and long term impacts will be from this pandemic.
With that in mind, and acknowledging that any predictions in the current environment come with a large caveat around second spikes, below are five themes that we think will likely define the second half of the year:
1. Continued uncertainty
Uncertainty will remain with the risk of a second spike looming in the background as autumn and the colder weather returns and the focus shifts back on the Brexit machinations. What’s certain is that prolonged uncertainty normally results in market polarisation. Long term income from strong covenants, in an exceptionally low and possibly negative interest rate landscape, will be in high demand whilst secondary assets with shorter lease profiles (and therefore more variables) are likely to see outward yield shift.
2. U-shaped recovery with a tail
Assuming a second spike is avoided, we expect this recovery to initially be quicker than in previous downturns, but still with a long journey back to full recovery. Leverage in real estate was historically low going into this crisis and critically, the banking sector remains intact following the extensive reforms following the GFC. However, we will be emerging with enormous public debt and a legacy of higher unemployment and reduced consumer spending for some time to come – with widespread effects.
3. Acceleration of societal shifts
The real estate industry has faced unprecedented change over the last 10 years, with material structural changes to the way people behave (online retail, shorter leases, co-working and customer focused expectations), so there was already a significant amount of disruption and uncertainty in the long term outlook for the retail and traditional office sectors. Understanding how people will use offices and their approach to commuting going forwards is particularly hard to gauge – the “work from everywhere” mantra will be with us for good, now that management across the UK have familiarised themselves with the tools for running teams remotely. It’s always interesting to try to predict what structural or legal changes may be precipitated by a crisis response – in this case it seems employee protections and rights to flexible working may be on the table for discussion in the coming months as Government inevitably moves to a strategy of personal responsibility around virus exposure. Having said all of that, even with an increase in de-centralisation of teams or flexible working it seems unlikely that the need for office space is going to radically alter in the near term and therefore well located, well laid out offices are likely to remain a good investment prospect when analysed asset by asset. In any event, the recessionary environment will likely have a far bigger impact on office demand in the immediate future than the probable societal shifts.
4. Not all sectors are equal
No sectors will emerge completely unscathed, but there is a difference between those that have suffered short term income losses from rent holidays and deferrals, and those for whom the income losses are longer term (and therefore accompanied by falling investment values).
Sectors underpinned by strong demographics or long term demand/supply imbalances will be the least affected. The residential for rent sectors (BTR, PBSA, single family etc) will face lower rental growth and short term voids, but this will be short term and not a source of significant distress. The fundamental lack of housing supply and the appeal of Higher Education for domestic and foreign students will remain intact. I am expecting most universities to return to business as normal by the end of the year. It seems unlikely that quarantine requirements will remain in place by September and more likely that track and trace will be more materially employed.
Retail just cannot get a break it seems and Covid-19 has further demolished this sector in a way that I don’t expect ever to recover. For us, retail is a repurposing opportunity where it may be possible to create residential, senior living, healthcare, storage or other alternative uses. Hospitality and leisure have a longer journey to recovery and some significant distress along the way if travel and group activity restrictions remain in place for any significant time. Logistics, data centres and real estate focussed on life sciences could well end up being beneficiaries of this pandemic. We have been focussing on ‘beds and sheds’ for many years now and that is likely to continue to be the case.
5. Opportunities will still be available
There is an uncomfortable truth that distress and opportunity are always bedfellows. There will be stress and distress coming out across the real estate sectors, presenting some opportunities for those with the conviction (and capital) to back or repurpose these. In the alternatives sectors, where Moorfield has focused its attentions more recently, we expect the demographic drivers to remain compelling. I suspect we will not be alone in also looking more closely at healthcare related investment themes as the societal and economic risks may recede but will not be forgotten. Our investment strategy has always been both thematic and opportunistic – in different proportions depending where we are in the cycle. We will continue with our thematic investment strategy but see the next 6-12 months as likely to also present pricing led opportunities, which we are well positioned with our UK specialism to identify.