As the first tentative signs of an easing of COVID-19 restrictions occur, it’s timely to look ahead and see how real estate investment may be affected as the cycle resets.
At the start of this crisis, much attention was given to liquidity and the fear that it would dry up.
We do not believe this will be the case. When I compare this crisis to the ones I worked through in 1991 and 2008, it’s different. Its genesis is an external event – a non-monetary shock to the financial system – occurring at a time of high liquidity.
In recent years, investment markets have been characterised by a large wave of capital looking for a home. While this capital is somewhat reduced, it has by no means disappeared.
This is in contrast to Australia in 1991: a time when Australian banks were in distress, superannuation funds were yet to gain their powerhouse momentum of today, and there was a lack of capital wealth held by ultra-high net worth individuals, hedge funds or private equity players with an appetite for distressed debt.
So whilst the setback and business closure is more severe, particularly within small retail businesses, it is occurring at a time when central governments around the globe are flexing fiscal policy to stabilise and stimulate local economies; bail-out programs for displaced employees are in effect; a strong banking sector is acting as an extension of government; a significant build-up of wealth has occurred in super funds; and private investors have accrued significant dry powder (in the form of cash).
These trends, and continued capital competition, we believe, will provide a floor for the real estate investment sector at least in so far as costs of capital, yields and overall return expectations.
That doesn’t mean we are out of the woods; on the contrary, it is fair to expect dislocation in property markets, particularly in certain sectors. A key aspect that is unknown is the sustainability of income on real estate and in particular there will be sectors where a short- or medium-term view of income is hard to predict. However, we have enough experience of previous cycles to make educated guesses about the manner in which a downturn and recovery will play out.
Confidence will be lower relative to 2019, but property funds set up to buy into distress situations will demonstrate a strong readiness to act, perhaps not in the first couple of months, but over the next year. This will provide a natural floor to yields and costs of capital and assuming that income remains sustainable, will translate to a floor in property asset pricing. We anticipate a sharpened focus from investors on quality and sustainability of income as a determining factor in differentiating between properties. This is likely to combine a mixture of deep analysis on sectoral trends for tenants industries as well as fundamental credit analysis on each and every tenant.
From a macro property perspective, we expect there to be several distinct steps in the recovery process, in line with the resolution of the health crisis.
The four stages towards recovery
- Current stage (lockdown): new projects and opportunities will be limited; instead, there will be a heightened focus on making sure existing investments are all performing ok. During this period, those who need capital from banks and alternative lenders will crave certainty about whether they can secure it.
- Partial return to work phase: Developers will seek to obtain finance on projects that were ready to execute pre-COVID-19, but were put on hold. We will continue to see funding certainty as a core theme.
- Domestic restrictions lifted: Announcement of an effective treatment plan that will provide higher levels of domestic activity (not overseas travel inbound or outbound) therefore allowing smaller businesses to begin a reboot – e.g. restaurants and larger social gatherings. This will be a stage where smaller investors start to regain confidence and look to return to the investment markets
- Vaccine announced – return to a new normal: This will hopefully allow investment levels to recover, after a period of rebuilding. However, it will be gradual: we expect that a return to what was once considered ‘normal’ could take 2-3 years from the time of a vaccine being available for the general population.
Overall, it’s realistic to expect that a recession in Australia may last for three consecutive quarters or more, and it will take up to four years to fully rebuild into the next cycle.
Not all Real Estate will fare the same
Property investments will behave differently during this period, depending on their use, income profile and proximity to trends created by the pandemic.
We expect residential to be defensive, as Australia will showcase itself as an attractive place to live, with its borders protected by vast ocean and its ability to control who crosses into its borders. For those considering a permanent move to Australia, the virus may slow their migration, but demand will likely be strong.
We consider office to be relatively neutral. While employers are discovering the benefits of their people working from home, thereby lowering demand for office space, they will also need to reduce the density of occupants to maintain social distancing. It’s possible that these forces will balance each other out.
Industrial assets that are focused on the movement of goods throughout our post-COVID-19 economy, in particular those focused on food manufacturing and logistics as well as those catering to the online shopping industry should continue to be very well sought-after, particularly at an institutional level.
Unfortunately, until a vaccine is found, we expect property assets with exposure to retail, food, hospitality, and some healthcare, will find it more challenging. However, they will appeal to the counter-cyclical investor and benefit from lower interest rates. Those investors who view COVID-19 as a temporary phenomenon – as the global equity markets appear to be – could be tempted by the downturn in these asset categories.
While nobody has the crystal ball they might wish for in these unusual times, the fundamentals of investing in property remain the same. Attractive opportunities should arise for those with expertise, discipline and access to capital.
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