The question is not whether European commercial real estate will be affected by Covid-19 but how severely and for how long. But Scope does not expect a crash, like in the aftermath of the global financial crisis.
“Risk reassessments and social impacts will speed up structural changes, although the consequences will likely diverge between locations and asset types,” said Florent Albert, associate director in Scope Ratings’ structured finance team and co-author of a report out today.
“Differentiation between prime and secondary assets and locations will increase, and investors will focus more on assets in prime locations. Investor flight to quality will result in CRE value and debt being repriced, as already indicated in the CMBS and REIT equity markets.”
In the short term, differentiation will also occur between asset types with sectors most exposed to non-essential activities, social distancing, and international customers.
“Beyond 2020, structural trends will accelerate the reshaping of the CRE sector,” said Adam Plajner, senior analyst in Scope’s structured finance team and co-author of the report.
“The office sector may be at an inflection point following the successful world’s biggest-ever working-from-home experience. The already gloomy retail outlook will worsen, while logistics, residential and healthcare may benefit from capital reallocation. The hospitality sector will need to adapt to the new trends, which will take some years while student housing may also have a more prolonged recovery.”
Most non-essential businesses have faced a sudden and unprecedented halt in their activities, exposing many to a liquidity crunch. Most exposed or opportunistic tenants have partially or completely stopped paying rent, in some cases advocating for a force majeure type of event.
Consequently, landlords will experience not only rent deferrals but lost rents if they fail to show flexibility since in the absence of that it is highly likely that their losses would be even higher.
Government measures will likely not allow for enforcement in the short term due to missed rents. Indebted landlords immediately started cutting cash outflows by reducing operating costs (including temporary lay-offs), postponing capital expenditures and drawing on their liquidity lines to honour their debt payments.
“CRE lenders have taken a wait-and-see approach to new transactions; currently only pre-crisis committed deals are being executed,” said Plajner.
“But this should be temporary and not attributable to underlying factors affecting their ability to lend unlike during the GFC.” Lenders are reviewing their books, reassessing the credit risk of the sector and their portfolios, while appraisals are also on hold.
Borrowers with debt maturing soon are therefore exposed to lengthier refinancing processes. “There are already signs, through ongoing price discovery, that (re)financing conditions will tighten,” said Albert.
“Lenders are focusing on areas that were not at the centre of attention recently, like liquidity risk, counterparty risk and tenancy industry profiles. Fundamental cashflow-driven analysis will more than ever be the cornerstone of CRE investment in the near future rather than focusing primarily on leverage metrics.”
Scope expects that this will result in increased differentiation between prime and secondary assets and locations. This means that after some years of decrease in the gap, asset differentiation will materialise in terms of both yields and refinancing conditions. This will be accelerated with some CRE appraisals likely to tumble when the dust settles.
The full report can be downloaded here.
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