European CRE Outlook Remains Uncertain as Eurozone Contracts
May 11, 2020
The European Union (EU) suffered a record-breaking 3.8 percent drop in economic activity in the first quarter of 2020, the EU reported on April 30, amid shutdowns to combat the spread of the novel coronavirus. In response, the European Central Bank (ECB) extended new credit lines to banks at an interest rate as low as negative 1 percent, giving institutions a bonus to borrow and lend. EU finance ministers had already agreed to a €500 billion stimulus package in early April, and ECB President Christine LaGarde suggested the eurozone economy could contract by up to 12 percent in 2020.
The unprecedented economic blow is creating massive uncertainty for commercial real estate investment, transaction volume and property values. “Response across the eurozone is not monolithic, and businesses must navigate an array of legislative, regulatory and logistical shifts that will intrinsically change how business is done,” said Lisa Williams, Head of Europe for SitusAMC.
For example, Germany approved a new law giving employees the right to work from home, and other countries are changing rules around sick pay and benefits to encourage people who feel ill to self-isolate. Meanwhile, with so many professionals joining the work-from-home revolution, and the possibility of extended social-distancing requirements, many companies are rethinking their offices and location strategies. “Long-term we could see significant changes in the way we work,” Williams noted. (For its part, SitusAMC quickly established a remote-work infrastructure and its professionals have been operating at 100 percent capacity.)
Lenders are generally taking a flexible and collaborative approach to borrowers on payments and covenants, said Olga Delval, Head of Workouts for SitusAMC in Europe. But some lenders are asking sponsors to contribute additional equity before they will consider loan modifications. “Defaults have been few and far between so far,” she noted. “They could kick in by July or August, depending on how quickly the economies come back.”
While new loan and CMBS activity has slowed, liquidity and equity remain in the market. But the cost of debt is rising as income security becomes uncertain. In addition, the inability to travel and visit assets is creating obstacles to due diligence. “A few big players have raised funds and they have to deploy the capital,” Delval noted. “Whether they can get credit approval is another issue. Nobody will really commit seriously to an investment before there is more clarity.”
A critical question is what happens to property values amid unpredictable cash flows. “By the middle of the year we expect industrial asset values to fall by 3 to 5 percent, and shopping centers could fall by as much as 25 percent, depending on the quality of the assets,” said Hugo Raworth, Managing Director of SitusAMC and leader of the valuation business in Europe. “That drop has to feed through in mark-to-market values. But these are early, broad brush estimates, since we have few transactions on which to benchmark value change.”
As for the impact on transactions, “security of income is not going to be what it was 12 months ago, and investors will expect a discount in price to reflect the cash flow risk,” Raworth added. “The question is how quickly pricing moves out and whether sellers will accept a shift in values. At the moment, nobody is ready to significantly reduce price to get assets sold, but the situation might look different in three to six months.”
Raworth expects the eurozone to rebound once a vaccine is found for COVID-19, but also anticipates recovery will be uneven across geographies and sectors. “We expect well-developed economies across Europe to recover faster, while weaker jurisdictions may take longer to return to normal. Increased national debt across most affected countries will be a significant economic burden for the foreseeable future,” he noted. “The more secure, mainstream real estate sectors, such as industrial and logistics, will recover reasonably quickly, and values will stay relatively stable. But we expect severe value erosion across prime assets in socially relevant sectors, such as hotels, retail, entertainment and health care.”
While the outlook may be murky, one certainty is that companies will need to remain agile to adapt to market dynamics. “While the current situation is unprecedented, our team at SitusAMC has helped clients through three market cycles,” said Williams. “Given that experience, clients are coming to us seeking perspective and guidance. Many simply don’t have the resources or expertise in house, and are looking to us to create nimble, custom solutions that include loan advisory and workout solutions, primary and special servicing, loan surveillance and valuation services.”