We are facing an unprecedented global health crisis, with a real impact on our economy that is still difficult to predict and that will depend largely on how the pandemic evolves.
The temporary shutdown of economic activity, transport, and trade will inevitably lead to a recession that will affect all sectors to a greater or lesser extent. Goldman Sachs, DB and JP Morgan forecast a complete collapse in GDP in the second quarter, equivalent to a drop in GDP of around 22% for the Eurozone.
The short-term impact of this crisis is already beginning to be felt with a cascade of ERTEs (temporary employment regulations) being filed by Spanish companies as a consequence of the cessation of activity. They will inevitably force a large number of people into unemployment causing a collapse in consumption in the short term.
The tourism sector, which currently accounts for 14% of GDP, will be one of the worst hit by this crisis with the closure of establishments and borders, and limitations on the movement of people.
Unlike in 2008, the crisis we are facing today is being driven by a collapse in activity, not a lack of access to credit. The greatest challenge that companies are facing now is how to survive at a time when income is non-existent, and fixed costs remain the same.
Over the medium and long term, we will likely see an increase in the default rate on the balance sheets of financial institutions. As banks see the risk of their assets increase, so they will require greater guarantees when it comes to granting new loans.
The real estate sector is no exception and is already suffering from the immediate effects of this crisis: the halt in house sales, waived rental payments for offices and homes and even payment holidays from property developers for new build properties. But, how far will the impact spread?
If we take a look at the figures for the sector in China, according to data published by the National Bureau of Statistics, during January and February, investment in the sector contracted by 16.3%, equivalent to USD 140 billion. In terms of property sales, they contracted by 36%, while the impact on prices is still not palpable in most of the regions. Investment in new build properties, however, has been able to weather the situation somewhat better, with a contraction of close to 16% thanks to the measures taken by some of the largest property developers in the country, such as the China Evergrade Group. Foreign investment in the sector has suffered the most dramatic contraction, down by 77.2%, according to data from the National Bureau of Statistics.
It is clear that the sector in Spain will suffer a sharp downturn that will go beyond the obvious effects of the restrictions due to the state of emergency. The collateral damage caused by the standstill of the economy almost across the board will inevitably be felt in a sector that had already been warning of bankruptcies. The hotel sector could be the biggest victim in the short and medium-term due to restrictions on the movement of people and the escalating border closures that we are experiencing worldwide.
Effects on residential sales
The house sale market is already suffering the effects of this crisis with the inevitable suspension of sales as a result of, amongst other reasons, the measures implemented by the government during the state of emergency: the impossibility of visiting properties, notaries operating minimum services and working only with “cases of extreme urgency”. But these are just the immediate effects of a crisis that we are still unable to quantify, and which will depend largely on how long the battle against COVID-19 goes on for.
What seems clear is that the wave of ERTEs across the country will unleash a situation of economic crisis in the short term, with a drop in consumption and a sharp reduction in the number of house sales. Although there are no official figures available yet showing price decreases, they will be the inevitable consequence of the contraction in demand, and those owners who are forced to sell to obtain liquidity will have no choice but to cut their prices. The few operations that are being closed today are distressed operations with discounts of between 20-40%.
We will also have to watch the ability of the financial institutions to continue providing credit with the generation of new mortgages in a contracting economy: higher LTVs, weightier guarantees, …
This situation will put in jeopardy numerous companies directly related to the sale of homes, such as estate agents and even some small appraisal companies, which will see their businesses drastically reduced over the coming months. We are likely to witness the closure of many of them in the short and medium-term.
As for the rental market, whose situation was already uncertain what with all the regulatory changes announced by the government in recent months, it will also need to make some adjustments in the short term. Both new and existing rental contracts will fall victim to these changes, which could well extend beyond the state of emergency. This situation would be favoured by different effects:
- On the one hand, the economic crisis and temporary unemployment situation of many workers will require urgent measures if we are to avoid cascades of defaulted payments in the short term. Although it is true that the Government did not deal with the issue of rents in its decree law governing the state of emergency, the main players in the sector, such as Témpore and Lazora, have already announced a moratorium on rental payments for all tenants in financial difficulties as a result of the Covid-19. Several autonomous regions had already announced a similar measure for their rental housing stocks. The situation of numerous families forced into unemployment as a result of the crisis, could bring about the exodus of those families to their cities of origin, whereby relaxing the markets in the major cities.
- On the other hand, a longer-than-expected drop in tourism could cause many of the properties that are currently being advertised as tourist rentals, to be included in the supply of long-stay flats instead. This effect would be especially important in major city centres where the rental market has been very stretched in recent months.
Sales of new build properties are evolving in line with those of second-hand homes, with a sudden halt that goes completely against the roadmaps set out by the property developers. With building work still underway, the country’s large property developers have taken action by agreeing to postpone the collection of the upcoming payments for their presale properties to ease the impact of the coronavirus on their buyers. Maintaining the level of deliveries that they had planned for this year will become a difficult task and we would not be surprised to see price decreases as those players try to cope with the situation as best they can and cover their operating expenses. The high prices paid for land over the past two years could make numerous developments unfeasible, which means they will be quarantined for the coming months.
However, if this situation is prolonged, it could lead to a sharp drop in land prices, which are very high at the moment, and which some developers could take advantage of to fuel their stock for the coming years.
The office sector has been enjoying a grace period in recent times with a considerable reduction in supply and slight increases in rents. However, the impact of the crisis will force it to take measures in the short term to help companies to make their rental payments through repayment holidays or rent discounts over the coming months. Meanwhile, co-working companies will be facing a different situation entirely – for the most part, they have short-term contracts with their tenants and long-term liabilities with their landlords, and many of them will be cancelled or not renewed. We will have to monitor closely the effectiveness of these types of solutions.
With most companies requiring their employees to work from home during the lockdown, it seems reasonable to think that once the situation returns to normal, companies will be more open to this type of practice, which will allow them to minimise their structural costs by opting for smaller spaces with employee rotation. If so, demand for physical office spaces would be reduced, whereby increasing availability and placing downward pressure on rents over the medium and long term, especially in secondary and peripheral areas. This same effect could result in people choosing not to live so close to their places of work, and instead looking for solutions on the outskirts of cities in exchange for an improvement in quality.
The retail market will be one of the most affected by the pandemic. We are experiencing a hiatus in commercial activity that has forced the closure of most establishments in the country. They are having to cover their rental and personnel expenses without generating a single euro. Here, we can also expect to see both the cancellation and deferral of rental payments, which will also have a negative impact on the income statements of the landlords. Socimis such as Lar España, Castellana Properties and General de Galerías Comerciales (GGC) are just a few examples.
This episode will be one more blow to a sector that was already limping before the start of the crisis. Digitization will accelerate and the real losers will be the retail stores that, unable to cover their fixed costs, will be forced to close with the consequent downward pressure on rents in secondary locations.
The decline in tourism and the closure of tourist accommodation is leading the sector into an unprecedented crisis: zero tourism. The sector is filing more ERTEs due to force majeure than any other, with 165,000 workers affected in the Canary Islands alone, equivalent to 20% of the active population of that archipelago.
Hoteliers are classifying this year as “chaotic” and estimate that the recovery will not be immediate once the pandemic has been brought under control, rather the psychosis will take a few months to dissipate. Furthermore, the closure of borders that we are seeing around the world as the virus spreads, could further slowdown that recovery. Tourism companies specialising in package holidays are facing massive write-offs that are causing them to run out of liquidity and could threaten their long-term viability.
The role of the logistics sector in times of a crisis such as this is crucial, and logistics is positioned as one of the best-affected sectors of this crisis.
In the short term, the effects are clear: the demand for e-commerce, as we already mentioned, as one of the direct consequences of this period of confinement, and the need to supply supermarkets and chemists, are driving up demand for storage spaces on the outskirts of cities for the next few months.
Experts in the sector are venturing as far as to say that the impact that this crisis will have on the sector in the long term goes beyond a greater penetration of online commerce, to the overhaul of supply chains, with increases in inventory and more regional networks that help us all to better endure disruptive periods like the one we are experiencing. In the end, it will be a question of making the numbers work and weighing up whether the cost increases offset the risk for greater supply chain security. If so, the situation would lead to increased demand for these types of spaces on the outskirts of cities.
We think that the alternative assets sector will not fare as badly as some of the others in the long term, although the impact will be different for each asset type.
Student residences are currently half-empty, with the majority of students having returned home after classes were cancelled. Many halls of residence have already written off the year “as lost” and although they will have to take measures to cut costs in order to compensate for the lack of income this year, once the pandemic has been brought under control, we do not see any effect on the demand for this type of establishment, at least not from domestic students, who account for more than 96% of the total.
Nursing homes, by contrast, face a much greater challenge: guaranteeing the health of their residents during a pandemic that has already wrought havoc on several nursing homes across Spain, causing the death of groups of OAPs in the very establishments they call home. Over the medium and long term, this emergency situation could force these establishments to implement more onerous health and control protocols that could directly affect their income statements.
As for investment, we expect a significant contraction, if not a halt in the short term, motivated by the significant uncertainty that currently prevails.
In light of the drastic declines that the financial markets are experiencing, everything seems to indicate that the minimum yield levels that were being paid months before the outbreak of the crisis, will not be sustainable over the short and medium-term, causing a decrease in valuations. One example of this can be seen in the current share prices of the large Socimis, such as Merlin Properties, which has dividend yields of around 6% after its share price dropped by almost 40%.
Andrea Rodríguez, Director at Aura REE.