These are extraordinarily challenging times both for the real estate market and our clients. Depending on their geography and asset class, real estate fund managers are feeling the impact in different ways. The important considerations for the real estate sector are also likely to differ over the short and medium term. The preservation of value, as well as the safety of tenants and visitors, is coming into focus in the current climate. In addition, the future might see office spaces and industrial areas transformed in light of significant changes to where people work and how the supply chain functions.
While it is too early to predict what may happen, we have considered various potential scenarios for our real estate clients. In particular, as we try to assist our clients through these difficult times, we believe it is imperative to maintain strong corporate governance for all real estate structures.
Tailored guidance for each real estate category
Considering that the market situation varies per asset type, we have differentiated our thoughts per asset class:
Retail is likely to be the most impacted asset class. We would recommend that all holding companies and property holding companies with retail assets should convene a board meeting as soon as possible to discuss the impact of the current crisis and consequences of temporary shop closures.
.Over the last 18 months, opportunistic investors started moving back to the retail space and have been acquiring undervalued assets, such as shopping malls near large towns. Now, further potential acquisitions could be postponed. Unsurprisingly, the sentiment towards retail property, especially in the UK, has in recent weeks become increasingly negative.
Besides valuation and cash flow issues, it would be important to discuss during the board meeting potential CAPEX opportunities to improve customer experience in the retail areas. This is largely dependent, of course, on whether CAPEX facilities are available with lenders. If funding is available, this current period could also be used as an opportunity to differentiate assets from competitors in the market.
- Student housing
Student housing is another sector that is seeing an early impact of COVID-19. It is therefore imperative to convene board meetings as soon as possible to discuss the situation and document the conversations and updates received from the operating company and asset manager.
Due to the closure of universities, a large number of students are leaving their units and potentially terminating or defaulting on their contracts. Where operators are allowing students to terminate their contracts if all of their outstanding debts have been paid off, this will of course have an impact on cash flow. Other options should be reviewed and discussed at board level, prior to any decision being made.
- Care homes
Unfortunately, the impact of COVID-19 on this sector is also significant. Board meetings should be held as soon as possible to discuss the current status and adjusted annual budgets.
The operating costs of these assets may increase going forward, lowering the yields and potentially making this sector less attractive for certain investors.
Hospitality is another sector being heavily impacted by the pandemic. There has been a short-term impact on occupancy rates due to travel restrictions but it is expected that the market will bounce back quickly. Where possible, it is important to use this time for any outstanding CAPEX work to be undertaken and to maintain the assets in good condition, in order to be well prepared to take optimum advantage of the situation when business resumes.
Due to the impact of Coronavirus on the sector, a further consolidation among large hotel chains may well be seen later on this year.
For now, residential property appears to be the least affected by COVID-19 as it seems that rents are only slightly impacted.
However, we recommend that asset managers should give updates to the board on the development of the situation, at least on a quarterly basis. This is because, due to foreseen government support, there is a risk of temporary freezing of tenant obligations. Hence, constant monitoring of build-to-rent (BTR) schemes is recommended due to potential terminations.
In general, the mid- and long-term outlook for residential property appears to remain positive and we have already seen this asset class as a preferred option for any potential diversification of real estate portfolios.
- Office space
In the office real estate context, convening board meetings due to the current situation is not as urgent as for example in retail or student housing structures, but is still recommended within the coming weeks.
Some tenants might seek to re-discuss rents, reduction of leased space and early termination options. For assets with low occupation rates, next steps in leasing activity and adjustment of annual budget should be discussed as soon as possible at board level.
However, the long-term view remains clouded for this asset type as people get used to working from home. Questions will be raised about the nature and use of office spaces in the same amount/format and location as working practices change perhaps forever.
Logistics may well be the least impacted sector as traditional supply chain disruptions are likely to be compensated by increased e-commerce.
It is therefore no wonder that numerous transactions are still going ahead in the logistics domain, with Blackstone having completed deals in the last week alone worth €200 million.
In addition to the above, we should also highlight the following considerations for real estate clients across asset classes:
Clients should be prepared for Q1 valuations to come later than usual where provided by external valuers. Due to the large number of uncertainties, it is almost impossible to accurately predict future cash flow for certain assets. Indeed, there may be some exceptional cases where valuers s might not even issue their Q1 reports. In any case, Q1 valuations should be discussed in detail at board level when they become available.
For client companies with construction or development activity, the health and safety of their workers should be the utmost priority. If such activity can continue despite the COVID-19 restrictions in each jurisdiction, boards should receive regular updates from asset managers on the measures being taken and how workers are being protected.
Covenants should be carefully monitored and worst case scenarios should be discussed at board level. This is particularly relevant where the loan-to-value (LTV) ratio is still above the covenant threshold. Boards should also review cash trap scenarios and potential solutions to avoid that situation. We recommend proactively seeking up-front discussions with banks if risk of default is high, and clearly documenting the outcome of such discussions at board level.
Furthermore, for clients discussing (re-)financing transactions for their assets, we recommend ensuring that such discussions are progressing and the board meetings can be held as soon as terms are agreed upon to avoid the risk that lenders change the terms or even pull out of the deal due to the market uncertainties.
Fast evolving ground realities
The above represents some of the considerations that the IQ-EQ Real Estate team has already encountered over the last few weeks. This will be an evolving position as the situation continues to develop throughout Europe and globally. We will keep you updated on a regular basis as new issues come to light and the market adjusts to the “new normal”.
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COVID-19: A checklist for private equity fund managers