2020 > The Year of the Swan
By Simon Vardon, Global Head of Real Assets, Sanne
Towards the end of 2019 the macroeconomic landscape included several well documented downside risks, as was reported in the IMF Global Outlook at the end of 2019. The US/China tariff wars continued, there was nervousness in the Gulf following the seizure of an oil tanker in the Strait of Hormuz and there was the rumblings of Brexit.
With the headwinds present, 2019 had been a subdued year for some investors targeting the overseas real estate markets, with many taking a ‘wait and see’ approach where they had the luxury of being able to do so.
Many within the real estate industry saw the glass ‘half full’ as the new- year arrived. There was expectation that in a US election year, the US/China trade friction would de-escalate with expectation that attentions might be focused elsewhere. Perhaps 2020 was going to be the right time to make a more positive move for real estate investors looking overseas and would see the continued robust performance of the domestic US real estate market.
What followed, of course, over a matter of weeks, has shaken the global economy. The advent of COVID-19 precipitated an acute economic shutdown, moving rapidly from country to country. The disruption has been seismic, with a global recession looming.
A ‘black swan’ event has characteristics of rarity, extreme impact and where, in retrospect, there exists some predictability. The term is derived from the saying that ‘black swans don’t exist […until one arrives]’. COVID-19 appears to neatly meet the definition of a black swan event.
Initial impact on real estate
As the scale of the pandemic was realized, the overwhelming response for managers of real estate portfolios was to focus on immediate liquidity needs. Planned quarterly distributions were cancelled and capital calls were made. Cash was maintained at the asset-level to ease liquidity as many tenants were given options to defer rental payments by Governments around the world. Asset managers have also turned quickly to their debt providers to seek some breathing space as impact assessments were concluded and business plans re-drafted. Liquidity concerns are set to resurface again when deferral windows expire, and rents become due.
The impact of the measures imposed by Governments to protect their citizens had differing impacts on sub-sectors of the real estate industry, principally dependent upon the extent to which the asset relied on social activity. Retail, hospitality and travel-related infrastructure have all been hit particularly hard by the restrictions imposed.
Asset managers with a diversified portfolio might fall into a ‘suffering but coping’ category. A small number of sub-sectors have actually performed very well, supermarkets and logistics being two such examples. Adding to the challenge in the real estate sector, material valuation uncertainty is currently inherent for many assets, and open-ended real estate funds have been obliged to suspend redemptions as a result.
The impact experienced by asset managers will vary depending upon leverage within structures, the tenant mix, and the ability of the tenants to see-out and survive the current restrictions on their abilities to trade. The ability to be flexible is going to be important. Many sound businesses, through no fault of their own, suddenly find themselves closed and in financial difficulty. Supporting these businesses and reducing administrations, redundancies and ultimately the depth of the recession to come, has been central to some of the financial packages deployed by Governments. If investors, asset managers, landlords and lenders can be flexible in their respective reactions, then a more positive outcome for tenants and by consequence, wider stakeholders should prevail. Examples would include:
- Flexibility on payment dates, such as granting monthly instead of quarterly payment plans. Landlords have also been amenable to agreeing to a deferral on the due-date for some tenants.
- Flexibility on the overall lease to support the immediate cash flow constraints that some tenants face, such as agreement to a rent free in exchange for an extension to the lease for the same period.
- Lenders have in general also been keen to be helpful. It has been common to see lenders loosening covenants for an interim period, helping tenants avoid technical covenant breaches owing to the turbulent market (with both valuation and rental forecast uncertainty impacting covenant calculations).
What now is a realistic scenario for real estate in 2020?
Asset managers should be through the initial reactive stage. They will have cashflow forecasts and business plans updated for the remainder of the year and beyond. The majority of new plans will remain contingent upon the loosening of restrictions and the speed at which a degree of normality is able to return. By way of example:
- An asset manager with a development site under construction will have concerns around supply-chain disruption and the ability for workers to return to the site and continue construction. It seems inevitable that timelines will be stretched out to new dates.
- An asset manager holding student accommodation assets, will have concerns around when international flights are able to resume, and universities are able to reopen. Refunds may have been extended to students and there will be fluctuations on occupancy levels witnessed in the sector, depending on whether students returned home or decided to stay put.
- Contrasting fortunes will also arise where not previously contemplated. An asset manager investing in long-income assets, could have two investments once considered alike e.g. two 10-year leases with incremental fixed uplifts, both returning the same yield. Vastly different scenarios will be presented currently if one lease is with a supermarket operator and the other with a restaurant chain.
Valuation uncertainty and movements will be present throughout the sector and many asset managers will need to review financing options to avoid covenant breaches and possible foreclosure of security by the debt providers.
For most asset managers, it seems unlikely there will be a quick bounce back to normality. Those currently holding assets seem destined to play out a patient waiting game, managing what is within their control for the months ahead.
Asset managers will be keen to understand the inputs and assumptions being made by external valuers particularly where the assets are in a sub-sector impacted negatively by the restrictions on movement and trade passed by governments. Investors are also keen to see greater disclosure in this area at this time.
Disruption breeds opportunities
Many investors were already turning their eyes up the risk curve during 2019, seeking improved returns because yields in core markets had become increasingly compressed. Investment into real estate debt has seen rapid growth as the sector becomes more established and familiar for investors.
Opportunistic real estate strategies, including development is another way investors have been taking more risk in the expectation of improved returns.
Many fund managers are planning new funds as a result of the fall-out from the current situation. Funds targeting distressed or special situations strategies are being lined-up, buoyed by investor demand to have a stake in potential upside. Fund managers with a track record for these strategies are thus very well placed to exploit the disruption.
Looking further ahead
The current ‘black swan’ looks set to dominate the macro landscape for the immediate future.
Prior to the COVID-19 outbreak, several significant trends were being witnessed and these are expected to continue. ESG considerations have rapidly moved up the list as managers increasingly discover the positive impact ESG measures can have on returns and risk management. Investor appetite to be associated with investments linked to responsible and sustainable ESG policies has risen in recent years, as evidenced by the continued year-on-year growth in the assets under management of funds which adhere to the Principles for Responsible Investment (“PRI”) since its principles were launched at the New York Stock Exchange in 2006.
The ability to measure and report on ESG measures is catching up, as well as the emergence of recognized standards. Momentum is very much expected to continue in this area, which is such a positive trend.
Technology advancements in recent years have rapidly changed social habits, behaviors and the use of buildings and infrastructure requirements. Governments have pledged to improve infrastructure aimed at advancing the productivity of their economies, supporting the connectivity needs of business and citizens as they continue to become more technology advanced, and dependent. Indeed, it is noteworthy that so many businesses have been able to continue to operate, whilst invoking work-from-home plans, owing to the resilience of technology and remote working capabilities.
The next swan could be green
In January 2020, the Bank for International Settlement (“BIS”) published a paper entitled “Central banking and financial stability in the age of climate change”. The paper highlighted that planet earth is facing a climate emergency and without coordinated intervention, which is increasingly urgent, ‘green swan’ events will materialize. It is a sobering thought that the shape of another global crisis is already in the wings, currently without the required coordinated reactions.
One such concern highlighted is from the continued warming of the planet. The combination of rising sea levels and increasingly extreme weather patterns could pose considerable threats to costal zones, which includes 8 of the World’s 10 largest cities and significant agricultural resources.
One positive reflection, is to consider the way in which many businesses were able to make immediate and fundamental changes to their operations, demonstrating resilience and the ability to make significant change, which would otherwise have been much more incremental.
Substantial and urgent adjustment has been proved to be achievable. It’s just possible that lessons learned from the black swan, will help us avoid, or at least diminish the green swan in the future. Those involved in the real estate industry across the globe will have a part to play in influencing the change required.
Established over 30 years ago, Sanne Group is a leading global provider of alternative asset and corporate administration services to alternative investment funds. Sanne currently administers over $315 billion and employs more than 1,800 people with 20 offices located in the Americas, EMEA and Asia-Pacific. Sanne has an extensive roster of leading real estate asset managers as clients with a deep pool of talented professionals with real estate expertise. Sanne’s expertise in real estate-specific issues helps us meet the complex and evolving operational and reporting needs of our clients. Sanne currently administer over 1,600 real estate structures and funds globally.
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