When can we expect the turnaround?
With thousands of people dying and tens of thousands of infections every day in many countries, we are still in the eye of the storm. But the vaccination process has already started in many countries in December and further vaccinations from different producers will be availabe within the next three months. Optimistic scenarios forecast that we can reach the goal of herd immunity already in the second quarter of 2021, more conservative views by the end of 2021, beginning of 2022. All that means is that we still have to be patient for a while until we can lead the life we were used to, with all its consequences. Restricted personal and work life, restricted cultural life and restricted travelling for a large part of 2021. The turnaround will therefore come slowly, beginning in the second half of 2021. The question will be how long
"Realistically, we are going to have 10% less passengers in 2025 compared to before the crisis."
Carsten Spohr, CEO, Lufthansa it will take for a full recovery. This is going to be dependent on the return to normal goods traffic and the individual and corporate willlingness and ability to travel nationally and internationally.
What are the impacts for the commercial real estate market?
With interest rates historically low and the stock market as the only other alternative, investors do not have much choice. Real estate has to be on the list. And Germany remains one of the safest places in the world to invest. Despite the yield compression of the last few years, the spread between the ECB base rate (0,00%) and core real estate (3,00% - 3,50%) is still significantly high. On top of this, a majority of German family offices and corporate investors are facing negative interest rates for cash deposits, which further motivates them to look for higher interest alternatives.
In 2020 the German investment market was quite robust with roughly 80 billion of transaction volume (minus ca.12% of 2019, but still among the top 3 years since 2010!). We have seen increasing demand for residential and logistic properties and decreasing demand for the asset classes, which were strongly affected by Covid19, e.g. retail, hotels and also office space. While we see, that it makes sense to be cautious in investing in hotels and some parts of retail for the time being, we consider the reserved position against office buildings, especially in the non-core risk class, exaggerated. Because on the other hand, the core yields for office buildings even tightened slightly on a very high level, as investors are pushing for them more than before.
Are there any opportunities?
Yes, there are! While the herd is running for safe haven products such as residential and logistic properties (we partly do not understand some price levels there!), especially the asset class of non- core office is being neglegted as described above. As a result, there will be great opportunities for unemotional investors in the submarkets of the big cities in 2021. The reason is that some investors completely withdrew from those markets. Therefore we expect a window of 6 to 18 months to be able to invest in opportunities with little competition. As more risk invetors are willing to take as less competition they will have. But international investors shouldn´t be too optimistic about reductions. We are not talking about 50%, it will be rather around 15%-25% compared to pre-Covid pricing. Most sellers won't be willing to take more than that and would rather hold instead. At least for office buildings. There will be even better opportunities in the hospitality sector. A very weak 2020 and a poor outlook into at least a big part of 2021 forces many owners to sell and/or to recapitalize. Opportunities will be bigger here as well as the risks.
"We still do strongly believe in office buildings - but more than ever, it has to be the right one !"
Office markets have been very weak in the previous year with a minus of take-up of over 35% in the Big 7 German markets. This didn´t come as a very great surprise to us. With very limited to no travelling, adjustments to working style with the new health codes and the insecurities, that go along with every crisis, corporates delayed relevant letting decisions, if they were able to do so. Additionally some industries, e.g. the hospitality sector, air travel, tourism as well as everything around events to name some of them, were hit really hard and do currently more think of how to survive. So it makes sense for non-core investors to be careful about where to invest, what the target audience for that particular building will be and how long it will take to finish the repositioning job. As a result, business planning for a building has to be more conservative within almost all levels of the underwriting for the next three years. Not to forget, that finance from more risk averse banks will be more limited on different levels - with regards to availability, leverage and cost of capital. Alternative lenders are going to profit from this trend and the market in this segment will expand within the next couple of years. Regarding tenant behaviour we don´t see a fundamental change with office demand in the big citites in the long run. Flexible work space was en vogue before the crisis and it will be even more now. But that does not necessarily mean less office space. The opposite could be the case, the big cities and their fringes always were the winner after a crisis, because the workforce was cut elsewhere and merged into the national and global relevant centres. Additionally we don´t see a global workforce working from home longer than needed. This would kill a companies culture, innovation & development abilities. If one agrees with that, it will be more than ever rather important to look closer at the building you are buying. If it is for example an older building it should have the potential to be refurbished to a modern standard. This becomes more and more important, since larger companies and organisations are increasingly comitted to stronger ESG standards and these includes also in what kind of building they are. So homework on building quality, competition and letting and capital markets forecasting will be key.
What are the biggest risks?
It's all going to be about the length of the crisis and the insecurities and side effects a longer recovery time involves. Delayed global delivery chains, unemployment, low or negtive GDP growths and an even more dramatic impact on the negatively affected industries than we have seen so far are the biggest risks. Potential market interventions by governments and authorities as a result of the crisis, in order to fight the impacts of the crisis, could deter investors from investing and would therefore be a furter threat.
Generally it will be the hardest part to convince investors to invest in non-core assets as long as the market numbers are not supportive - and they won't be for a while. Like in all crisis before. it will need visionary investors with confidence and stamina, who know that also this crisis will end. This combined with good analysis will be the winning factor for the next two years.
We wish you a great start into 2021 !
Stay calm, don´t lose your optimism and foremost stay healthy!!
Oliver A. Obert
