A new (28 May) report by AEW, one of the world’s largest real estate asset managers with €71bn of assets under management, predicts that Covid-19 will eventually lead to a decline in market rents for commercial property across Europe.
Covid-19 related rent concessions to tenants this year are expected to be highest for retail property (-18%), then offices (-6%) and lowest for logistics (-4%).
AEW reported: “To quantify the short term impact on prime capital values across our European market coverage, we built upon our previous risk premia work and introduced two new scenarios (a May-20 L-Shape recovery and a May-20 V-Shape recovery), which reflect more refined analyses and additional data.”
According to the forecast, the cumulative 2020-21 value impact for prime property across all sectors in the L-shape scenario is estimated at -9%, consisting of a -15% move in 2020 offset by a 7% recovery in 2021.
The V-shape scenario shows a cumulative value impact of -7% across all asset classes over the two years, consisting of a more dramatic decline of -19% in 2020 offset by a strong 15% recovery in 2021.
“Consistent with our previous Covid-19 updates, the all property results are driven largely by the poor results in retail, which is predicted to have a 12-15% downside in capital values for 2020-21. Offices and logistics are expected to have a much lower downside in the two year period across the L and V-shape scenarios, at -4-6% and -2-4%, respectively.”
Covid-19 related rent concessions to impact cash income distribution
Landlords are faced with possible income shortfalls amid the COVID-19 pandemic as rent concessions to tenants such as rent-holidays, deferrals and renegotiations of rent (especially in retail) put pressure on the ability of investors to collect all of the rents owed.
The report adds: “To estimate this shortfall of income, we estimate cash shortfalls by sector as the percentage of income that will remain unpaid in 2020. This percentage is based on discussions with brokers and desk research, focusing mainly on preliminary rent collection figures for the second quarter (retail 50%, offices 70-80%, logistics 80-90%).
“Retail (high-street and shopping centre) is expected to have the highest cash shortfall at 18%, while for offices and logistics shortfalls are much lower at 6% and 4%, respectively. The second quarter of 2020 is also expected to show the highest percentage of shortfalls. However, as the COVID-19 crisis evolves, the impact of rental defaults in the last six months is expected to decrease as lockdowns get lifted.”
AEW says that the estimated risk for retail is higher than offices and logistics. This reflects the impact of e-ecommerce, the lack of liquidity and relative high cash shortfalls in the sector. Therefore, initial yields are expected to move out further in retail compared to offices and logistics.
“By combining the rental defaults, risk premium scenarios and the forecasted declines in market rents due to the Covid-19 induced recession and 2021 recovery, we can estimate capital value changes in the short-term. In the case of offices, we are seeing in our L-shape scenario a cumulative value impact of -6% over the two years, consisting of -9% in 2020 offset by a 4% recovery in 2021. On the other hand, our V-shape scenario shows a cumulative value impact of only -4% over the two years, consisting of a more dramatic -13% move in 2020 offset by a robust 11% recovery in 2021.”
Retail market rents are projected to have the biggest decline amid increased pressure from e-commerce and a relatively high sensitivity to the pandemic. Based on the most recent market evidence, retail landlords are suffering the biggest loss of received cash rents relative to offices and logistics. “We assume that this will affect 2020 income only, as lower market rents and early renewals should limit continued weakness in 2021.
“Prime retail does benefit from lower increases in initial yields in 2020-21 compared to the GFC (Global Financial Crisis), due to a lower absolute level of government bond yields. In balance, we expect in our L-shape scenario a cumulative drop for prime retail of -15% over the two years, consisting of -24% in 2020 offset by a 12% recovery in 2021. Our V-shape scenario shows a cumulative value impact for prime retail of -12% over the two years, consisting of a more dramatic -28% in 2020 offset by a very strong 22% recovery in 2021.”
As retail rents suffer from increased e-commerce penetration, logistics rents continue to benefit. Combined with a lower sensitivity to GDP growth and the pandemic, logistics are forecasted to have the smallest declines in market rents. In addition, logistics landlords are suffering only modest losses of received cash rents relative to retail.
Like the other property types, logistics benefits from lower increases in initial yields in 2020-21 compared to the GFC. AEW concludes: “Based on these factors, we project that in our L-shape scenario a cumulative 2020-21 value impact for prime logistics of -4% the two years, consisting of -6% move in 2020 offset by a 2% recovery in 2021. Our V-shape scenario shows a cumulative value impact for prime logistics of -2% over the two years, consisting of a -10% move in 2020 offset by a 9% recovery in 2021.”
