The real estate asset values are under pressure in the current scenario, owing to market uncertainties trigged by the pandemic. But investors from the Middle East are always in the lookout for an opportunity to acquire grade-A assets at discounted values across continental Europe.
Zawya spoke to Suliman Alaujan, portfolio manager at Credit Suisse Asset Management based in London for an overview on the investment market, occupational market and funding trends in the wake of COVID-19.
What trends have you noticed during the market uncertainty triggered by COVID-19? Are investors in the Middle East disposing of their assets, or do they see this as an opportunity for buying assets?
Well-capitalised and liquid investors are seeking to deploy capital, not necessarily at reduced entry prices but also in consideration of a shallower buyer pool and therefore increased potential for success. To justify entering the market now, some investors may be targeting higher return criteria or factoring in more conservative business plan assumptions, but the weight of capital and lack of opportunity together with current transactional evidence are causing owners to maintain pricing resilience, particularly around core assets with strong fundamentals.
Investors are finding it challenging to execute transactions with lockdown restrictions preventing access to buildings. We have seen how quickly the industry has adopted new remote working practices, and groups that want to transact will find ways to do so.
In light of the COVID-19 situation, Middle Eastern investors are tactically monitoring the European real estate market for dislocations and will allocate to core products with stabilized income profiles if and when pricing is adjusted accordingly. Generally, market sentiment is quite low, given regional public market performance on a year-to-date basis. A considerable number of investors we talk to are holding on to cash as a contingency. Others would seek to tactically structure transactions and achieve pricing haircuts to deliver attractive risk-adjusted returns.
How has COVID-19 affected debt funding?
There has been a clear effect on debt funding. Raising debt funding has become very challenging, unless investors have a strong historic relationship with financing providers or the income is secured against strong tenant profiles.
Even then the loan-to-value offered will be limited to 60 percent maximum, with relatively higher margin rates. The lack of available debt will limit the size of the investor pool and the incremental increase in debt cost will start to push cap rates up further.
In these times, equity purchasers will seek haircuts to reflect the secure nature of their capital compared to leveraged buyers.
What are the trends in occupational markets such as office spaces and retail? How have they been impacted by COVID-19?
Tenants are seeking to discuss rent deferment, monthly rents and/or rent holidays, and this trend is more evident and exacerbated in the retail sector than office. However, it remains a case-by-case situation very much and is relevant for most sectors impacted by COVID-19 (e.g. fashion retailers/tourism).
Rent review/valuation dates post-March 2020 are likely to cause more valuation variation between parties as the effect of COVID-19 remains unclear on rent and terms. There is a focus to settle rent review dates from March 2020 onwards by landlords while rents remain strong.
Regionalizing work hubs is emerging as a possible trend as occupiers are sounding ideas around creating regional hubs through flexible office providers to enable small teams to work efficiently in an office environment away from distractions. However, this may be viewed as a short-term solution until life normalizes once again.
Middle East investors were eyeing $5.3 bln London commercial property spend in 2020. One quarter down the line, how is this scenario changing?
In London, Middle Eastern interest in core products has generally dried up, following market sentiment that maintains a “wait and see” stance. To justify entering the market now, MENA investors will be targeting higher return criteria or factoring in more conservative business plan assumptions, but the current transactional evidence is leading owners to maintain pricing resilience, particularly around core assets with strong covenants and fundamentals. This will limit MENA activity in the London market for the coming few quarters.
2019 London investment activity fell 15 percent to £13.9 billion, down from £16.8 billion in 2018, as Brexit uncertainty and a shortage of available assets constrained the number of deals. How long will it take before the investment activity picks up?
Geopolitical headwinds are being further exacerbated by the COVID-19 pandemic. The challenge is increasingly going to be how to execute on transactions, as market lockdown restrictions prevent site inspections. Furthermore, we anticipate greater challenges on the debt funding side, as more lenders will take precautionary measures to safeguard their loan portfolio during these uncertain times.
Undoubtedly, we will witness limited market activity compared to the pre-COVID-19 period. Pricing adjustments on certain assets will take place, but with the caveat that the degree of such adjustments will highly correlate to the length of disruption to economic activity and wider governmental measures taken. We do not anticipate that office and logistics assets will be at the center of this storm, while we think retail and hotel assets will likely suffer.