The most common question asked by investors over the last 5 weeks has been: how far have prices fallen since the start of the COVID-19 lockdown? The honest answer is that the UK investment market is suffering from inertia and the dramatic fall in transaction volumes means we have had little pricing discovery on deals launched post-COVID-19. So, how do we interpret a fall in volumes?
A sustained fall in transaction volumes is often a pre-curser to a market correction. Over the 12 quarters, since Q1 2017, we have enjoyed a healthy investment market with transactional volumes averaging around £15bn per quarter. Q1 2020 volumes were £12bn with Q2 2020 forecasts expected to fall by 70% to around £4bn, making it even lower than the worst point of the Global Financial Crisis (GFC) when Q3 2009 delivered £4.4bn!
Back in the GFC it took six consecutive quarters of reducing volumes to arrive at where we have in just the last five weeks. And back in 2009 we had three quarters of low volumes before the market rebounded in the fourth quarter with real pricing discovery that allowed a choked market to function. On this basis, we could be expecting far lower volumes for the rest of this year.
We can interpret the fall in volumes in different ways. Some vendors believe the current situation is determined by government policy, rather than economic forces, and once we return to work, the markets will pick up where they left off and pricing will remain constant. Others believe the COVID-19 virus is here to stay until scientists develop a vaccine. We will have to adapt the way we work and live and therefore prices will fall. In this scenario, buyers will have to revise their underwriting assumptions for future rental growth, tenant default risk and debt availability.
So, what are we seeing and hearing at the coal face within Cushman & Wakefield in terms of real-time transactional evidence and daily conversations with investors? Well, this differs significantly across sectors and geographies. There are many sophisticated investors, both domestic and international, still willing to transact in the current environment. Their return requirements and risk appetite differ enormously. This amended demand profile shows us some sectors will prove extremely resilient while others will suffer long-term pricing corrections.
Our own experiences show us that Central London is remarkably robust. Whilst several transactions are on hold for logistical reasons, transactions are continuing with especially strong interest from overseas investors who see good relative value. Other sectors that appear resilient include logistics and industrial where investors’ belief that the structural change to online shopping will accelerate, creating more demand for warehouse and last mile logistics. Office demand will likely be affected by the desire of people to stay six feet apart, and businesses more exposed to ‘social-spend’ (leisure, pubs, clubs, restaurants, retail etc) will have to learn to deal with the behavioural change that will inevitably come from social distancing. There has been an almost total collapse in transactions in these ‘social-spend’ markets.
Looking forward, investors will scrutinise the tenant’s ability to pay rent and they will need to underwrite in greater detail to better understand an occupier’s business model. Investment committee members with a fiduciary duty might be reluctant to sanction deals until there is greater clarity around revised market pricing. That said, some distressed selling is likely to start soon.
In summary, COVID-19 and the related behavioural changes will lead to a substantial fall in investment volumes and we expect the impact to be asymmetric, hitting certain sectors drastically whilst leaving other sectors unaffected or even positively affected.
The big question for many investors will then be: where will they find the best relative value?