It is inevitable that the economic fallout from the COVID-19 pandemic will lead to a “big hit to commercial property values” in the UK, according to Capital Economics, reported by IPE Real Assets.

The economic research consultancy has downgraded its forecasts for the UK economy and, as a result, is projecting a 9.4% decline in capital values.

According to its report, “the shock should be short and sharp”, but it has not ruled the advent of a “full-blown crash”.

With greater travel, work and venue restrictions in place and the ramping up of social-distancing advice, UK GDP is forecast to fall as much as 15% quarter on quarter between April and June.

“This is a temporary, if very severe disruption, however, and the economy is expected to recover much of this ground by the end of 2021,” Capital Economics said.

“Property is better in theory placed to weather the disruption than other financial assets, as rents are generally contracted for several years, so much income is secure.

“But the deeper and more prolonged the crisis, the more downward influence new leases, breaks or re-negotiations will exert. And of course, there is a growing risk of existing tenants defaulting. So it is unlikely that rents will be unscathed.”

Capital Economics’ central case now predicts a 50bps rise in real estate yields and a 10% one-off fall in rents during Q2, “given the severity of the slump, though we assume a reversal as the crisis dissipates”.

As a result, total returns in 2020 are expected to end in negative territory (minus 4.8% is the central case), although a rebound in 2021 is expected to deliver a total return of 9.8%

However, Capital Economics admitted that “current uncertainty is huge” and so “a more extreme downside with a weaker recovery cannot be ruled out”.

The report said: “This would push us closer to previous crashes, with values down by more than 25% this year as a result.

“But the GFC market contraction lasted more than two years and this shock should be briefer. And with no debt-fuelled investment boom and supply tight in many markets, some risk factors are absent.

“In addition, further mitigation may come from more aggressive policy measures if the crisis is prolonged.”

Commercial landlords under pressure as rent break begins

Commercial property owners have warned they could struggle in the face of the coronavirus pandemic, after missing out on millions of pounds worth of rent payments due today, reports Evening Express.

Quarterly rent bills were due to be paid by thousands of businesses on Wednesday, but the Government announced on Monday that landlords would be unable to claim forfeiture or repossess properties for the next three months if rent is not paid.

Some of the UK’s biggest landowners laid out plans to support under-pressure retailers, pubs and restaurants in response today, while others remain locked in negotiations.

We want these companies, which support thousands of jobs and invest billions in UK towns and cities, to survive, and most will with the right interventions

Edward Cooke, chief executive of Revo

Shopping centre owners and other property firms have warned ministers that they will face “extreme challenges” without support to replace lost rent.

Edward Cooke, chief executive of Revo, said talks were underway with the Government about what support can be made available to landlords, potentially in the form of loans or grants.

He said: “We want these companies, which support thousands of jobs and invest billions in UK towns and cities, to survive, and most will with the right interventions.”

However, hospitality business owners have warned that some landlords have still demanded payment today.

Jonathan Downey, the founder of Street Feast, told BBC Radio 4: “I run a WhatsApp group of over 2,000 business owners and some have been amazing, like Shaftesbury and Argent in London.

“But I can quote some who have said ‘we will be coming down hard on any tenant who doesn’t pay their rent and service charge today’.”

This will impact those invested in commercial property, some of whom may depend upon the regular income it provides

Andy Pyle, UK head of real estate at KPMG

Trade bodies and hospitality business owners celebrated news of the rent reprieve on Monday, claiming its will protect jobs.

Kate Nicholls, chief executive of UKHospitality, said hospitality businesses “want to work with landlords constructively during this crisis”.

However, analysts have said that some property owners could default on their own loans if they fail to secure expected rent payments.

Andy Pyle, UK head of real estate at KPMG, said: “If rental payments are to be missed, property companies will be under increased pressure to pay interest on their own loans and they may even default.

“This will impact those invested in commercial property, some of whom may depend upon the regular income it provides.

“Far from just private or family wealth, these investors include those in receipt of pensions and savings, shareholders in REITS (real estate investment trusts) or beneficiaries of company and state pension schemes.”

Covid-19 halts brief rally in London commercial property

‘When we started this year things were looking in really good shape,’ said Zachary Gauge, lead research analyst for Europe on UBS Asset Management’s real estate team, speaking with “Investment Trust Investment”.

In the UK, interest in commercial property was returning after the Conservatives’ election win provided investors with political certainty.

Prime London property looked cheap compared to continental markets like Berlin with investors and developers looking to re-engage with the city.

‘It’s been a sea change … over the past couple of months, particularly with interest in central London becoming extremely strong again,’ said Gauge.

Coronavirus is now spoiling that rosy picture. As real estate investors like to see what they are buying, or ‘kick the tyres’, Gauge cautioned the London property rally could now be doubly-hit by the spread of Covid-19: dampened by crashing global markets, and throttled by the fact Asian, and now European, investors who had been ready to move into the UK would delay investment.

‘With travel restrictions, there is going to be a hiatus in investment activity over the next six months, at least,’ he said.

‘That’s the potential risk. Irrespective of where they are they are like coming over to see the asset,’ said, Jonathan Hollick, chief investment officer for the EMEA region.

The opportunity has been created as London ‘missed out on three years of really strong growth’ elsewhere in Europe, according to Gauge, who says Amsterdam, for example, has seen prime property capital values increase by 80% since 2016 compared to flat or lower prices in London.

‘The investors who have been particularly focused on some of those European cities are now looking more at London,’ said Hollick, who is responsible for managing around $1.8bn (£1.5bn) of real estate in the UK. UBS bank holds $79bn in direct property investment globally.

‘Especially [for] the big overseas Asian investors…there are really only two alpha cities in Europe: London and Paris. And their preference for historic reasons, the location, language and legal system, is London.’

The UK’s capital had also come back on the radar of European investors, especially German institutions struggling to find good returns in the eurozone.

‘The question now is are they going to sit back? Are they going to have some travel restrictions as well?’ asked Hollick.

‘Because while everyone was getting comfortable with London, they all needed to be re-educated on it. And how quickly can that happen if you can’t actually walk around the city.’

How London became high-yielding

The key theme across Europe has been investor tolerance for ever lower yields, with inflation in the eurozone struggling to reach the European Central Bank’s 2% target and interests rates cut again in September last year to record lows.

‘We thought 3% was going to be the benchmark for the lowest prime yield in Europe. Over the second half of last year, that changed again,’ said Gauge.

He picked out Berlin, in particular, as possibly overheated with prime commercial property yielding 2.65%. Munich, Paris and Amsterdam are not much cheaper, with prime yields around 2.75%.

Even in the context of the -0.62% yield on 10-year German government bonds, that represents a negligible rate of return once costs are factored in, especially given owners in the EU will need to spend more on their buildings to meet tightening environmental requirements.

Anecdotally, that prime property in the City of London yields 4.25%, more than the 3.8% of French regional office markets, is another signal of the ‘major mismatch’.

‘You’ve got a kind of ideal situation in London where you’re getting 150 basis points premium to a similar core European office market like a Munich or a Paris, and then you’re also looking at some of the strongest rental growth markets’ said Gauge.

‘The other thing which we really like about the situation now is that development in central London is falling away dramatically over the next few years.’

Hollick agreed that a building slowdown since the Brexit referendum has meant a lack of major developments coming online.

‘We continue to see overseas capital looking at London. One of the biggest problems you’ve got at the moment is a real shortage of stock available.’

Until the pandemic, an IPD forecast had put UK commercial property on course to deliver a total return of 3.5%, compared to 2.1% in 2019.

UBS’ base case is that, despite considerable downside risk, numbers of transactions will fall this year but properly values will not slide drastically, as low-interest rates and the hunt for yield continue to offer support.

‘The real question is does this peter out by the second half of the year? If that is the case I think the impact on the real estate markets over the one-two year horizon would be pretty limited,’ said Gauge.

‘But clearly the risk is that this is the triggering event that everyone’s been worrying about for some time, the black swan event that actually tips the world into a global recession.’

Some UK property funds ban withdrawals over coronavirus