Special Report: Cities, Real Estate And The COVID-19 Vaccination 

December 9, 2020 by David Thame

Vaccines, High Hopes And Property Pricing: A Complicated Story

Photo: Aviva Investors

The property market is all about the future — planning it, procuring it, and above all pricing it. Yet as lockdown succeeded lockdown during 2020 the moment when the future could be priced receded into the distance. The new normal never arrived.

The nationwide rollout of COVID-19 vaccination in the UK, and the imminent approval of vaccines in both the U.S. and mainland Europe, changes all that. The economic mood has flipped. The stock markets have rocketed, with property stocks among the biggest risers.

But for commercial real estate the arrival of a vaccine crystallises a problem. Pricing is, of course, simultaneously the most basic and most complex conundrum in property. Coronavirus vaccination just turned it into the mother and father of all unknowns. For buyers, the problem is pricing risk. For vendors, it is the struggle to price hope.

The imminent arrival of vaccines clearly affects sentiment in commercial real estate — but has it yet affected behaviour in capital markets? Is it already leading to more deals, new loans or delaying bankruptcies? And what is the right investment strategy to employ in a market where you know a return to normality is nearer, but you still don't know quite how far away it is?

Where evidence exists it points to yields/cap rates moving out during the year with signs of them moving back in as the year ends. Across the U.S. CBRE said cap rates (yields) in the office sector moved out by 19 basis points in Q3. It is the same story amplified in the UK. The average prime yield across the main office markets slipped from 4.31% to 5.33% in the third quarter, Avison Young said. 

Investors with seriously big money are of more or less one view. Although they express it with professional caution, they think anyone who believes the vaccine rollout signals the bottom of the market hasn’t got their head screwed on properly.

Aviva Investors, which has $15B in real estate assets under management, works with investor clients on both sides of the Atlantic as well as investing its own resources. Recent buys include partnering with Canada’s Public Sector Pension Investment Board to fund a 65K SF Cambridge office building, the kind of top-of-class offering Aviva likes. And it resolutely refuses to call the market.

“I definitely won’t say we’re at the bottom of the market,” Aviva Investors Head of UK Real Estate Research Jonathan Bayfield said. “There might be further drops in the next six months until a vaccine is rolled out, and perhaps another year or so until the UK economy is back on its feet.”

“The vaccine has come fast, and is better than we were expecting and the public markets — not just for real estate stocks — have rallied on this as uncertainty has reduced. But the big uncertainty is how the economy will behave. We’ll have more retail casualties, and it depends on fiscal policy, and the support the government provides and what they claw back in the short term, so things are still very uncertain from an economic point of view."

Aviva is telling clients that the short-term is still uncertain, Bayfield said, adding its models do not assume much rental growth. 

Aviva likes longer-term plays and their real estate still looks attractive on that basis. But short-term, especially with uncertainty around what happens when government stimulus wears off, maybe not so much.

M&G Fund Manager Paul Crosbie said good news on vaccines has yet to filter through to investor demand or pricing and, like his counterparts at Aviva, he thinks the market hasn’t bottomed, not by a long way. M&G has $17B in real estate assets under management.

“The UK has yet to face up to the economic consequences of COVID-19; a rise in unemployment is inevitable. Meanwhile, consumer spending will be hit by this latest round of lockdown measures and rent collection stats will come under scrutiny again during December," he said. "We fully recognise the economic headwinds and consequences of COVID-19 for the occupational markets and expect to see downward pressure on rents for some sectors.” 

Photo: Courtesy of Hermes Investment Management

A version of the opposite view is prevalent in the London brokerage world, particularly from those handling the still-considerable but largely pent-up flows of international capital.

“You could argue the prospect of a new vaccine has breathed a bit of life into the market,” Savills UK’s Head of Cross Border Investment Rasheed Hassan said. He contrasted this with “the deepest recession in history, record peacetime borrowing, a huge problem in world finance that needs to be resolved. Three weeks ago that would have been the pretty firm view, so things have changed.”

Hassan isn’t yet seeing this affect pricing, which in prime London offices is 25-75 basis points off the top of the market, but he thinks it might have an effect eventually. “We’re not seeing people pull out of sales, or asking for higher prices, although we could, but we are seeing discussions [on pricing]. It’s still so early, nobody knows how quickly vaccines will be distributed but the fact that we’re even talking about this tells us we’re probably not going to be working from home by next March or September.”

A little new optimism and “discussions” about pricing don’t add up to the bottom of the market but it does feel like a market on the turn. 

Market participants in another major UK market, Birmingham, reported that news of the vaccine was already having a tangible effect. 

For the last four weeks — since the first mid-November 2020 announcement that the Pfizer/BioNTech vaccine has 95% efficacy — capital market-makers in the city noticed a change in mood that was quickly reflected in pricing expectations.

“Some [vendors] are definitely expecting some kind of yield improvement based on a vaccine and the world coming back to work as normal," Knight Frank Head of Birmingham Ashley Hudson said. "We’ve seen Birmingham pricing slip as we got deeper into the crisis, perhaps 75-100 yield basis points for some value-add assets as buyers got more nervy. But if we get a vaccine, and we’re not all wearing masks, people return to the workplace and the uncertainty ends, that price slip could reverse. So some vendors want to hang on and wait and try to benefit from that return to normality.”

Not all asset classes will rise or fall at the same rate, Cushman & Wakefield Head of UK Capital Markets Jason Winfield warned. Pricing is particularly difficult for operational property investment from cinemas and hotels to golf courses and service stations.

“Operators will think the vaccine is great news, but if you were a potential buyer, would you buy it now or wait until June," Winfield said. "Those operator tenants might not be able to survive six months, in which case you don’t want to buy it now fearing the tenant will default in two months’ time.”

Like many Bisnow talked to, Winfield is expecting Q2 2021 to be significant; not because vaccines rollout will be well underway, but because many lenders’ patience will by then be exhausted. Tenant (and landlord) debt holidays will abruptly end, and distress sales will result. But even distress sales aren’t without their problems. Winfield said private equity will be reluctant to buy into retail even if it is at bargain prices, having been caught out last time it declared retail prices to have bottomed out, in 2016. And who wants to take on a half-built skyscraper or other development? Winfield doubts many will have the stomach.

“Next year might mean a hard Brexit [for the UK], the vaccine may not prove as effective as we like to believe, there could be an enormous recession, so rental values go down and at that point …” Winfield doesn’t finish the sentence, but he doesn't need to. The market, in this view, hasn’t touched the bottom. Not yet.

Photo: Courtesy of Patron Capital

That resounding “not yet” holds promise for agile private equity players.

“We see a lot of interesting value in the office market at the moment,” Colmore Capital founder David Corridan said, and that (for him) happy situation isn’t about to end. “Vendors who need to sell now will be flexible, but those who think we’ll have a distributable vaccination programme in the next three or four months will hold on and see what happens. Their view is that pricing can’t get hugely worse, but that underplays the potential downsides from significant redundancies."

For some buildings the bottom might be miles off or we never reach the bottom of the market — their value may go down to zero, Corridan said.

He sees buying opportunities in this complicated situation as large institutional portfolios are rebalanced to meet post-coronavirus economic realities. “There are some half-decent offices held by institutional owners that perhaps they shouldn’t be holding. It doesn’t make sense for them to invest in them, but it might make sense for us,” he said.

A consensus appears to be emerging: The market has not bottomed, and will not for perhaps six months. But before you let this consensus harden into certainty, listen to a powerful contrary view.

Patron Capital has been funneling private equity into European real estate for the last 20 years: So far about £4B from institutional and high net worth investors from Europe, the Middle East and the U.S. It has transacted 65M SF in 16 countries and its feel for the texture of the market is second to none, which makes Patron Capital Managing Partner Keith Breslauer’s call all the more fascinating.

Breslauer’s view is that pricing expectations will not change much because, foolishly, most people had already convinced themselves vaccines would appear early, be efficacious and be rolled out successfully. This confidence, confidence never shared by medical experts,  is already baked into property pricing.

“I don’t think we’ll see any hardening of market sentiment on pricing, because the market wasn’t really hacking back expectations before the vaccines,” Breslauer said. “The vaccine news just confirmed what everyone believed anyway. Confirmation bias if you like. So they don’t feel they have to sell at a new price.”

Unless vendors have some particular reason to sell — end of year figures to make, maybe — nothing has changed. “Most people are in the no-pressure zone.”

What is unusual about the Breslauer analysis is that this story ends not with a crash, but with the whoop of animal spirits and a Nike swoosh curve.

His analysis starts with a question: Are Aviva, M&G and almost everybody else wrong to worry that the arrival of the vaccine will simply unmask the huge economic hole into which the world economy has fallen? You bet they are, he said.

“It’s too early to call a recession," Breslauer said. "We have no idea what the animal instincts of consumers will be once we come out of lockdowns. Look at China — it is booming — and although the U.S. is in the midst of political crap, it could do just as well when it comes out of it.

"In the UK there will be a shock to the market, unemployment will be up significantly, but it will be a one-off adjustment. We expect rents to be back as they were in December 2019 within two or three years. The shape of the recovery is a Nike swoosh curve, we go down and then recover from a lower base."

Governments could screw this up with untimely tax rises, in which case a typical recession begins. But providing government keeps its hands behind its backs, the economy will bounce back. “We expect the market to be smaller, like we stepped back four years, but it will be on a growing trend,” Breslauer said.

His advice is not to wait and see but to plunge right in. “Now is the interesting moment. To buy now in a moment of total uncertainty,” he said, pointing to the remarkably rapid recovery in sentiment after 9/11 and other global shocks.

Has the property market hit bottom with the coronavirus vaccine news? Is it all price growth from here into the sunlit uplands of 2021?

Nobody knows. But whilst most of the market is betting one way, some are betting the other. You can be sure that one of those two groups is going to be surprised.