LONDON (Reuters) – The COVID-19 pandemic has forced sovereign wealth funds to think the previously unthinkable.
FILE PHOTO: Empty offices are seen as the spread of the coronavirus disease (COVID-19) continues, in London, Britain March 19, 2020. REUTERS/Simon Dawson
With prime office blocks lying empty around the world, hotels half-vacant and retailers struggling to stay afloat, the funds are retreating from many of the real estate investments that have long been a mainstay of their strategies.
Sovereign wealth funds (SWFs) invested $4.4 billion in the sector in the first seven months of 2020, 65% down from the same period a year ago, according to previously unpublished data provided to Reuters by Global SWF, an industry data specialist.
The nature of property investments is also shifting, with funds increasingly investing in logistics space, such as warehousing, amid a boom in online commerce during the pandemic, while cutting back on deals for offices and retail buildings.
Such shifts in behaviour can have seismic effects on the global real estate market, given such funds are among the largest investors in property and have interests worth hundreds of billions of dollars in total. Three sovereign funds sit within the top 10 largest real estate investors, according to market specialists IPE Real Assets.
A big question is whether the changes are structural for the funds, for which property is an asset-class staple at about 8% of their total portfolios on average, or a temporary response to a huge, unexpected and unfamiliar global event.
“Real estate is still a big part of sovereign wealth fund portfolios and will continue to be so,” said Diego López, managing director of Global SWF and a former sovereign wealth fund adviser at PwC.
“What COVID has accelerated is the sophistication of SWFs trying to build diversification and resilience into their portfolio – and hence looking for other asset classes and industries.”
Sovereign funds have been more bearish on property than public pension funds, another big investor in the sector, Global SWF found. While they have outstripped the pension funds in overall investment across most industries and assets this year, by two to one, that ratio is reversed for real estate.
For a graphic on Sovereign wealth fund property holdings:
FUTURE OF THE OFFICE
Funds are nursing hits to their existing property portfolios stemming from the introduction of lockdowns and social-distancing restrictions. While other parts of their portfolio, such as stocks and bonds, have rebounded from March’s trough, a real-estate recovery is less assured.
Property capital value globally is expected to drop by 14% in 2020 before rising by 3.4% in 2021, according to commercial real estate services group CBRE. Analysts and academics question whether the pandemic’s impact may prove long-lasting, with more people working from home and shopping online.
“I think there’s a real threat to some commercial business districts in the big cities as I can’t see us all return to the 9-to-5 schlep in, schlep out,” said Yolande Barnes, a real-estate specialist at London university UCL.
The value of property assets of some funds has fallen in 2020, with those experiencing the biggest drops including Singapore’s Temasek Holdings and GIC, Abu Dhabi Investment Authority (ADIA) and Qatar Investment Authority (QIA), according to data compiled for Reuters by industry tracker Preqin.
Those four funds have collectively seen the value of such assets drop by $18.1 billion to $132.9 billion, the data showed.
Reuters was unable to confirm whether the fall was due to lower valuations or asset sales. The funds either declined to comment or did not respond.
Many sovereign funds do not publicly disclose data on property investments, with Norway’s one of the exceptions.
The Norwegian fund, which has around $49 billion invested in real estate, up from $47 billion at the end of 2019, said last week its unlisted property portfolio returned minus 1.6% in the first half of 2020.
Sovereign funds have also largely steered clear in 2020 of new direct investments in London or Los Angeles, hotspots in normal times, according to property services firm Jones Lang LaSalle (JLL), which said SWFs were “on the defensive”.
LOGISTICS AND BIOTECH
The funds’ advance in logistics properties, such as warehousing and goods distribution centres, comes at a time of high demand as people have bought everything from toilet paper to trainers from home during lockdowns.
So far this year, logistics have accounted for about 22% of funds’ real-estate investments by value, compared with 15% in 2019 as a whole, the Global SWF data shows.
Meanwhile, investments in offices have fallen to 36% from 49% last year, and in retail property to zero versus 15%.
Marcus Frampton, chief investment officer at the Alaska Permanent Fund Corporation (APFC), told Reuters that real-estate deal volumes had “slowed down substantially” in general, but that, anecdotally, he saw activity in industrial facilities like logistics and “multi-family” apartment blocks.
The wealth fund’s holdings have risen to $4.7 billion, up from $4 billion at the end of June, after the purchase of multi-family and industrial REIT stocks on July 1, Frampton said.
“Commercial warehouse activity is strong,” he added.
In a sign of the times, Temasek participated in a $500 million investment in Indonesia-based e-commerce firm Tokopedia in June.
In contrast, physical retail, a significant part of many funds’ holdings, has been hit hard. QIA-owned luxury retailer Harrods in London has reportedly forecast a 45% plunge in annual sales, as visitor numbers plummet. Many other retailers have sought to renegotiate rents.
The outlook appears brighter for some fledgling sectors such as biotech, which has come to the fore during the pandemic.
“We have seen significant demand for life sciences space. That’s ranged from office to specialist lab and warehouse space,” said Alistair Meadows, JLL’s head of UK capital markets.
For a graphic on Sovereign wealth fund real estate deals:
The U.S. office market is expected to face its first year since 2009 of more space becoming vacant than leased, according to CBRE.
Still, investors are betting on a rebound of sorts in some quarters. For example, Canary Wharf Group, partly owned by the QIA, unveiled plans last month for a large new mixed-use development, including business space, in London’s financial district.
And while hotels face huge challenges, occupancy rates are expected to rebound near to pre-COVID levels – but not until the end of 2021.
The Libyan Investment Authority has experienced problems with the operating expenses of some of its properties, including some hotels in Africa owned by its subsidiary, Chairman Ali Mahmoud Hassan Mohamed told Reuters.
But it remains committed to its real-estate portfolio, estimated at $6.6 billion in its latest valuation in 2012, as it was able to restore its value, he said.
Crises can also present opportunities, however.
In the aftermath of the pandemic, some funds may look for bargains as distressed properties emerge.
The Hong Kong Monetary Authority, which operates a fund, told Reuters it would “closely monitor market conditions with a view to capturing appropriate opportunities”.
And in an uncertain world, some academics argue that property remains a solid bet for savvy investors.
Barnes of UCL said sovereign funds could be “lighter on their feet” than some other institutional funds and more able to adjust their behaviour to suit changing circumstances.
“Real estate is one of the better sectors to be in, in a world of turmoil,” she added. “But it’s very much about picking the right real estate.”
Reporting by Tom Arnold in London; Additional reporting by Alun John in Hong Kong, Gwladys Fouche in Oslo, Saeed Azhar in Dubai and Anshuman Daga in Singapore; Editing by Pravin Char
This Week’s Top Stories: Canadian Real Estate Prices Forecasted To Fall, As Households Make Fewer Payments – Better Dwelling
Time for your cheat sheet on this week’s most important stories.
Canadian Real Estate
One of the world’s largest credit rating agencies confirmed an early forecast of falling home prices in Canada. Moody’s had expected government measures would delay any impact to home prices. The firm believes this is still true, and even elaborated on which markets will be hit. They expect enthusiasm over stimulus measures will begin to wear thin. At this point, the reality of a damaged labour market, and how meaningful improvements have been will start to hit sellers. This is expected to be stronger in some markets, like Toronto, than other markets – like Vancouver.
Despite booming Canadian real estate sales, condo apartment prices have now fallen from their peak price. The aggregate benchmark reached $478,700 in August, up 6.45% from last year. This number is down 0.15% from the all time record reached in April. As you might expect, not everywhere is falling. Three markets have printed new all-time highs as of August. The rest however, have fallen – and some markets haven’t seen an all-time high in over half a decade.
Canada’s national housing agency, and state-owned insurer, sees a lot of risk in real estate markets. Seven markets are now flagged as having “moderate” levels of vulnerability, up from five in the spring. Toronto and Vancouver remain in the moderate category, while Montreal continues to be considered low risk. The organization did say things appear better than the reality, due to disposable income temporarily being inflated by government support. Once disposable income falls back to non-supported levels, overvaluation metrics should rise once again.
Canada’s biggest real estate markets are seeing one of their fundamental drivers continue to deteriorate – immigration. Toronto only saw 4,450 permanent residents arrive in July, down 64.0% from last year. Vancouver saw 1,300 people, down 71.1% from last year. Montreal fell to 2,110, down 47.2% from last year. Toronto and Vancouver have seen the declines become larger from the month before. Montreal bucked the trend by seeing a smaller decline, but has also seen a much longer trend that goes back before the pandemic.
Canadian mortgage debt is swelling, but households are making a lot fewer payments. The amount paid towards mortgages hit $90.27 billion in Q2 2020, down 3.32% lower than last year. Almost all of this is due to paying off less interest. Breaking the numbers down, we see payments towards principal are on the decline, while payments towards interest are actually rising.
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Office real estate market will get back to pre-Covid level, in 2025: Cushman & Wakefield – CNBC
The coronavirus remote work experiment will become a permanent trend, but at some point, employees will return to the office in numbers that match the past. When? It could take five years, according to a new forecast from Cushman & Wakefield.
Global office vacancies will not return to their pre-Covid peak levels until 2025 and, in all, a net 215 million square feet of office vacancy will have been lost due to the pandemic, according to the outlook from one of the largest real estate services firms in the world. Between Q2 2020, when Covid-19 hit the U.S., and Q3 2021, the net negative office square feet damage will reach 95 million square feet, roughly 10 million square feet more than the financial crisis trough.
The situation will be the worst in the West. During the financial crisis, Canada, Europe and the U.S. recorded a combined loss of 120.5 million of square feet occupancy from peak-to-trough. Including Q2 2020, that will reach over 200 million square feet of “negative absorption” peak-to-trough in the Covid recession, according to Cushman & Wakefield’s analysis.
Work from home is ‘very real’
“We know this work from home trend is very real,” Kevin Thorpe, the firm’s chief economist, recently told CNBC.
For the study, Cushman & Wakefield surveyed some of largest companies around the world about the future of the office, and attempted to measure both the cyclical impacts of the Covid recession and structural impacts assuming a higher increase in work from home.
Thorpe said two key findings emerged. First, office leasing fundamentals will be significantly impacted and vacancies reach an all-time high. But the second find is more encouraging: the office real estate market will fully recover, according to Cushman & Wakefield, largely due to employment growth and the ongoing shift in the U.S. economy’s concentration in certain types of professional jobs.
In all, the real estate firm estimates that 82% of the damage will be related to cyclical factors: permanent office job losses and the rise of coworking, while 18% is related to structural factors: primarily assumptions about permanent remote workers and hybrid workers — those who work remotely some of the time.
Work from home will double, and hybrid workers will increase. The study estimates that the share of people working permanently from home in the U.S. and Europe will increase from roughly 5-6% pre-Covid-19 to between 10% and 11% post-Covid, while the share of hybrid — also referred to as agile workers — will increase from between 32% to 36% to just under half of all workers.
Levi Strauss & Co. CFO Harmit Singh recently told a CNBC @Work virtual event that it pulled the plug on any new commercial real estate during the crisis. “The myth that work from home is not productive has been busted,” the Levi Strauss CFO said. “I believe we will settle into a culture where working from anywhere will be the new norm, with work from home or office or a hybrid arrangement.”
Google recently announced it will try a hybrid model of work as most of its employees do not want to be in the office every day.
Many younger workers are taking advantage of the Covid remote working shift to travel, embracing a “digital nomadic” lifestyle, a shift which could become permanent for a new generation of labor.
Over time, as economy shifts to a knowledge-based, professional services economy, it will offset the flexible workforce trend, Cushman & Wakefield’s study concludes. “But in the near-term, there will be significant challenges for the office sector,” Thorpe said.
Many workers still do not feel safe enough to return to office. One study found that only 14% of workers said that they trust their CEOs and senior managers to safely lead them back to work.
Global office vacancy will rise from 10.9% pre-Covid crisis to 15.6% by Q2 2022, the study forecasts.
Some of the largest companies in the world have been expanding office space in major cities, such as New York, during the crisis.
Facebook, which has been acquiring New York real estate for years, agreed last month to a major lease at the old James A. Farley post office building in Manhattan. Amazon has also purchased the Lord & Taylor building on 5th Avenue, and that is even though Facebook CEO Mark Zuckerberg has said as much as half of the company’s workers may be remote in the future. In March, just as the Covid crisis hit the U.S., Amazon paid over $1 billion to acquire tha Lord & Taylor building in New York, which includes over 600,000 square feet of space.
Appraisal data shows scale of value destruction in US real estate – Financial Times
Commercial properties hit by the economic effects of coronavirus could have lost as much as one-quarter of their value or more, laying bare the scale of the damage being wrought across American malls, hotels and other commercial buildings.
Evidence emerging in the commercial mortgage-backed securities (CMBS) market from recent appraisals also raises questions over the value of the collateral backing commercial mortgages throughout the financial system.
Properties that have gotten into trouble are being written down by 27 per cent on average, data from Wells Fargo shows. New appraisals are triggered when a commercial property owner starts to have trouble paying the mortgage, and the loan is handed to a “special servicer” that could eventually seize the property on behalf of CMBS holders.
“It’s a big number,” said Lea Overby, an analyst at Wells Fargo. “This is material.”
Recent examples show hotels being especially hard hit, given the collapse in tourism and business travel. A Crowne Plaza hotel in Houston was valued at $25.9m this month, down 46 per cent from when it was bundled into a CMBS deal in 2014. The hotel, which sits just off the Katy Freeway has not paid its mortgage since March and was transferred to the special servicer in May.
The Holiday Inn La Mirada, about 20 minutes drive from the centre of Los Angeles, was recently valued at $22.1m, down 27 per cent since it was securitised in 2015, having not paid its mortgage since April. Another Holiday Inn in Columbia, Tennessee, had its appraised value cut by 37 per cent this month to $7.7m.
“The numbers themselves are atrocious,” said Gunter Seeger, a fixed income portfolio manager at PineBridge Investments. “A 30 per cent markdown in appraisals pretty much across the board is horrific.”
The number of new appraisals is accelerating. The Wells Fargo analysis covers 116 struggling properties bundled into CMBS that have had new appraisals since April 1 — 68 of them this month.
Of the total, 75 of the mortgages were backed by hotels while 26 were retail properties, whose tenants have been struggling under lockdown-enforced closures and economic weakness.
Banks have been raising provisions to cover potential real estate losses this year, and the number of commercial real estate loans in US bank portfolios that were flagged as being potentially problematic spiked in the second quarter.
Meanwhile, CMBS investors have been keeping an eagle eye on appraisal values to gauge their risk of losses. Over the past four years, the average loan-to-value ratio on mortgages bundled into CMBS has been below 60 per cent, giving investors a sizeable cushion, even if a property has to be seized and sold for the loan to be repaid.
Coronavirus has substantially eroded that cushion, however, and loan-to-value ratio in the average multi-property CMBS is now almost 90 per cent.
“The longer this crisis goes on, we will move into a valuation problem,” said James Shevlin, president of special servicer CW Capital. “It absolutely concerns us but right now I still think we are covered.”
New appraisals are an early step taken by special servicers and help them assess how much time to offer borrowers to resolve their difficulties before they start foreclosure proceedings.
Special servicers and analysts said that it can be challenging to accurately appraise a property in the current environment. The potential sale value over the next few months could be heavily affected by another uptick in coronavirus cases, more stringent rules governing travel and people’s ability to go outside, or even a volatile presidential election. Equally, property values could appreciate if the economic recovery gathers speed.
“It’s someone’s best estimate of value,” said Alan Todd, an analyst at Bank of America. “Right now there is so much uncertainty. There could be a very high margin of error.”
Additional reporting by Robert Armstrong
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