Curlow’s Convictions: potential COVID-19 impact on real assets
Bottom line – while it is possible to identify the real asset sectors most exposed over the short term to COVID-19, there is no clear way to identify how significant the downside risks will be and therefore what the ultimate impact on real assets will be. An increased risk premium is warranted over the short term for those markets and sectors most impacted by the virus, but the rate cuts and rumoured stimulus have already provided this naturally so upward pressure on property yields from here may not materialise. Given where bonds yields have gone the ‘yielding alternatives’ will likely see yet another wave of capital emerge from asset allocators looking for yield so the ‘song remains the same’ on that front.
Nobody knows – so volatility will reign: It is impossible to know how severe the ultimate impact of COVID-19 will be as it is a new virus and even the health experts don’t fully understand how it is transmitted, was conceived, etc. Until a vaccine is developed, or containment achieved, it is likely to continue to spread so we are looking at varying degrees of downside risk to the economy and markets rather than any potential upside. Given this level of uncertainty we are likely to remain in a prolonged period of market volatility as investors respond to the latest news flow. While initially centred on Asia, cases continue to spread across the globe, with Europe and the US seeing an escalation.
Private markets slower to react: Anecdotal evidence suggests some leasing enquiry slowdown in Asia Pacific markets where the crisis began but most property and infrastructure sectors are likely to see a measured response to both short-term fundamental impacts and valuation adjustments. Until we have clarity on just how long and widespread an impact the virus is to have it is impossible to quantify the ultimate impact on real asset performance. However, given the traditional longer-term investment horizon of real asset investment it will likely take some time before this disruption materially impacts total return expectations. That said, the short-term uncertainty will clearly weigh on the NOI performance of retail, hotel, leisure, student accommodation and travel oriented assets in particular.
Shock to travel hitting hotel and air traffic demand: Business and leisure travel have plummeted – and in some instances banned entirely – with large gatherings including conferences and sporting events also being cancelled. We have seen the pain hit airlines already and the latest RevPAR figures aren’t encouraging in Asia with the spill over to Europe and the US only now starting to materialise. Hotel investments with a lease contract may prove more insulated from an income perspective over the short term, as compared to those with management contracts, but the underlying slowdown on asset level income generation will hit both structures.
Retail sector hit by rapid decline in footfall: Contagion concerns in the hardest hit areas is leading to some shopping centres closures with those that remain open looking like ghost towns – notably in China. This decline in footfall and sales will only exacerbate the profitability pressures that retailers were already grappling with due to online sales competition and the investment required to develop and implement an omni-channel business model. Depending upon how long and severe the coronavirus impact turns out to be we may see a rise in retailer bankruptcies and a subsequent rise in retail vacancies. The one bright spot for retail has been a reported spike in online grocery orders and panic buying of necessities – despite governments acknowledging that these are not necessary in Europe and the US.
Supply side disruption to logistics counterbalanced by an expected rise in online sales: The disruption in global supply chains may have a negative impact on certain logistics markets – particularly those centred on a globalised model as this disruption to just-in-time processes may accelerate the de-globalisation trend and shift towards localised/domestic production processes catering to local consumer demand. However, the increased use of online sales channels may provide a strong counter balance to logistics demand as more consumers look to home delivery as an isolation strategy, with those markets that have been slower to adopt online sales seeing an acceleration.
Accelerated adaption of flexible working in the office sector: Although the impact on the office sector are not as immediate as on those mentioned above, the crisis has already increased the usage of remote working technologies. This may result in a more rapid adaption of flexible working habits and a faster increase in obsolete office space than anticipated. In the short-term the increase in remote working (predominantly from home) might also have a negative impact on occupancy rates of coworking space and lead to a rise in insolvencies and consolidation in this segment as their operating margins are very sensitive to any changes in occupancy rates.
Real asset investment opportunities may arise: We expect most private market assets to be somewhat insulated from the level of volatility occurring in the public markets. However, the negative impact on underlying income generation in sectors most impacted above may lead to distressed assets where leverage levels are high and operational disruption most acute. In addition, the denominator impact from falling equities may lead some institutions to be overweight real assets resulting in tactical sales bringing good quality assets to market.
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All data sourced by AXA IM - Real Assets as at March 2020.
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