Given the major business challenges for the hospitality and real estate sectors due to the Covid-19 outbreak, how are investors currently navigating the crisis?
Mahdi Mokrane, a visiting lecturer in Glion’s Master’s in real estate, finance and hotel development, had just joined Patrizia AG as Head of Investment Strategy and Research in January this year, shortly before the Coronavirus hit Europe. Patrizia is the largest independent real estate manager in Europe, managing some 45 billion euros worth of assets.
What investments are being made?
“We’ve bought offices and residential,” Mahdi said, “as an illustration, we’re looking at operators in the flexible office space in different countries, which have a really good platform but are struggling today”. Patrizia, he said, is also looking at “health care operators or operators in the student housing universe. These more operational types of assets are the ones that are suffering the most today. But for some of them, we have a very positive long-term view of the sector and are ready to opt for a higher-octane risk-return strategy”.
As for investing in hotels, Patrizia has a hotel fund that has been tailored specifically for a pool of German investors. “The hotels that we had, by nature of the strategy, were leased hotels”, Mahdi said, adding: “We’re very pleased to have leased hotels, because as long as you have strong operators, we know we’ll be paid.” If the operators cannot meet their lease obligations, agreements have been reached to delay or stagger payments. “We have to find some sort of win-win agreement – or avoid a lose-lose agreement – whereby they commit to continue paying or we find other sorts of agreements but in exchange for example of longer leases. Real estate is often a complex negotiating game.”
“Going forward, I think we’ll still have a preference for leased hotels as long as the pricing is right.” As for possible markets for acquisition, Mahdi singled out Italy which had been hard hit by the outbreak. “The tourist season is going to be difficult and the hotel market there is very fragmented”, with the major brands such as Accor, Marriott or Hilton having ‘very low’ market share. “So we believe there could be opportunities for us to buy an asset or portfolio and reflag those with leading brands or successful boutique brands.”
Real estate markets: A framework
At the start of the session, Glion senior lecturer and real estate investment consultant, Andri Rabetanety, outlined an analytical framework to divide real estate markets into three interconnected markets:
Space market, where space is offered for rent (“With the expected contraction of global GDP by 2.5 percent in 2020, rental growth will be hampered.”):
- Office (reduced rental growth and/or increased vacancy rates)
- Retail (increased level of default due to lower footfall)
- Industrial (mitigated by growth of e-commerce)
- Hotel (increased level of default due to lower footfall)
Asset market, where properties are bought and sold.
- Listed real estate investment trusts or REITs (“not immune to the widespread sell-off affecting all asset classes.”)
- Private equity real estate (PERE) funds
Andri also highlighted two factors with regard to the asset market:
- Real estate risk premiums will reduce as government bond yields increase.
- Financing – “banks will focus on smaller deals and loans will tighten, so that only the players with the best track records will get financing. We will also observe an increase in loan delinquency in the coming months”.
Development market, where properties are bought and sold.
“This framework is especially useful to understand how an economic shock could negatively impact the ability of an occupier to pay its rent”, he said, and to understand how a financial shock could lead to lower sales or capital values.
Commercial real estate markets “are likely to be more heavily affected than the residential market”, Andri said, and with regard to the retail sector, “we might observe increased levels of default due to lower levels of footfall”. By contrast, the logistics market “might be the asset class benefiting from the crisis on the back of the growth of e-commerce”. As for hotels, there might be higher levels of default due to operational activities.
Residential – short- and medium-term strategies but due to a demand-supply imbalance, “it’s arguably low yielding but you can find some good quality, core residential that is higher yielding than, say, prime offices in the main office markets of Europe”.
Logistics – a “very clear winner” although if tied too closely to comparison retail (such as fashion for example) it “may be in trouble”. Longer term, however, “we think this is a good sector to be in”.
Food retail – “has done very well over the short run and we expect that to continue– with one caveat, increases in online food retail which has led us to downgrade it a little.” As for other types of retail, such as “fashion and anything you can compare with online is tricky today and is expected to face structural headwinds going forward”.
Hotels – very difficult in the short term. “We have a small hotel fund and rent collection has been pretty low. Longer term, we think it has the capability to bounce back very quickly. The sector may offer value-added opportunities over the coming months.”
During his presentation, Mahdi took participants through the stringency and timing of government responses to Covid-19, the difficulty in forecasting GDP currently, “the whole array of forecasts is just mind-boggling and amazing”, and approaches to scenario testing, “we have to be humble here, we don’t necessarily know what the shape of the future will be but we can model it”.
Mahdi also touched on REITs. Those linked to shopping centers “are suffering extensively from this crisis.” However, there are also two winners: Industrial logistics which are benefiting from online sales, and Residential. “This has been perceived as a very resilient sector with rent collection nearing the 98-100 percent mark.” (Patrizia manages about 11 billion euros in this asset class.)
Banks will be “on the back foot”, Mahdi said, “but they’ll still continue lending”. As for the economic impact of the pandemic on the northern parts of Europe, “the way Covid-19 is going to play out, it’s going to be either through consumption or investment, but not the job market”. As for Italy, Spain and France, “the impact is going to be much larger,” while the UK “is going to be one of the worst hit in terms of unemployment levels”.
“We believe that it takes longer to recover once you’ve shed jobs and if the job market has been severely hit, it will take a shallower way back to recovery.” While countries such as Germany may experience a V-shaped recovery, he said, as they will be able to resume investment and consumption activities quickly, countries like Italy should see a shallower recovery in terms of investment due to having shed a large number of jobs which will make the recovery “more difficult and lengthy”.
Residential and logistics, especially if linked to online sales, will be the winners. Banks will be working mainly with investors they trust and have long-standing relationships with. There are optimistic investors out there currently, but “not many distressed sellers”. Real estate investment trusts (REITs) are “not immune to the widespread sell-off”, with those linked to shopping centers “suffering extensively from this crisis”.
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