‘This is the initial phase of a major market disruption – illiquidity’

COMMENT Measures to contain the spread of the coronavirus – including travel restrictions, quarantine periods and shelter-in-place orders requiring many businesses to close – are causing significant economic disruption. In the near term, a global recession looks likely, and the question is how deep and long-lasting it will be. We are in the initial phase associated with any major real estate market disruption – illiquidity. A lack of liquidity caused by increasing fear grinds capital markets to a halt. Limited transactions result in sidelined investors waiting for price discovery. Buyers and sellers are less likely to transact, and real estate lenders – bank and non-bank – are equally hindered by the lack of market transparency. However, longer term, when price discovery returns, lenders with healthy balance sheets will resume lending, which in turn should support real estate price recovery.  The second phase is the duration of the shock. The situation we face today is extraordinary. While each market cycle is different, the current economic climate may be especially harsh for millions of small businesses around the world, many of which have been forced to close their doors. The duration of coronavirus shock will set the course for what the recovery looks like. Careful approach in Europe In Europe, investors will need to be highly selective in transaction activities until the situation normalises. For the time being, acquisitions are being put on hold, particularly in smaller markets and niche sectors, as well as higher up the risk spectrum where we believe market volatility will be greatest. The sectors most affected are retail, hotels, offices, and senior and student living, with logistics and the traditional residential sector less vulnerable. Additionally, core assets in major markets offering bond-like income characteristics are set to fare relatively well in a risk-off environment. The financing markets in Europe remain highly concentrated in the banking community, and this lack of diversity slowed the recovery coming out of the global financial crisis. While the markets are slightly less dependent on the banking community than in 2008, the European financing market is much less diversified than the United States. Banks remain the dominant force in providing liquidity for real estate in Europe. This lack of diversity will hamper the recovery, though to a lesser extent in the UK, where non-banks have created a noticeable market share.  Prepared for a US downturn The coronavirus outbreak may induce a US recession for which we have been preparing since 2015. The sectors likely to be impacted, most to least, are hotels and hospitality, discretionary retail, offices, industrial, discretionary housing, necessity retail, storage and necessity housing. With limited near-term upside in real estate equity, private real estate debt is looking relatively more attractive. Pressure on small business lenders, such as banks, will create opportunity for investors in the private debt space to fill the funding void. The diversity of capital providers in the US will strengthen the liquidity and thus the real estate recovery.  When we enter a recovery period, well-capitalised equity funds will have an advantage over funds with weak balance sheets. We see a number of potential opportunities, including in all kinds of housing. We are also looking at infill industrial opportunities, including cold storage, which are close to large US population centres, as well as industrial across Mexico as manufacturers seek to diversify their US-serving supply chains.  Navigating uncertainty in Asia Pacific It is clear the scale of the economic impact on Asia Pacific will be severe. The short-term growth outlook has deteriorated significantly and an economic recession in the region is a possible scenario. Nevertheless, the significant and seemingly effective measures taken by China, South Korea, Singapore and other countries in the region to limit spread of the virus may result in the Asia Pacific being one of the first regions to stabilise. While the hospitality and travel related sectors face headwinds, retail and office will also be impacted by social distancing and slower economic growth. Logistics is likely to benefit from an increased shift to e-commerce as consumers stay at home. The impact of the coronavirus on real estate debt and equity markets is being felt across the Americas, Europe and Asia. While it is important to remain cautious – particularly in the hospitality, retail and office sectors most affected – it is crucial to always keep an eye on the long term and, where possible, capitalise on opportunities arising from shifting structural trends. Eric Adler is chief executive of PGIM Real Estate