The Coronavirus impact on Asia real estate

The market dislocation from the Coronavirus is presenting interesting valuation opportunities in different segments of the Real Estate market. Our order of preference is Office, Industrials and Retail. Office remains the most resilient and vacancies in core markets remain tight. Industrials continue to benefit from modern supply chain logistics and last mile warehousing. Retail is the most impacted by COVID-19 but now provides very good value in certain markets and we continue to believe the strong operators will come to dominate this segment. The key is to be selective.

The Coronavirus outbreak has now afflicted more than 200,000 people around the world, at time of writing1, and spread to more than 100 countries. Many countries, led by China, have taken extraordinary measures to stem the rapid spread. But with the death toll rising from the rapidly spreading virus, the World Health Organisation has declared this outbreak a pandemic.

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The current quarantines, travel restrictions and supply chain disruptions are impacting the global economy and stock markets which have spiralled on recession fears. This is because many believe that unlike China, government response to the virus in countries outside of Asia may be slower with less draconian measures and therefore will be less effective. This implies that their virus containment measures and subsequent recovery paths may be more prolonged than observed in China, which dramatically increases the chance of a recession in the US and Europe.

Governments around the globe have responded swiftly with both monetary and fiscal stimulus measures. It is likely that we will see more policy support in the coming weeks in the form of fiscal easing which should eventually help stabilise markets and provide a buying opportunity for risk assets. Meanwhile a multi asset strategy that allocates across several asset classes can help insulate one from the full impact of the Coronavirus and market sell-offs. Our real estate strategy, for example, is benefitting from a diversified investment portfolio that has a combination of equities, bonds, REITs and infrastructure securities.

Diversification helps mute volatility

Recent experience speaks for itself; the bonds in our portfolio have shown lower volatility in the last two months compared to many of the equity securities. The equity portion is constructed to provide upside when the markets recover, delivering an overall smoother return experience for investors who want Asian real estate exposure with less volatility than investing solely in regional REIT markets.

Diversification across markets and segments also serves to diversify risk. For example, Australia performed well during SARS in 2003. Likewise, diversified exposure across commercial, industrial, malls, logistics, residential developers and infrastructure sub-sectors should help to cushion a real estate investment portfolio. For example, residential markets which are largely driven by local market dynamics, may experience a slowdown as potential buyers stay away from property launches. In contrast, e-commerce retailers (a major driver for logistics and warehousing) should be relatively less affected as they are likely to benefit from shoppers who prefer to buy from the safety of their homes. We have seen this play out recently in China, where buyers have used online channels in the Coronavirus circumstance as they had not been able to visit show flats or physical properties.

The impact on the real estate sector is inevitable

The China property sector has pulled back in the region of -11% year-to-date as at 11 March 2020.2 China’s residential property developers reported significant declines in contract sales in the months of January and February but have seen sales start to recover in March. Investors’ perception is that the worst of the fallout from COVID-19 virus is now past and China appears to be slowly recovering while the rest of world is now facing greater risks around the spread of the virus. China also continues to deploy greater policy stimulus measures both at the national and the local levels, including targeted property policies: delayed land cost payments, relaxation of pre-sales approval requirements or subsidies for new home purchases. This has helped to slowly tempt buyers back into the market, as Chinese citizens still require a place to live.

In the first week of March, residential units sold in tier-1/tier-2/lower-tier cities saw -45%/-44%/-29% year-on-year3. Sales are improving as offices reopen. Week-on-week sales are also showing strong improvement. Land sales in the top 100 cities have now recovered to 80% of those as of the same period in 20192. Smaller developers and developers with weak balance sheets are struggling to raise capital in this environment but our focus remains on the larger, better quality names.

The Real Estate industry in China is likely to see an acceleration of consolidation in 2020 as operating conditions become more difficult for smaller players. While the bulk of our China exposure is through the offshore USD Bond market, we are comfortable that these companies will be able to service their debt and raise fresh rounds of capital should the COVID-19 situation persist for longer than expected. Those developers that are short on near-term cash will likely resort to equity capital raises or asset sales to tide them through this difficult period, though the risk of default is heightened, making an active security selection approach all the more important.

On the retail side China mall operators are reporting increasing foot traffic as stores slowly reopen but some sites are only seeing 30-50% of the visitor volumes they reported a year ago2. Some stores and malls are still operating under reduced opening hours but over the next month or so we expect most operations to return to normal as consumers get back to work after weeks of isolation.

Can SARS serve as a guide?

The most cited comparison of the impact of Coronavirus is that of SARS that sickened over 8,000 people in 2003 and caused 774 deaths. Drawing correlated conclusions based on how SARS panned out has been too simplistic given that extent of globalisation and the interdependence of markets. Nevertheless, it serves a guide in terms of its impact on markets.

During SARS, transaction investment volumes in Hong Kong, Mainland China and Singapore declined sharply in 1H 2003 as sellers held back but activity resumed in 2H 2003. See Fig 1. Similarly, we can expect current transaction volumes to decline in the first half of 2020. If the outbreak is contained in China over the next few weeks, deal volumes should rebound due to the accommodative policies. Other Asia Pacific countries may take slightly longer but we also expect stimulus to begin to impact economies by 2Q-3Q 2020. Once growth in new cases peaks (as we have seen in China) the market is likely to show a recovery if the 2003 SARS model provides an historical context.

Fig 1: Asia Pacific ex Japan equities’ performance during SARS4

Virus impact Fig-1

This too shall pass, eventually

We believe the effects of the Coronavirus crisis will pass and Governments from China and Hong Kong to Singapore continue to step in with both monetary and fiscal support for the real estate sector, tenants and citizens, including Hong Kong announcing “helicopter money” of HKD 10,000 (US$1,200) for each permanent resident adult in the territory.

One of the major questions being asked is do Mainland China developers have enough liquidity to meet their loan obligations over the coming few years. Many developers had already issued bonds in December- January and the government has many more policy tools to ease financing conditions for the developers as discussed above.

The People’s Bank of China and Ministry of Finance have announced grace periods and extensions on mortgages with repayment difficulties. We also expect additional fiscal stimulus measures (such as VAT cuts or suspensions or subsidies) and monetary measures (including additional reserve ratio requirement cuts or rate cuts) in 1Q 2020. The Mainland Government continues to view property as a key sector for long-term wealth creation and social stability and will likely do whatever it takes to ensure medium-term price stability.

The virus risk premium and slower earnings is now mostly priced in but of course a full recovery is unlikely until cases in the rest of the world begin to slow. We are seeing value opportunities emerge, but we are being highly selective. We expect stimulus policies will begin to filter through to the economic activity in the coming few months. Also, as consumers return to their jobs, pent up demand should underpin the real estate sector, possibly by 2Q-3Q 2020. It is hard to determine what the long-term impact of the COVID-9 virus will be on the global economy but the indiscriminate selling we are seeing now is putting the Real Estate sector in Asia on very attractive valuations for investors with a medium-term investment horizon.

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