What are the practical difficulties when doing business in Germany at the moment?
One of the main impacts for our business over the next few months is the throughput of the public authorities. Where possible they are trying to stay open, but are reducing non-critical services, building permits for example, are in some jurisdictions no longer considered to be critical. Different local municipalities have differing views, so we are trying to understand the impact of this in each of the areas where we are processing deals, but no doubt it’s going to have a ripple effect across the market. Timing for registrations in the land book also remain unclear, thus affecting already signed SPA’s formal closing periods. Zoning processes that legally require public meetings are also on hold until mid-sized gatherings can resume.
How about taking delivery of building materials? How serious is the supply chain disruption?
We’re not under construction on our sites right now, though we are tendering and supply chains for materials are a major concern. The longer both factories and borders stay closed, the greater the impact. Personally, I’m optimistic that the worst of the health crisis is going to be over in the next couple of months in terms of Covid 19 in Europe, but borders may stay closed for many months. This is likely to be exaggerated due to the differing levels of response to flattening the curve from country to country.
How will that impact supply chain, not just in terms of tenant demand but also construction materials?
For us, finding contractors that control more of their own supply chain will become increasingly important and could put pressure on some of the smaller general contractors. Companies who have their own pre-cast factories for items such as columns will do well, like Goldbeck or Max Bogel. Germany has always been a challenging market for pre-cast/long lead items given the scale of logistics development each year is far beyond any other market in Europe. When the market resumes more normal activity, we do envisage materials supply to be a bottleneck with manufacturers. We may also see more inventive solutions such as pouring concrete columns in situ/on site rather than waiting for longer lead times from precast factories.
So, your challenge is to lock down your tenants?
That’s easier said than done right now. Nobody knows for sure how long this will go on for and the impact this has on tenants’ expansion plans, and on the impact on tenants’ underlying covenant strength. There are a few submarkets that are weathering the storm well such as supermarkets and medical equipment. Furthermore, one of the benefits of this crisis is it’s forcing the take up of online shopping to evolve more quickly, more people will be learning how to use online grocery delivery etc. Amazon in the US is hiring 100,000 new delivery drivers.
These industries are insulated. Unfortunately for bricks and mortar retail this is an incredibly challenging time. Investors will need to be even more diligent than before in terms of screening tenants credit ratings as well as taking medium term views on specific industry trends that will affect tenants balance sheets. There’s still a lot of uncertainty as to how deep this impact will be given government grant and loan processes are only now starting to be rolled out. Tenants will all be impacted in different ways. Some landlords who are able to are passing on rent reductions to tenants immediately. Certainly valuers and lawyers will have a busy time dealing with all these renegotiations.
How do you value real estate at the moment?
It’s up in the air right now, because ultimately, you’re valuing risk. We don’t know what the credit risk profiles of tenants will look like and we are not going to know for a while. All companies are being faced with hugely challenging decisions around how long they hold onto employees for and how much debt they will take on in the process. We will still see great demand for blue chip tenants, it’s possible to still price an Amazon building for example as you can compare those leases to Amazon bonds for a similar lease length, but B class buildings with multiple tenants will be extremely difficult to value and B class stock will see an outward yield shift given the risk profile of those tenants has increased.
Fundamentally, we need to see the strength of companies once they come out of this and we need to understand how you underwrite those deals from a risk perspective. Logistics leases are generally more fixed euro rents rather than turnover rents such as in the retail sector, which will insulate the immediate impact on NOI within the logistics sector. Positively (or surprisingly depending on your view) a number of investment deals are still proceeding as funds still have a ton of money that they need to deploy.
Funds are aware that should there be a market repricing, this will lead to a lag in available and ‘correctly priced’ product in which to place capital.
I am somewhat surprised that investment deals are going ahead except for single tenant or blue chip leases where investors are able to get comfort in some way on tenant covenant. The real estate clock has passed 12‚ it’s risky to be doing deals now whilst it’s not clear to what extend the market may reprice. For every fund who is still buying there are a handful of funds who have chosen to refrain from all investment decisions for the next 6-8 weeks. Banks, too, have started putting deals on hold. Investors who do not require bank financing will be in a strong position to capitalize on deals with activity resumes.
What other changes could you foresee resulting from this crisis?
Potentially there may be slightly less owner-occupier demand in logistics and more tenant demand because tenants will want to use their cash for operations rather than investing in their own buildings. As a result they may take more short-term decisions rather than long-term and when you look that way you’re less likely to want to put your equity into owning your own building as opposed to leasing it and freeing up cash for other parts of the business. So expect to see more sale and leasebacks.
This crisis may have soaked up a lot of that equity. Will that impact pricing?
One of the things investors are scared about is that if there is a repricing in the market from an investment standpoint, generally they take a long time to happen. People don’t want to take decisions, sellers don’t want to admit that there’s a new pricing level, so generally these things are followed by a significant period of inactivity. As you say investment funds are sitting on a lot of money and they’re going to want to place it. That may be why deals are closing, with people saying, ‘this may be our last chance for a while’.
