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Nataconnexindo.com Tangerang – The outbreak of the novel coronavirus, formally named COVID-19 by the World Health Organization (WHO), has been devastating to all those affected, both in China and worldwide. Our thoughts go first to the victims, their families, and the health-care workers battling the outbreak. Developments are extremely fluid, and tremendous uncertainty remains regarding how broadly the virus will spread and what its ultimate impact will be on health policy, economic growth and financial and real estate markets. Given the disruption the virus has already visited on large swaths of the global economy, it may be helpful to review a few early observations and provide an initial assessment of how the outbreak may impact the property markets going forward.

COVID-19 is severely disrupting China’s economy and its impact is spreading more meaningfully to other parts of the global economy. Large areas of China’s economy have effectively been shut down. Most airlines and cruise lines have stopped travel to and from China. Many Chinese factories have been shuttered. To help shore up its economy, the Chinese government is deploying several fiscal and monetary measures: lowering lending rates to retailers, hotels and other areas of the economy most impacted; increasing subsidies; increasing liquidity programs and instituting other stimulus measures. The PBOC has also cut the prime rate for one- and five-year loans. These measures will help cushion the blow to China’s economy.

Given China’s importance to the global economy—accounting for 16.9% of real global GDP in 2019—the COVID-19 outbreak in China is impacting many sectors and geographies around the world. The main impacts will be felt primarily through reduced demand for exports by China (and to a lesser extent the broader Asia Pacific region), supply chain disruptions (via bottlenecks for imports from the region), reduced tourism and business travel, and the potential for a crisis of confidence to emerge. Now that the virus has spread, it is unknown how these effects may be felt across a variety of countries.

All eyes are on the financial markets. U.S. and European equity markets which had been mostly resilient since the outbreak, are now starting to price in greater downside risk. In the last few weeks, we’ve observed wild negative swings in virtually all global stock market indexes including a 1,000-point-drop in the Dow on February 24, 2020. The outbreak has also prompted a flight to quality, driving investors into the bond markets which has in turn put upward pressure on the U.S. dollar. Ten-year government bond yields in the U.S., UK, across most of Europe and Japan, are currently approximately 40 bps lower since the beginning of the year. The drop in rates is creating more attractive debt/refinance options.

Past experiences—whether previous viral outbursts or supply chain disruptors such as the Thai tsunami of 2004 or the Fukushima tsunami of 2011—suggest that once the outbreak is contained, the negative impact to near-term growth will largely reverse as pent-up demand induces a surge in economic activity afterwards. It is on that basis, in combination with the aggressive response from central banks and China’s numerous government stimulus programs, that most baseline forecasts assume a significant rebound in economic activity to occur H2 2020.

Impact on Property Markets in 2020

The CRE industry reports most data on a quarterly basis, so until the hard data rolls in for Q1 2020 we cannot draw any firm conclusions about the impact from COVID-19 on the property markets. Further, CRE leasing fundamentals typically lag the economy, whereas the capital markets effects are more immediate. In many parts of the world, CRE metrics display seasonality with the first quarter of every year typically being the weakest, so drawing decisive conclusions must be done carefully.

China’s property markets will be the most severely disrupted in H1 2020 with longer-lasting implications that may reshape business markets. In the medium term, renewed healthcare sector expansion is likely while an acceleration in supply chain diversification may unfold (something already under scrutiny due to the U.S.-China trade dispute). In the near term, while retail and hospitality will be hardest hit, office demand will be restrained as well. Rising vacancy is likely to suppress office rent growth until business confidence and activity is restored. Industrial is more of a mixed bag, with export-oriented facilities seeing greater time and costs for entry-exit inspection as well as product quarantines. Bonded warehouses may suffer the most whereas Grade A warehouses should feel less impact given the supply-demand balance across mainland China markets.

In Europe, the global impact will put countries that are more reliant on trade and manufacturing—such as those in the CEE region1, the Netherlands and Germany—more at risk. Italy also stands to be impacted given the recent uptick in infections. Supply chain effects are already surfacing, from equipment manufacturers that are unable to maintain normal production rates to some auto manufacturers that are unable to find alternative component sourcing. Indeed, with China as auto manufacturers’ largest consumer market, the auto demand impact is expected to take a toll in the near term.

Despite this, the outlook for broader logistics remains unadjusted as eCommerce continues to expand structurally and reorganize supply chains to enable faster and more cost-efficient delivery. Retail and hospitality, reliant on both tourism (leisure and business) and goods sourced from Asia, will be viewed with caution.

Office occupiers may pause on expansions in the near term until the services sectors prove their resilience in the face of weaker near-term global demand. Overall investment and deal-making may be delayed on the margin, but no pullback in annual activity is expected.2 Only 1.6% of the total capital invested in the EMEA region over the last five years was from China and 2.7% when Hong Kong is included; that share climbs to just 5.7% when Asia Pacific is included. However, many investors from Asia have a physical presence outside of the region. Further, in recent years, China specifically has been less active in Europe and the U.S. as a result of multiple capital controls.

The U.S. is more insulated: 70% of the U.S. economy is driven by domestic spending and it generally has less exposure to Asia Pacific than do other global regions. However, the U.S. and China also have the largest bilateral trade relationship in the world – so the U.S. is far from bullet-proof. For now, it is too soon to say what the office sector impact will be, but more caution and unique challenges for the tech industry specifically indicate that some leasing activity may be curtailed in the near term as firms grapple with larger supply chain issues.

The hotel sector is the industry most obviously impacted by the sharp decline in Asian tourism. Around three million Chinese tourists visit the U.S. each year, according to Neilson. During the SARS (severe acute respiratory syndrome) epidemic in the early 2000s, the number of visitors from China and Hong Kong declined 25% between 2002 and 2003, according to the U.S. National Travel & Tourism Office (NTTO). The impact from COVID-19 is already tracking to be much worse, as Chinese travel and tourism to the U.S. has come to virtual halt. This weakness is being captured by the U.S. hotel REITS, which are down 21.3% as of February 27, 2020.

The U.S. retail industry is also being affected by the outbreak at a time when retail real estate is grappling with other challenges (i.e., tariff impact and eCommerce effect). The most immediate impact has been suffered by brands with a significant presence in China. While Asia Pacific accounts for 34% of all global luxury retail sales, China drives half of that number. Global fast-food brands also have a major presence in China; most of these brands have reported temporarily closing many stores in the most heavily impacted regions of China and reducing operating hours in others. Fast food chains have quickly ramped up “contact-less” delivery and pickup strategies to adapt. Still, nearly every major publicly traded retail or restaurant brand with a major presence in China has already revised their forecasts downward.

Another immediate impact of the outbreak for North American retail will be felt in the supply chain. U.S. wholesale inventories are generally healthy at the moment due to the efforts of retailers to get ahead of potential tariff issues and the Lunar New Year. However, the real retail inventory-to-sales ratio is already at its lowest point since the expansion began. While most spring and summer merchandise has shipped, disruptions in the retail supply chain could begin to be felt as early as April. Retailers with shorter lead-time replenishment models (JiT, etc.) could be among the first to experience supply issues. Dollar stores, consumer electronics, toys and the apparel categories all face potential disruption in the supply chain if the crisis drags on.

The industrial CRE sector is expected to remain largely resilient, however the industrial economy is likely to have a different experience. Certain types of manufacturers in the U.S. are disproportionately dependent on Chinese production for inputs and final goods. This means that supply chain effects could therefore surface via a few channels, but namely in delays for inputs and declines in external demand. Fortunately, manufacturers appear to have more room to dip into inventories in the near-term. The longer supply chain disruptions persist, the industry’s most dependent on Chinese inputs will be squeezed. This includes apparel, leather, computer and electronics manufacturing (and downstream industries). The good news is that these industries represent a smaller share of overall production and manufacturing inventory a small share of overall industrial inventory, softening the potential headline effects on both fronts. In no way do these near-term impacts derail the broader structural shift to eCommerce and the effects it is having on demand.

CONCLUSION

There are still many unknowns surrounding COVID-19. How long will the virus remain, how far will it spread? How many people will be affected? When will the health and medical community develop a vaccine? During this difficult time, we emphasize the fact that considerable resources are being directed to contain the virus and its impact.

First, global officials’ coordinated response to contain the outbreak has been aggressive. Whenever an outbreak is reported, quarantines have quickly followed. Travel between nations has been monitored carefully and severely curtained. Foreign nations are also responding aggressively with the International Air Transport Association reporting at least 54 jurisdictions that have closed borders or imposed restrictions on Chinese nationals and travelers from mainland China as of February 13th. Cargo being shipped from China is being treated under special protocols, including heightened inspections and, in some cases, quarantines. These efforts to contain the virus mitigate the probability of a larger and longer-lasting contagion and increase the likelihood of a quicker recovery.

Second, the Chinese government has far more dry powder and financial resources today compared to 20 years ago. For example, in 2003, China’s foreign exchange reserves totaled $400 billion; today they total $3.1 trillion. The Chinese government is deploying that capital now, which will mitigate some of the economic damage from the virus. Further, multiple central banks and governments are standing by, closely monitoring financial and economic conditions and have signaled their readiness to act.

Third, the number of daily COVID-19 cases reported in China has been declining rapidly—from 900 new cases per day in early February to around 300 to 400 new daily cases reported toward the end of the month. Perhaps we have passed the turning point where the worst is over at the epicenter of the outbreak. The WHO has reported that the epidemic in China likely peaked in late January/early February, but it could still be classified as a pandemic as infections spread in other countries.

With any event like this, there is tremendous uncertainty, and our report indicates possible but not necessarily probable outcomes. The global economy is bound to be impacted in the near term, but it will also benefit when pent-up demand resurfaces in the aftermath of the outbreak. CRE is likely to register the effects in the form of the timing, rather than level, of demand across most parts of the world. We will continue to monitor developments and provide updates along the way. (Cushman and Wakefield)