Governments And Central Banks Control The Real Estate Sector Today. What Happens When That Stops?
When the UK government said in February that its ban on evicting commercial tenants was to be extended until July, it made a tacit admission: It does not know how to bring to an end the yearlong policy without undue consequences.
As well as announcing the three-month extension, the Ministry for Communities and Local Government issued a “call for evidence” on the “best way to withdraw or replace these measures while preserving tenant businesses and the millions of jobs that they support.”
The problem of unwinding the eviction moratorium is a microcosm of the problems the government faces in how to manage the economy as it tries to emerge from the destruction wrought by Covid-19. What it does from here has huge ramifications for commercial real estate.
“I’m of course only speculating, but I think this is really a proxy for a huge debate going on within government right now,” British Property Federation Chief Executive Melanie Leech said. “The government stepped in at a time of crisis to support the economy, but now they can’t relieve that, and the can is being kicked down the road.”
The same question applies to the furlough scheme, whereby the government is paying 80% of the wages of millions of workers in order to keep unemployment from rocketing — what happens when that support is due to end in September? And beyond government, central banks stepped in when Covid-19 struck to massively reduce interest rates to stimulate the economy. Low interest rates in the past decade have spurred real estate prices in the UK to hit record levels, and the further reductions in 2020 helped put a floor under price falls. But in the long term, low rates aren’t a pure positive for the sector.
For Leech, the decision to extend the moratorium on landlord evictions and winding up orders from the end of March to the end of June was understandable — new variants of Covid-19 had pushed the UK into a second national lockdown, which kept retail and leisure tenants in particular from trading.
But the decision to issue the call for evidence, and the statement that “if there is evidence that productive discussions between landlords and tenants are not taking place, and that this represents a substantial and ongoing threat to jobs and livelihoods, the government will not hesitate to intervene further,” was frustrating, Leech said.
“In December, when they said that the moratorium would run until March, MCLG had the data set and felt confident it could make that decision. If they had that data set in December, why do they need a call for evidence and more data, what’s changed?”
The change is that wider conversation about how to move from damage control to trying to revert to something like pre-Covid normality without killing what will be a very fragile economic recovery, Leech said.
When it comes to how the relationship between commercial landlords and tenants plays into that recovery, Leech argued that presenting the end of the moratorium as a cliff edge after which tenants might no longer be supported by landlords paints an erroneous picture.
“I don’t think it is a cliff edge,” she said. “Something like the holiday on business rates or the furlough scheme, those suddenly coming to an end is a cliff edge. Just because a landlord can suddenly take action, if they were providing support previously, there is no reason why they would suddenly take that support away.”
Leech points out the irony that the Conservatives, the party of the free market, are now intervening to stop the free market taking action. If they thought about what landlords are likely to do in practice in this instance, they would realise that the end of the moratorium is unlikely to unleash a flood of evictions, she said.
“Take away the question of who is right and who is wrong, and think about what is rational behaviour,” she said. “It is a zero sum game. We’ve got a surplus of space, especially in shopping centres, and no landlord wants empty property in a market where there are unlikely to be many new tenants. Then there is no rent at all coming in, and you have to pay empty rates.”
NewRiver Retail Head of Asset Management Emma Mackenzie agreed. “Market forces will prevail, I can’t imagine any landlord wants a vacant unit and an empty rates bill right now,” she said.
While some landlords were perhaps unwilling to provide rent relief for tenants at the beginning of the pandemic, unsure as they were on how long it would last, as time has gone on, compromises have been reached, she added.
Leech said that there are likely to be some instances where the moratorium is allowing a tenant that is financially unviable to stay in situ in a unit, stopping a viable tenant from moving in.
“That is saving jobs now but hindering the creation of future jobs and future wealth,” she said.
Mackenzie said that in many ways, a hard end to the eviction moratorium would not be a bad thing, as it would focus the minds of both sides and bring parties to the table who might not previously have been willing to negotiate. But the reopening of nonessential retail Monday and the resumption of outdoor hospitality meant an improvement to cash flow for retailers and operators, which would put them in a better position to pay at least some of their rent.
She added that the call for evidence is likely a request for insights from smaller landlords. While big REITs and institutions generally have the capital buffer to provide some level of rent support to tenants, the same is not necessarily true of smaller landlords, and this is a significant issue: They make up such a large part of the property industry, and even the biggest landlord only owns a tiny fraction of the property in a city like London.
Leech said this is why the BPF have urged smaller landlords who are not typically members to get in contact and “tell their story” about how they have been impacted by the pandemic and how they are negotiating with tenants.
The UK government’s furlough scheme does not affect real estate as directly as the eviction moratorium, but its implications for the sector are nonetheless seismic — 4.7 million people were being supported by the scheme in February, according to figures from the Treasury, with 1.2 million of those working in hospitality. In total more than 11 million people have been given furlough cash in the last year.
The scheme is due to end in September, with various think tanks and economic forecasters seeing it as inevitable that unemployment will rise once furlough ends.
Rishi Sunak, the chancellor of the exchequer, earlier this year extended the scheme beyond the point in June at which Covid-19 restrictions are due to be lifted, and Mackenzie said the hope among retail and leisure tenants is that they will have a few months to build up a cash buffer, potentially limiting job losses when the scheme ends.
There is a precedent for the impact of ending furlough schemes, and they show that while furloughs benefit economies, and thus property, in the short term, in the longer term they have hidden costs.
In European countries like Germany, the Netherlands and Austria, furlough schemes have been a part of the welfare state for some time, and were extensively used in the wake of the financial crisis. They are designed for use by employers in sectors like manufacturing, so when for example a factory owner sees a big drop in production, which they expect to bounce back, they can furlough staff rather than having to fire them and then rehire them.
This time around, service sectors, especially retail and hospitality, have been most likely to utilise the furlough scheme, and the end of the scheme creates uncertainty for property owners.
“Sectors that have a future will bounce back quickly, but you don’t know what will come back, and what will eventually just disappear anyway,” Nuveen Head of Research for Europe Stefan Wundrak said. “Things like restaurants will probably get back to the same level at some point, and things like holiday travel. But business travel and anything around that is difficult, and retail is an even more difficult story.
“Furloughs are good in that they can take a lot of pain out of the economy. But you are propping up businesses that might be better off going bust, and give people the chance to invest in something with more [of] a future.”
For real estate owners, it is hard to say right now which of their tenants are being kept alive artificially by the boost to cashflow provided by the furlough, but might go under eventually. The question becomes, at what point do you try and cut your losses and find a new tenant?
This is a very Anglo Saxon way of looking at an economy, Wundrak said — the creative destruction that argues it is better to let things go bust fast and then move on, rather than the more European idea of continuing support. Proponents of the argument point to the fact that while recessions in the U.S. and UK tend to be sharper, they also tend to be shorter, compared to the longer periods of lower growth in Europe.
On the human level, Wundrak said maintaining furloughs could hinder labour mobility in a way that could also be seen as detrimental to growing sectors of real estate. If a worker stays in the retail or leisure sector because their wages are paid by the furlough scheme, they might be disincentivized to go and find a job in the booming e-commerce sector, where staff are in short supply. Supporting one sector thus holds back another.
Probably the biggest stimulus of all impacting real estate is the huge amounts of cheap money pumped into financial systems by central banks the world over in response to the pandemic. And this has undoubtedly been beneficial to the sector, with the gap between real estate yields and bond yields continuing to make the sector attractive to institutional investors.
The question of how economies wean themselves from central bank support has been one pressing economists since the global financial crisis of 2008, when this particular form of response was first introduced. But for Wundrak, it is not something that real estate investors need to worry about unduly yet.
“I was laughing about it just the other day,” he said. “For the past 10 years you have seen these charts predicting that bond yields will rise in a few years’ time, and it just hasn’t happened. Most people have given up on the expectation of rates rising. The circumstances to raise rates are still very far away, there is such a big output gap and there is no expectation of lasting inflation.”
The U.S. Federal Reserve recently said it was unlikely to raise rates before 2023, and the UK and Europe are normally at least a year or two behind, meaning rates are likely to stay close to zero until around 2025.
The potential downside for real estate is — too much investment in real estate.
“It means capital doesn’t flow to productive uses,” Wundrak said. “Whether it is an institution or a private investor, everyone just sticks money in houses and property.”
That might seem a paradox, but in the long run it means less investment in technology, innovation and research, which makes companies less productive and slows economic growth. Investment in property is great for the sector in the short term, but slows the economic growth that fuels the sector in the long term.
A problem for another day, but a problem nonetheless. When it comes to withdrawal of government support and stimulus, nothing is as simple as it seems.