By:- Shubham Tiwari
Expressing his opinion over the possible impact of the outbreak, Samantak Das, Executive Director and Head of Research, REIS, JLL, says, “The COVID-19 situation remains volatile, and uncertainty still looms on the possible economic impact of the outbreak. Global supply chains across domains will be disrupted in the short-term. We are already experiencing a slump in the hospitality industry due to flight cancellations. Moreover, the plunge is already being reflected in the delayed business decisions by developers to lease. While the commercial sector has remained on a strong foothold, investors will adopt a wait-and-watch approach in the near future.”
- Absence of a force majeure clause– there must be a force majeure clause in the agreement in order for a party to invoke force majeure. If there is no such clause and an event has made the performance of a party’s obligations impossible, such party may be able to rely on the doctrine of frustration. Case law on this doctrine is sparse and careful consideration must be given to the facts. In the leasing context, the payment of rent is usually carved out of force majeure clause, in which case, tenants are still obligated to pay their rent.
- Rent deferral strategies – commercial landlords and tenants have adopted various strategies to address situations where tenants are not able to pay rent. While simple deferral or abatements are commonly known solutions, other tenant-specific solutions include converting tenant inducements into rent abatement and revisiting percentage rent. Available relief should be taken into account, including business interruption insurance and government programs.
- Transactions are still being completed – loan agreements are being revised to address current challenges by considering more frequent reporting requirements and forbearance, for example. Acquisitions and dispositions are closing smoothly with the effective use of technology and, in some provinces, title insurance.
- Collaboration is key – in some cases, strict enforcement of contractual rights may not possible, practically speaking, and positive outcomes can be achieved through collaboration. A tenant’s financial position or physical distancing guidelines may make it impossible for tenants or landlords to perform some of their obligations under a lease and litigation may not resolve the issue. Current court closures are another incentive for parties to collaborate in finding arrangements.
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China and the real estate connection
China has been a manufacturing and construction giant for many years now. COVID-19, a flu-like epidemic which originated from Wuhan, had directly affected the construction and other economic activities in China initially. However, it has now engulfed almost every country on earth and the death toll has surpassed 2.5 lakh.
The threat started with extended lunar holidays and official advice of staying at home. However, the severity of COVID-19 was greater than a flu and it has claimed thousands of lives both in China and the rest of the world. Interestingly, China has started to recover from the pandemic and limping back to normalcy.
If the direct effect on the construction industry is considered, Japanese earthmoving equipment manufacturers have experienced a visible dip in the use of its machines in the construction activities in China and across the world.
The major allied industries helping the construction and real estate across the world are iron ore and steel industry. To check the spread of the virus, China has officially closed two-third of its production lines. The lockdown of fourteen provinces, including the manufacturing hub of Hubei, where Wuhan is located, has hit the supply of essential construction material to the importing countries.
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The scale of impact can be gauged from the fact that the locked-down regions constitute 90 percent of China’s copper smelting industry, 60 percent of steel manufacturing, and 40 percent of the coal output.
Global upheaval
The devastating downward spiral of Dow Jones and a virtual halt of air travel has contributed to a plummeting US economy. Being called a ‘COVID-19 recession’, the economic impact is estimated to erode 0.7 percent of the US GDP over the next quarter. That too if the virus is contained (or at least tamed) in the next three months. However, as a result of extensive efforts by the Government, over 50 percent of the construction projects in New York and nearby areas are anticipated to resume construction by July 2020.
According to a research report by Bain and Company, a forced lockdown of two months could result in the US losing a quarter of all business establishments (amounting to $4 trillion). Even USA’s close neighbour Canada is heading towards a recession and COVID-19 (coupled with plunging oil prices) is a big culprit here. Special monetary packages to the tune of billions of dollars are adding burden to the ailing economies.
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In fact, a COVID-19-induced reduced economic activity is predicted to be affecting the housing market of Australia as well. Rising unemployment and delayed building approvals indicate a slump in the construction sector.
In addition to this, the whole of Europe is severely hit by the deadly virus. The ever-increasing tally of infections has virtually pushed Italy and Spain into a forced countrywide shutdown. Already hit by recessionary economic activity, Italy is reeling under a severely downtrodden healthcare system. It reported almost a quarter of total new cases in the whole of Europe. Spain is also down with over 2,41,550 cases
Added to this list is Russian federation. The rate at which the infection is spreading in Russia is indicative of a shattered economic scenario for Europe. The recent disaster of oil-spill in the Arctic rivers is another blow to the country’s economy and health as the clean-up would cost hundreds of dollars over the next decade.
If we look at the global commercial real estate scenario, a report by JLL suggests that the investment will remain slow. The reasons are directly and indirectly related to the Coronavirus crisis. Locked down cities, strict social distancing norms and travel restrictions would continue delaying the investment decisions across the globe. However, another report depicts a brighter future for the commercial sector.
According to a report by Savills, the post-COVID-19 scenario will provide a fresh start to the commercial real estate, particularly in India. As commercial property gives an average rental yield of 6 to 10 percent as against a residential property, which gives an average rental yield of 1.5 to three percent, the commercial segment will remain a hot favourite of investors, and it will continue to attract Private Equity (PE) investment.
A positive trend is that technology is being used extensively to connect parties and bridge gaps towards productivity and engagement in real estate. However, the uncertainty related to the duration of the pandemic will maintain barriers, and the recovery will depend on how countries deal with the pandemic.
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While the investors across the globe have deferred the decisions regarding new acquisitions, some high net worth institutions might go ahead with the decision, keeping a long term horizon in perspective. However, credit arrangement can be a challenge for investors. According to a report by CBRE, construction lending is facing more challenges than the overall financial markets. Due to social distancing norms and uncertainties across construction timelines, lenders and underwriters are being conservative and highly selective towards borrowers across the world.
A cause of concern is the case of Singapore. The country was one of the least affected initially, but due to an incoming wave of resident citizens, the country has got severely embroiled in the growing number of COVID-19 cases. It is also harmful from the housing business perspective as Singapore is one of the leading investors in real estate markets of Asia-pacific.
Overall, the economic cost of COVID-19 infection is still being measured, but the calamity will cost the world economy in millions of dollars, and more importantly, a precious human capital.
The impact back home
Uncertainty is not good for development. The tide of speculations surrounding possible ill effects of the COVID-19 spread is delaying investment decisions, especially coming from the eastern countries. According to a report by Colliers Research, the decisions over commercial real estate acquisition are expected to be delayed due to coronavirus scare, especially by the occupiers who depend on overseas clearances from Asia.
The impact is primarily indirect and can be gauged from the following points –
- Almost 28 percent of the total investment in Indian real estate came from Singapore, Hong Kong, and China in 2019. In fact, the United Nations (UN) is predicting that India is at risk of facing an immediate trade loss of approximately Rs 2,510 crore.
- As the supply chains from China will remain constrained, finding newer markets for the supply and even achieving self-sufficiency will take time and hence, India might face reduced economic activity.
- Commercial real estate market will be more impacted as it is a slow mover. If the virus keeps impacting the economic supply chains for longer terms than expected, the commercial investment decisions may take a backseat.
- A flight of capital can be expected as the investors would tilt towards a more stable bond market for investment.
- Financial markets are also sensitive to the spread, and the recent crash of the Indian stock market is a sign of growing anticipation of further decline in investor’s sentiment.
- As exports from China will decline, the cost advantage on account of cheaper supply from China will take a hit and would directly affect the profit margins of the real estate developers.
- National Real Estate Development Council (NAREDCO) has opined that the real estate sector could see rates falling by more than 20 percent in the coming quarter.
- Tourism is one of the worst affected areas, and the ongoing travel bans have hit the hospitality industry and the earning potential of businesses dependent on tourism across India.
- The IMF has revised the global GDP estimates from 3.3 percent three months ago to a contraction of 3.3 percent, something not seen after the great depression of 1930s.
- With the Coronavirus crisis affecting the Indian economy for over three months, approximate weighing of losses has started. According to a report by KPMG, the consequent losses of COVID-19 pandemic to the Indian real estate sector is estimated to be Rs 1 lakh crore by the end of the financial year 2020-21.
- The KPMG report also points towards a significant reduction in the sale of residential units. As per the report, the credit crunch emanating from the pandemic situation will contract residential sales and bring down the numbers from 4 lakh units in 2019-20 to 2.8 lakh units across the top seven cities in 2020-21.
- A recent report by JLL also depicts a dismal picture of the first quarter of 2020. According to the report, the Coronavirus pandemic disrupted the residential market in March 2020 as the walk-ins reduced by 50 percent, before coming to a sudden halt after a nationwide lockdown. The slowdown has resulted in a 30 percent decline in sales in Q1 of 2020.
- The JLL report points towards a trend of consolidation in the residential real estate market with affordable housing taking the lead. Bigger developers will be on the lookout for small yet credible projects and their acquisition.
- According to the JLL report, the de-densification and splitting of offices will take centre stage. At the same time, the path to overall recovery cycle will be led by the office real estate sector.
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Measures taken by Governments across the world to provide relief to the real estate sector
As the Coronavirus induced fear and crisis has engulfed the world as a whole, the International Monetary Fund has indicated that the world has already entered into recession. However, the governments’ world over are taking measures to cope with the situation and announcing relief measures viz-
- To ensure capital flows and liquidity availability in times of crisis, the Australian Government has reduced the benchmark Repo rate. It has also created a special funding facility to the tune of AUD 90 billion to help the ailing economy.
- The French government has agreed to consider the Coronavirus epidemic a ‘Force Majeure‘. It clarified that no penalties would be levied on the contractors or developers for any delays attributed to the deadly pandemic.
- In the United States of America, though the building and construction have been categorised as ‘non-essential’ services and most of the construction activities have stopped, the Congress is mulling a special financial package (due for a vote). The package is expected to help construction workers and will provide relief to federally-funded projects.
- In response to the Coronavirus-induced crisis, the Government of Canada will provide $27 billion direct support to Canadian workers (including construction labourers). Some states such as Ontario have also included the building and construction into essential services list. Construction Association of Canada has also released a detailed safety guideline for construction workers amid COVID-19 pandemic.
- The Singapore Government has made special provisions to help the affected construction industry and labourers. It has allowed a refund on account of Man Year Entitlement (MYE) for construction companies starting April 1, 2020. They have also allowed the foreign construction workers to change an employer midway if they face hardships with the current employer.
- Germany, which is also hit by the COVID-19 crisis, has readied the largest ever (Euro 400 billion) welfare package for the country, especially targeting the blue-collar working population. The government has also pledged to take over the wages for employees and compensate for the lost working hours due to Corona crisis.
- The United Arab Emirates (UAE), which has been a construction hotspot for years now, has also rolled out a special package for small and medium enterprises and construction industry. The government has released $27 billion stimulus to aid the economy hit by Covid-19 crisis.
- The International Monetary Fund (IMF) and United Nations (UN) have urged the developed countries to put on hold the debt payment from the poorest of countries so that they can effectively fight the COVID-19 crisis.
- The World Bank has pledged $14 billion aid package for the countries around the world to fight the Coronavirus menace. It is in addition to the monetary packages announced by the IMF for countries such as Tanzania, Pakistan and Madagascar. To fight the Coronavirus crisis, the World Bank has also released $1 billion in aid for India.
- In a recent projection by the IMF, the GDP of 170 countries is shrinking due to the Coronavirus pandemic. The ill-effects of this crisis may go into 2021 and could trigger a further downturn.
- Due to the Coronavirus crisis, the Chinese economy has shrunk to 6.8 percent. It is more important from the perspective of the world’s dependence on raw material from China.
- In a major decision against the rapidly spreading Coronavirus, United States of America has announced a 60-day ban on immigrants seeking to live and work in America. It can be extended depending on the economic fallout of the Coronavirus crisis.
- The United Nations (UN) has predicted that the current crisis could trigger a widespread famine, pushing more than 256 mn people on the brink of starvation.
- The US federal government has provided a moratorium of 120 days on evictions from federally subsidised property backed by a mortgaged loan. The US federal reserve has taken a ‘whatever it takes’ stance and is prepared to let go the lending rates up to zero. It has also provided the government with a $ 500 bn in liquidity.
- Several European countries have either halted evictions or provided temporary mortgaged relief to the citizens. The commercial real estate owners are also being offered mortgage holidays.
- Countries such as Canada and Brazil have done a significant rate cut in the policy rates to infuse liquidity into the markets.
- China has also provided a special refinancing to the tune of Yuan 800 bn.
- Italy, which is one of the most badly affected country from the COVID-19 crisis, has also formulated an emergency purchase program to support the economy.
- Despite being hit by the COVID-19 crisis, the IMF has recently said that India will remain the ‘fastest-growing major economy’ in 2020.
Special measures taken by the Indian government
Sharing his inputs about the steps Government can take to revive the Indian real estate sector, Pavan Gupta, CEO, Muthoot Housing Finance Ltd says,
After an initial relief package announced by the Reserve Bank of India and the Finance Ministry, the Indian Government has come up with further measures to deal with the economic slowdown. A special funding window of over Rs 30,000 crore has been created for the Non-Banking Finance Companies (NBFCs) and Housing Finance Companies (HFCs) of the country. It will help inject liquidity into the system and will lower the cost of credit, especially helping the stressed real estate sector.
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