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Markets & Geopolitics

Covid-19 and the UK economy: A long road to recovery?

Those hoping for a V-shaped recession may be disappointed.

World Built Environment Forum, RICS
14 April 2020

Those hoping for a V-shaped recession and recovery may well be disappointed. That is the view of RICS chief economist Simon Rubinsohn, who believes that, on the balance of probabilities, UK economic activity is unlikely to return to pre-pandemic levels until early 2022. “The support measures taken by the government and the Bank of England have been impressive and unprecedented, but they can only cushion the blow. There will inevitably be some corporate failures and a legacy of job losses.”

Rubinsohn acknowledged as encouraging what he described as “tentative signs of recovery” in China but cautioned more generally against attempts at bogus quantification. “Crude economic forecasts are of questionable value in such extraordinary times.”

Central bank interventions are likely to bloat the balance sheet, but he is “fairly sanguine” about this eventuality. “While we are going to see a significant uplift in money supply, I think that will help facilitate recovery over the medium term, rather than lead to an upsurge in inflationary pressures.”

Walter Boettcher, Colliers International’s Head of Research and Economics for the UK and EMEA adds: “There has been a closer integration of monetary policy with fiscal policy. There’s even talk about the government’s fiscal deeds being financed directly by so called ‘monetary financing’, though the Governor is not too pleased about the concept, as it has a terrible historic reference to the Weimar Republic. But there is a countervailing view that, for a short duration, and if targeted extremely carefully, it should be okay.”

The £330 billion in loan guarantees and £65 billion in salary supports announced by Chancellor Rishi Sunak in March equate to roughly 17% of GDP. Boettcher notes that this broadly aligns the UK response with those of most comparable economies in the Eurozone; France and Spain, for instance, have respectively committed 15% and 17% of GDP. It is Germany, though, that has announced the most extensive package, committing roughly a third of GDP to emergency relief measures.

Overall, Boettcher sees more cause for optimism than Rubinsohn: “I think what the market is really waiting for is some positive virus news. When the number of new cases begin to fall, that will bring a huge amount of confidence, because it will make real the expectation that this initial impact will be of limited duration.”

Covid-19: Regional Economic Impact series

The global economic ruptures caused by the Covid-19 pandemic continue. This series of four webinars, focusing in turn on conditions in Asia Pacific, the UK and Ireland, Europe and North America looks at the ongoing impact for commercial real estate investment markets and the construction sector and assess and medium/long-term prospects of recovery. Further consideration is given to whether various government support packages can ease the financial burden; how the crisis may prompt a paradigm shift in workplace, logistics and supply chain management strategies; the exacerbating effect of the crisis on the already struggling retail sector; and how the hospitality industry can weather the storm.

One upshot of this waiting game is that he is yet to see evidence of widespread deal cancellations – an observation echoed by Kathleen Fontana, Managing Director of Public Sector, Critical Infrastructure and Projects at MITIE. “Deals are on hold, but not cancelled. And the construction world is continuing in an almost business as usual fashion. Different parts of the market are affected differently, but there is still a lot of business going on, which is encouraging.”

Peter Cosmetatos, CEO of the Commercial Real Estate Finance Council (CREFC) Europe believes one particular element of the government’s intervention may have unforeseen consequences for credit markets. “The three-month moratorium on evictions for commercial tenants seems to have encouraged rather more organisations to assume it was okay not to pay rent this quarter than the government perhaps intended.” While acknowledging that the moratorium “was not necessarily the wrong thing to do”, Cosmatatos is concerned it may set in motion a chain of events that ultimately damages SMEs. “The figures from the Cass Commercial Property Lending Survey show that roughly 40-45% of the debt in the system is provided by UK banks; another 35% is provided by other banks; 15% is provided by insurance firms; and 10-12% provided by other non-bank lenders – private equity firms, hedge funds and others.

“Whereas banks can afford to be flexible, for the debt fund lenders the position is very different. They might find it harder to show the flexibility they would like. The reason that this matters is that their 10-12% share of UK commercial real estate debt is the 10-12% that nobody else wanted to provide: SME’s; regional assets; smaller ticket assets; complicated portfolios; and transitional, Cap Ex heavy assets. The right intervention for regulators to make is to ensure that rents are paid. Otherwise, credit challenges for debt funds might come back to bite us.”

Howard Meaney, UK Managing Director and Head of Real Estate at UBS Asset Management points to the fact that around two-thirds of UK retailers have exercised the option to forego rent payments – a small measure of reprieve for an already embattled sector. He can find little in the way of similar respite for the hospitality sector which has been “decimated” by the complete closure of hotels, pubs, restaurants, gyms and cinemas. “It employs something like 9% of the workforce and is the third highest contributor to the UK economy, so it’s very important that we get it back running as soon as we possibly can. I would mention that a number of these operators are offering meals and accommodation to health service workers through these difficult times.”

I think what the market is really waiting for is some positive virus news. When the number of new cases begin to fall, that will bring a huge amount of confidence.

Walter Boettcher
Head of Research and Economics – UK and EMEA, Colliers International

Not all sectors have been so hard hit in these early days of the crisis. “The majority of office occupiers have been able to instigate disaster recovery protocols and have activated remote working”, says Meaney. “From a revenue point of view, office occupiers will be less impacted in the short term, as they’re able to continue to operate effectively.”

While accepting that the knock-on consequences of falling GDP are likely to include an overall reduction in demand for office space, he notes: “Markets across the UK already have low levels of supply. With the situation as it is, the pipeline is not going to be added to in the near term, so we think, when we get back to normal, this is a sector that could perform well.”

This may seem to go against the grain of much recent commentary on the topic. It has been widely speculated that lockdown conditions might accelerate the transition to homeworking as the new normal for millions of professionals. But Kathleen Fontana is in full agreement with Meaney, stating that the predicted demise of the office sector “has been exaggerated somewhat.”

The Covid-19 pandemic will inspire a reinvention of the global economy.

There are a number of sectors that are completely reliant on the built environment to support their means of production. The idea that soon everybody will work from home is hugely overplayed.

Kathleen Fontana
Managing Director of Public Sector, Critical Infrastructure and Projects, MITIE

“Warren Buffet said ‘When the tide goes out, you can see who swims naked.’ I think you can see now which organisations have got the capability and the culture to move to this new model. But if you don’t have the right leadership model of delegated authority and autonomy, and a really strong communications platform, it’s very difficult to pivot quickly. I don’t think any organisation in the next 6-12 weeks is going to undertake a huge workplace transformation strategy; I think most people are focused much more on the fundamentals of stabilising their business.”

Fontana also warns against taking a “metrocentric” view of workplace. “There are a number of sectors that are completely reliant on the built environment to support their means of production. The idea that soon everybody will work from home is hugely overplayed.”

It is reasonable to expect that the Covid-19 pandemic will have lasting implications for the economy, and society more generally. And while consensus on the nature and speed of the healing process has frayed slightly, the general sense is still that the challenge of recession will give way to opportunity on he rebound.

Says Rubinsohn, “There is a watershed here. There are going to be businesses that don’t transition effectively to the new environment. But the commitment of government to facilitating the recovery will pave the way for a really interesting and dynamic environment.”