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Markets & Geopolitics

Leading Indicators: Is the road to recovery paved with good intentions?

Leading Indicators is a monthly column written by RICS Chief Economist, Simon Rubinsohn. This month, he considers how pressures on balance sheets may restrict those seeking to build back better.

Simon Rubinsohn, Chief Economist, RICS
10 July 2020

There is growing belief that the EU will get the necessary support from member states to put in place the Recovery Fund worth €750bn. This, for me, is one of the most encouraging developments of recent weeks. Debt mutualisation and the distribution of related grants and loans on the basis of need is a significant step forward for the institution. After the faltering response to the Global Financial Crisis, it should help pave the way for a broad-based economic recovery over the coming years. Significantly, it is also proposed that the measures adopted from this pool of funding should align with the EU Green Deal. However, whether it is sufficient on its own to live up to Ursula von der Leyen’s grandiose claim that ‘this is Europe’s moment’ remains to be seen.

Arguably less encouraging, and coming from a very different perspective, are some provisional results emanating from the latest RICS Global Commercial Property Monitor.

The Q2 survey asks professionals working in the real estate sector ‘whether (they think) tenants would be willing to pay more for better health and well-being facilities in buildings?’ Such facilities are likely to be an integral part of the post-lockdown return to work. The responses received so far suggest that, at a headline level, just around one-third are answering in the affirmative. I should stress that this is based on only a part sample at this point. The full results, including country breakdowns, will be available at the end of this month, but this early sighting is a stark reminder of the challenge that lies ahead.

The Q2 2020 RICS Global Commercial Property Monitor asks professionals ‘whether (they think) tenants would be willing to pay more for better health and well-being facilities in buildings?’ The responses received so far suggest that, at a headline level, just around one-third are answering in the affirmative.

It is against this backdrop that I have been thinking about the focus on ‘Building Back Better’ (BBB), the theme of much of the output on WBEF this month. As I am sure you are aware, most multilateral organisations and many individual businesses have been lining up to support the build back better sentiment. The OECD, for example, has waded in with a report Building Back Better: A Sustainable, Resilient Recovery after Covid-19. This sets out the agenda pretty cogently and has clear targets focused around improving wellbeing and driving inclusiveness. The question in my mind is whether, over the coming months, we will begin to see substantive examples of how this is being delivered in practice.

At one level, I retain a degree of optimism. The EU Recovery Fund, which still needs to be ratified by national governments, is an example of how things can be done better. But the insight from our survey of professionals working in the built environment nags away at me. Not all initiatives being called for as part of BBB necessarily incur a higher price tag, particularly if viewed from the perspective of the lifecycle cost of the asset. But many will require some additional outlay – at least in the short term. And that is something the survey results suggest could be a challenge.

Now it is possible that the feedback we are receiving reflects the depths of the cyclical fallout from Covid-19 in which many businesses are immersed. Even as lockdowns ease and more companies get back to work, activity trackers in many parts of the world are still well down on recent highs. Improvements in confidence look fragile as concerns about a second wave of infections abound. Moreover, fundamental changes in behaviour, accelerated by the pandemic, are also weighing on the corporate mood. From what I can see, CFOs are generally not viewing the current environment as conducive to taking additional risks with balance sheets.

Against this uncertain backdrop, public and private sectors will need to collaborate effectively in establishing the framework to encourage a “step change” in approach. This will be necessarily if the talk of BBB is to be delivered at scale. Effective signalling by governments will be part of the process, but there will inevitably be a financial dimension that can’t be ignored. Budget deficits and levels of outstanding debt are climbing – in many instances to multi-decade highs. It is encouraging that governments are not giving the impression that a period of retrenchment is in store. The provision of incentives to the private sector, as well as the direct delivery of programmes that fulfil these ambitions, will be essential in progressing the agenda.

Budget deficits and levels of outstanding debt are climbing – in many instances to multi-decade highs. It is encouraging that governments are not giving the impression that a period of retrenchment is in store.

The risk of backtracking, at least initially, would seem to rest primarily with a re-emergence of inflation and the pressure that would put on interest rates. This would lift debt servicing costs and the share of government revenues they account for. But the understandable desire to arrest, and indeed reverse, the upward trend in indebtedness might at some point also temper the activism of the public sector.

Meanwhile, investors will also likely have a key role in driving this agenda forward – partly through engagement as ESG vigilantes. We have already heard lots about ESG investing and indeed, the recent outperformance of funds or parts of markets that adhere to these principles. Whether this is sustained through the next phase of the cycle is open to question. A recent UBS report noted that: “portfolios contain(ing) diversified (sustainable investment) approaches are positioned defensively relative to conventional portfolios.” This is worth bearing in mind.

Oil, needless to say, goes part way to explaining this. Economic recovery is likely to support some rebound in the petroleum market, albeit leaving prices in the near term still short of levels seen prior to the pandemic. What this implies for investment in renewables may be an early test of whether the post-Covid-19 world is really going to be any different. Will the International Energy Agency be right in its warning that the economic slowdown could stall renewable infrastructure development? Or is the judgement of most analysts, who see significant risks to large chunks of the oil sector, likely to be closer to the mark? This is something we may get a good feel for pretty soon.