How the value of properties is affected by temporary loss of rent

Life is not easy at the moment, for a number of reasons.  umea-1

Although the pandemic is more advanced now, we still know relatively little about how things will develop in the immediate future. But how will the value of properties be affected by temporary loss of rent?

 

The real estate industry is not avoiding the side effects of COVID-19, obviously. However, discussions with a number of market players reveal that the overall picture is relatively stable, and few real estate owners are stating that the current situation is making any major changes to their day-to-day operations – apart from the fact that management has a heavier burden to bear in many discussions with tenants. However, real estate owners with many commercial tenants will find that rental income will be reduced or simply not paid at all. Government assistance with rents has been announced, but as yet there is little clarity on how the funds are to be distributed and real estate owners can only apply for this funding from July.

 

One hot topic at the moment is what will happen with real estate valuations. Valuations are based on key ratios and price levels in business completed previously. This means that valuations are normally slightly behind as those of us compiling them usually make sure there are quoted prices that support increases or decreases in value levels. However, very little business is done when times are harder, which means that the valuation data is generally highly limited. In turn, this makes it difficult to justify the exact extent by which real estate values should be downgraded.

 

As stated above, things are going pretty much as before the pandemic for many real estate owners, which means that their properties are essentially being valued to the same level as before. At the same time, there are players who are keen to buy and are expecting “coronavirus discounts” on properties. This means there is a discrepancy in the prices buyers are expecting to pay and sellers are expecting to charge; and in combination with the issue of finance, this is a major reason as to why sales are less likely to happen when times are harder. It also means that “coronavirus discounts” will only be given if properties have to be sold in order to maintain the liquidity of a single real estate owner, for example. We can start talking about a real estate crisis if we end up in such a position, but that is not the situation at present.

Nobody can say how real estate values in general will be affected by this crisis, as it is impacting different industries and real estate segments very unevenly. The effects for hotels, culture and restaurants have been devastating. Commerce in general has suffered, but this is not true of all segments: food stores, budget stores and DIY stores are reporting a major influx of customers. Nor is it possible to state that the office market in general will be affected, as things are entirely dependent on individual tenants.

 

We have quantified valuation scenarios for a number of different segments in order to get some idea of how the values of individual properties may be affected in the event of lost rents. These have been implemented as simplified valuations of returns for template properties located in a city region. It is important to point out that these are not actual adjustments that are conducted but are merely to be viewed as a table of how real estate values would be altered mechanically in the various scenarios. Payment of any government assistance with rents has not been taken into account below.

 

The column on the right shows the change in real estate value when the adjustments are taken into account in a returns spreadsheet, all other things being equal.

From the list above, we can see that the outcome will not be particularly dramatic if we only look at lost rents and an increase in long-term vacancies. What we have to remember is that the net operating incomes will be weakened or even negative for the scenario for hotels, which means that the government assistance with rents will be important to real estate owners who are greatly exposed to affected sectors. This is particularly true if you link this to the reasoning above, that real estate owners will have to sell properties in order to maintain their liquidity, which in turn may trigger significantly more worrying trends on the real estate market.

 

Unfortunately, real life is not as simple as in the example above: there are a number of parameters such as market rents and yields that may be adjusted depending on the property in question and the types of tenants occupying it. So the boring answer to the question of how real estate values will be affected is: it depends. However, what we can say is that if lost rents are only temporary and we do not end up in a deep recession, these losses will only have a minor impact on long-term real estate values.

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