FALSE: The initial impact of COVID-19 on the investment market was severe and rapid. The result of lockdown restrictions was material valuation uncertainty; a sudden inability to adequately price income or obsolescence risk. In Q2, investment volume dropped 70% on the previous quarter to £4.8bn.
This was indeed the lowest quarterly volume since Q2 2009, but the slump was largely a result of sellers opting to delay disposals until material valuation uncertainty ended. Investor demand continued to build for assets either seen as safe havens, such as Central London offices, or sectors perceived as beneficiaries of the trends accelerated by the pandemic, such as logistics and Build-to-Rent residential assets.
As such, deal volume bounced back strongly in the second half of the year as lockdown restrictions eased and investors felt more able to price assets with more certainty. Demand for logistics continued to surge, particularly from US Private Equity buyers, with the sector recording its busiest Q4 on record. In Central London, demand from overseas investors tripled to £3.3bn in Q4, almost in line with Q4 2019.
Overall, investment volume reached c. £43bn in 2020, far exceeding expectations at the start of the pandemic. While down 20% on 2019, and 20% below the 10-year average, this was still comfortably above the levels seen at the height of the GFC. That the slowdown was not much worse is testament to investors' confidence in UK and London real estate's ability to generate income in the face of acute volatility.
FALSE: The global flight to core and increasing real estate capital allocations have resulted in fierce competition at the top end of the market, meaning prime office yields have stayed at 3.50-4.00%. This is despite a surge in tenant-controlled space coming to market and continuing debate over the future use of office space. In addition, with levels of distress relatively muted compared to post-GFC levels, all-property annual capital value decline has been much less severe than in 2009, bottoming out at 7.9% in August versus 31.6% in May 2009 according to MSCI.
Look beyond this, however, and the reality is much more nuanced. It is clear that COVID-19 has exacerbated a long-term divergence in sector performance. Rampant demand for anything related to logistics has resulted in a 25 bps compression in industrial yields, while retail yields continue to march higher as negative capital growth has accelerated. The latest MSCI annual results suggest that the spread between Industrial and Retail Capital Growth is at record highs.
COVID-19 has also brought about a sudden upward correction in property's risk premium to risk-free income yields, which is now at its highest ever. This, along with weight of capital, will act as a constraint on yield decompression, and suggests we are in for a downward correction once pent-up economic growth returns, assuming central bank policy remains accommodative.
However, we are still in the midst of a major reassessment of what our office and retail spaces will look like post-pandemic, along with a general reallocation of capital away from these sectors towards logistics and alternatives. This will have an impact on the definition of core real estate, but it is still too early to say for sure what COVID-19's long-term impact on overall attitudes to income risk will be.