COVID-19 is wrecking the economy pillar by pillar and the property market will not escape unscathed. On the healthcare front, the Australian government and the healthcare works performed admirably in containing the spread of the disease but the economic impact will still be severe.
However this does not the mean economy was unscathed. Australia is a modern economy which has shifted away from manufacture to provision of services. The implementation of shutdowns and social distancing designed (and worked) in reducing risks of the coronavirus has disproportionately impacted the service sectors the most (tourism, hospitality and restaurants) which has immediate impact on employment.
The recovery will be tough and nothing like the anemic experience seen by China after their reopening as the Chinese economy is still dominated by manufacturing which can restart easier and faster. Even then the experience is patchy at best.
The service sector being a large portion of the Australian economy means that the reboot post COVID will be slow L shaped recovery spanning a number of years rather than a quick V shaped recovery.
The property market is not immune from the broader economic impact of the coronavirus. Property is not safe haven port but will be impacted just as much as the rest of the Australian economy. Furthermore Australia has not had a recession since 1990 and as result there is significant degree of leverage in the system.
Unlike the GFC where the financial and real estate sector were the ground zero of the crisis and more importantly, whilst commercial property was damaged, the residential property market will not be immune like last time. The sector will hit as result of the second order effects from the increase in unemployment rate and decline in income levels.
The order of effects will take time to take shape but we outline a broad short and long term impact of COIVD-19 based on experiences from other markets around the world.
Each part of the real estate market will be impacted differently but here a highlight of what we think are key risks for each
Slow in Residential Property Auctions
The weekly number of auction slowed to a crawl during the lock down period and we would not expect volume to pick back up. There is no pent up demand as the level of uncertainty from job losses will be a key driver in slowing purchases going forward.
Unfortunately to add to this is increase in listing from mortgage stress from the current and future job losses and will hamper prices. This will increase until the job market stabilizes and net jobs are created years down the track.
Tighter lending standards
Lenders (banks and non-bank lenders) have already tighten their lending criteria which will limit the available of credit to fund purchases. We are seeing lenders pulling cash outs and redraws with new loans on a overall lower LTV (<70%) relatively unimpacted.
Lender mortgage insurers which are crucial in allowing banks to provide high LTV loans (85%+) are pulling back. This will reduce availability of options for those that are able to buy but does not have the 20% deposits. Mortgages LTV in banks lending books will fall but overall risk in banks will increase as the extent of the bad debt charges are unknown.
The Australian banks are some of the most well capitalized banks but no matter how prudent they were pre-crisis this will test their risk capital before we fully recover. We have always said the biggest risk to the domestic banks if there is a material rise in unemployment.
RBA can support the banks only so much and their actions are more limiting the amount of damage rather than egging the lenders on.
What will happen to property prices after COVID-19?
The key question in the minds is how will house prices react to the economic slow down from coronavirus? We think the risk will be a decline in houses prices as the pressure from pullback in buyers and increase stock on market.
The model we are following is what happened to the Perth property prices after the end of the mining boom. The market did not experience a sharp drop like the fall in US house prices during the GFC but a slow drip that will take years play out. This is mainly because there is no massive force selling as mortgages are full recourse loans where people cant just walk away.
Apartment construction will slow down
An obvious third order effect of a slow down in volume and gradual decline in house prices will further reduce future supply. After the completion of projects currently under construction, it will be very hard for developers to start new projects as pre-sales and construction lending from banks will be hard to source. One spot light are the funds raised by non-bank lenders can possibly plug the gap but they are still a tiny portion of the overall lending market.
Given the interlink of the sectors, this will further hamper construction jobs.
Impact on the rental market
Depending where you sit on the ledger, if you are renter then there are some positives. Weekly rents will likely to drop as units that were previously let as short term rental will come back into the market (conversion of previous Air BnB units back to long term renting). There will be less competition for rentals as demand for moving will decrease given the weak economy. There is also a higher degree of certainty in remaining in their current homes.
In the long term there will be a structural shift following this crisis where a subset of people knowing that they could lose their job any minute will remain or convert long term renters from homeowners.
Indication from listed Real Estate Trusts on COVID-19 impact on commercial real estate
The listed market already leads the real asset values due to immediate liquidity providing price discovery. The all ords index today is already in a bear market, the ASX Property Trusts performed even worse by under performing by further 15%.
Commercial properties faces a different set of risks from the virus. There was nothing sadder than walking down the street during the crisis and seeing the retail shops closed. Every single shop is someones business and they are facing a very uncertain future.
The first order is the stop of rent payments which hits the retail landlords are hit particularly hard. The likes of Scentre (Westfield) and Vicinity has already seen some of this and will continue.
The long term effect of this is still playing out but the casualty so far for the sector is an existential one where the leases can be invalided during times like this.
Office landlords with a large exposure to smaller tenants are also working hard to make sure their tenants are paying rent. Asset value will drop and the only questions is by how much. Similar to the residential market, new office supply will slow and the long trend of working from home will affect the demand for the existing stock. It is likely office rents will go backwards in the immediate future and subleases options open up as corporate try to move the lease obligations off their balance sheet.
Similar to previous cycle peaks, there were minimal spread between the prime and secondary stock. Office cap rates overall will blow out but the better quality assets (CBD premium and A grade assets) will outperform secondary assets. It just shows it always pays to pay up for good quality assets during the good times and chasing yields will also come back to haunt you later.