Bottom hit? Ready for risk?

The third and final day of our GRI Opportunity eSeries Europe gathered GRI Club members online to understand the European real estate investment and transaction landscape. Most members agreed that they are not seeing distressed assets as of yet and they are focusing their efforts on understanding new trends and demand, as well as going back to investment basics.

Next to retail and hospitality, offices was seen as another asset class where distressed opportunities might hit the market in the next 12 months. However, most investors are still adopting a wait & see attitude as of yet, also due to increasing debt and prices across the more resilient assets.

Special thanks to Anas Halabi (3S Capital), James Piper (TPG), Joseph De Leo (Benson Elliot), Karim Habra (Ivanhoé Cambridge), Laurian Douin (BC Partners), Peter Plaut (WIMMER FAMILY OFFICE LTD) and Tavis Cannell (Goldman Sachs).

The GRI Opportunity eSeries Europe featured GRI Club members as a warm up for our Europe & France GRI in September in Paris where the conversation will continue:

#GRIClub #RealEstate #investment #Europe

Creative Accounting and Deceptive Practices

Over the past decade companies, investment banking advisors, accountants and other consultants have all contributed to distorting the traditional accounting concept of cash flow most commonly referred to as Earnings Before Depreciation and Amortization or EBITDA by adding back adjustments.
EBITDA is a standard measure used for company valuation and thus stock value as well as for bank covenants in loan agreements. While selected adjustments can be justified, many of those being made in recent years have been used simply to deceive investors and creditors leading to higher stock valuations and in my view fraudulent accounting or just outright fraud.
Companies argue that these non-GAAP adjustments are important as they help to provide a clearer picture of a company’s underlying cash flow by removing extraordinary events. However, if these events are recurring for at least several quarters then I believe the adjustments are deceptive to investors. The latest adjustment likely to become more prevalent will be the use of EBITDAC or EBITDA excluding Corona virus impacts. As we are unaware of the full impact and duration of COVID-19, I do not believe it’s prudent for a company to add back all the expenses related to Covid such as business disruption, layoffs, furloughs, etc., especially if the business impact will be over several quarters. Regulators and investors need to be especially vigilant in analyzing company’s quarterly earning and financial reports in these unprecedented times.

Covid-19 Financial Victims

During these unprecedented times and with unemployment rates reaching staggering proportions not witnessed since the Great Depression, now is the time to be extra vigilant. This is most important given the prevalence of technology including the internet, email, social media platforms, virtual wallets, etc. In many cases, fraud and the perpetrators behind it are targeting the most vulnerable sectors of our society not least of which the elderly and the sick.

Some of examples of fraud:

  • An email coming from Amazon, PayPal, Apple, Google, etc asking you to click on a link embedded in the email which then asks you to put in your credit card for verification purposes. This is FRAUD!
  • A call from someone claiming to be an IRS representative and asking for your credit card over the phone. This is FRAUD!
  • A letter purporting to be an official document from the IRS, a US government agency or court asking for a credit card. This is FRAUD!
  • A stock broker calling from a firm you have never heard of selling a stock of a company that has a miraculous cure for Covid-19. This is FRAUD!

Please be wary of the fraudulent practices you see trending around you. These things can happen to anyone, and they can happen to you. Some cons are better than others, so please be aware of financial predators and fraudulent behavior during COVID-19 when people are especially vulnerable. 

Coronavirus & USA Real Estate – Crisis, Blip or Opportunity?

Last week, I had the pleasure to moderate a GRIClub eMeeting on the COVID-19, and it’s impact on the US real estate market – Coronavirus & USA Real Estate – Crisis, Blip or Opportunity? The e-meeting had over 80 participants, including C-suite real estate executives and asset managers. My co-chairs included Andrew Miele, Head of Development for the Americas Six Senses and David Parnes, The Agency, and Star of Million Dollar Listing Los Angeles on Bravo TV.

To kick-off the meeting, I provided an overview of the macroeconomic backdrop, which is summary of a more detailed article published on the GRI website in early April titled “The Super Economic and Social Depression of 2020”

The Worst Crisis since the Great Depression of the 1930s

Over the past 2.5 months, China’s coronavirus has triggered the worst economic crisis the world has experienced in almost a century. The IMF’s recently released World Economic Outlook estimates that global gross domestic product will shrink 3% this year and mark the deepest dive since the Great Depression. Many countries in the developed world will see double-digit declines in GDP in Q1 and Q2. This is much more pronounced than the global economic contraction witnessed during the 2008-09 financial crisis. The cumulative loss in global GDP this year and next could be $9 trillion (according to the IMF), more significant than the economics of Germany and Japan combined. Every component of aggregate demand is collapsing, including consumer consumption, capital investment, and residential investment with no near-term end in sight. Just as disturbing as the demand shock, is the fall in output. Unemployment in a matter of weeks has skyrocketed across the developed world with unprecedented weekly rises in US unemployment claims, and unemployment is now over 22mm with the unemployment rate in the mid-teens and rising. We are already seeing the impact on corporate and bank earnings in Q1, and we will likely see record declines in revenues and earnings in Q2 and the remaining quarters of the year.

Forget a V Shape Recovery – Equity Markets To Dive Again

A V shape recovery has all been ruled out. Whether we see a broad U or L shape recovery is uncertain and depends on the longevity of the pandemic and its effect on economic activity. With unemployment skyrocketing, we can expect further declines in aggregate demand and output, and this will have an impact on the U.S. and global banking system, despite their relative strength. The recent rally in equity and debt markets is likely a bear market bounce as corporate earnings and projected earnings continue to be revised downward.

People Need to Get Back to Work for Economies to Function

On a positive note, those countries that have been aggressive in isolation and containment policies have shown progress. Still, for the crisis to end and economies to function, people need to get back to work so businesses can produce goods and services. The unprecedented and rapid monetary and fiscal responses can only do so much. The problem with massive fiscal packages, in some cases amounting to 10-15% of GDP, is that this will need to be monetized at some point. Government borrowing will crowd out the private sector. And in the medium term, we will likely see higher interest rates associated with this unprecedented government spending.

US Real Estate Market Q&A

Some of the questions posed to the participants focused on the following questions:

  • How does the current crisis impact real estate markets in the US?
  • How are US Residential and Office markets holding up?
  • Which assets are the safest?
  • Which assets are the worst?

In general, the participants provide a very somber outlook for the state of US real estate market in the near term, given significant uncertainties surrounding the Covid-19 pandemic. As expected, the office outlook was quite negative, especially the retail. However, within this sector, industrial, storage, and data were viewed quite positively with rents and prices holding up nicely. In residential, the Build to Rent (BTR) was signaled out as performing well in the months of March and April with rent payments over 90% in some cases; obviously, May and June will be important to watch. One of the participants said that LA residential housing prices were down about 15-20%, but he was seeing strong interest from affluent buyers seeking value in the higher end luxury market. Surprisingly, some of the participants were constructive on the outlook for the high-end hospitality space and believed that this space could benefit from social distancing.

The Super Economic and Social Depression of 2020

In the past three decades, China has emerged as one the most admired economies and a super engine for global growth. In the first three weeks of March 2020, China’s coronavirus could trigger the worst economic and social depression the world has experienced since the Great Depression of the 1930s. 

The Super Economic and Social Depression of 2020 has already wiped out trillions in global equity, commodity and credit market valuations. Moreover, the widespread containment measures many governments around the world have imposed on their populations – to deal with the spread of the virus – will result in the sharpest decline in second quarter global economic activity in almost 100 years. Every component of aggregate demand is collapsing including consumer consumption, capital investment, and residential investment with no near-term end in sight. The duration and severity of government mandated quarantine and self-isolation policies will have far reaching implications beyond the financial market and economic impacts to the cornerstones of democratic principles including freedom, liberty and the pursuit of happiness both individually and collectively. 

In many respects, the 2020 Super Economic and Social Depression of 2020 is much more severe on the average global citizen than the Great Recession of 2008. Indeed, the financial crisis of 2008 was primarily centered around the global banking system and housing markets. Although the global economy and banking sectors were strong when the pandemic started, the 2020 Super Economic and Social Depression of 2020, will wipe out entire sectors of the global economy beyond the likely headline and high-profile bankruptcies of the largest airline, hotel, cruise ship, and hospitality companies. More importantly, small and mid-size businesses that have been the backbone of a majority of global growth and ingenuity will not be able to survive a protracted economic slump.

The global trend over the past 50 years away from large industrial conglomerates and the exponential growth in the service and technology economies have resulted in a paradigm shift toward small businesses, self-employment, partial employment, outside contractors, and freelancers; otherwise known as the “gig” economy. The gig economy may be as large as a third to a half of some developed world economies, including the United States. These individuals do not have a “safety net” to fall back on in times of global economic and financial distress. The result could be unprecedented mass bankruptcies among small and mid-size companies and a sharp spike in global unemployment. This has far reaching implications for society in terms of economic and political stability.

Social distancing has become the new normal for possibly the remainder of 2020 and beyond. Almost every person on the planet is under mandatory or voluntary quarantine/ isolation to prevent the spread of the deadly COVID-19 virus, which does not differentiate between social class, race, colour, culture, nor religion and because of modern transportation has become a global pandemic in a matter of months. The most heart wrenching is that the most vulnerable to the virus are the oldest and weakest members of society that once exposed must be isolated and thus can’t be with their loved ones for worries over contagion. 

On a positive note, the crisis has prompted unprecedented policy responses from central banks that have reduced interest rates to 0 and flushed the global economy with liquidity. Global policy makers and world leaders are implementing fiscal measures to help businesses and people. In this regard, the United States has announced the largest government stimulus package in the country’s history of $2 trillion that could grow to over $6 trillion to help the country’s struggling businesses and its citizens. European government will likely follow with large government spending initiatives. These measures should help lessen the impact on companies and individuals, but they are only temporary measures.

Moreover, with the resulting blow up in government budget deficits (some cases as large as10-15% of GDP), they will eventually need to be monetised with future impacts on interest rates, inflation and global growth. In the interim, the United States government spending package includes an immediate and one-time government check/direct deposit of a $1000+ to individuals and families. This may cause a small spike in U.S. consumer spending (in particular online shopping), but it is not sufficient to cover rent and mortgage payments, food, medication, and utilities for the masses. Thus, larger scale government intervention measures will need to be taken for both companies and individuals beyond the immediate fiscal pump priming such as mandatory deferments on rent and mortgage payments, taxes, utility costs, etc. Otherwise, the implications for the U.S. and global banking system will be severe as consumer and commercial loan defaults spike alongside public panic. The result will be further falls in global equity and credit markets and a sustained decline in economic activity. 

Away from the financial market and economic impacts of COVID-19, there are encouraging social signs that highlight some of the best aspects of humanity in times of crisis. Indeed, people are coming together and helping each other. This can best be seen by the unselfish and tireless support of doctors, nurses and other healthcare workers putting their own lives at risk to help others. In Italy, people are singing from their balconies to remind their neighbours that we are all in this crisis together. Another trend is that companies both large and small are recognizing that people working from home can be just as productive and successful as they are in the office workplace. This trend has implications for the continued trend toward flexible work arrangements such as telecommuting and remote working from home and can be supportive in the future to the continued growth in the global Build-To-Rent (BTR) market.

Hopefully, government-imposed containment measures will succeed in levelling the number of Covid-19 cases by midyear 2020, which combined with the support of the massive policy responses, will result in a “V” shaped bounce in economic by Q4. Unfortunately, the new normal for our global village will be further global pandemics, heightened volatility in financial markets, sharp swings in economic activity, and social distancing. How governments and individuals respond in the future will be the true test of humanity, but thus far there are reasons for optimism.