As we have all witnessed over the last few weeks the world has arrived at a defining moment, when societal and economic norms are being set aside on a daily basis. Global stock markets cannot accurately price in the potential corporate impacts of such an uncertain outlook, especially given the unknown length of the crisis, so extreme volatility will be prevalent at least in the short term. Never has the collaboration of public and private sector funding structures been more important.
In the real estate market, investment and asset values are being impacted from material uncertainty with a resultant loss of liquidity, one of the primary supports of any equity investor-based market. In such a situation, commercial debt is impossible to obtain, let alone price, for projects that do not involve a reasonably certain investment return and exit. Several central governments, notably the US Federal Reserve and UK Government have moved swiftly and extensively to address four key stages of funding markets:
- Liquidity through corporate bond buying and reducing borrowing costs via repo rate reductions to support the economy’s capital structure.
- Market stability associated with confidence and lower spreads across the risk spectrum.
- Solvency, meaning corporate and also consumer access to credit, including cost mitigation on the burden of job retention for example through the furlough scheme or business rates relief for occupiers.
- Stimulus. Post lockdown, the initiation of major infrastructure and construction projects, alongside continued access to cheaper debt.
These four groups of measures are designed to bridge the economy over the extraordinary losses of income and momentum caused by lockdown. One of the key targets is to support employment as much as possible and reduce the unprecedented levels of job losses occurring as businesses look to cut costs during the crisis.
My colleague Simon Russian offered a thoughtful piece last week on the importance of the construction industry as a vital economic and employment component of the recovery post lockdown. Governments must be challenged to see this sector as a key recipient of support in order to calm nerves about the impairment of contractors, uncertain input costs and disruption to supply chains through and following the crisis. It has a direct bearing on regeneration and funding adaptability in the real estate markets of our towns and cities, encompassing not just commercial investment, but more importantly social and medical care, as well as the infrastructure that supports these areas of economic and community wellbeing.
Even before lockdown, the real estate market was facing up to the seismic changes in working, shopping and leisure patterns driven in large part by e-commerce. Repositioning and regenerating town centres has instantly become even more of a challenge – as well as an economic necessity. What seems certain, however, is that national governments will emerge from this crisis more heavily indebted than ever. So where will finance come from for adapting and regenerating the hearts of our communities?
One potential saving grace is that in such risk-off times, private capital is drawn to the safest havens. One primary segment is asset-backed, real estate investment secured upon investment grade covenants. Government-backed entities supporting our NHS and major infrastructure developments continue to be a priority, with Local Authorities also having the opportunity to drive viability and capitalise on the ultra-low cost of capital linked to bond and gilt rates at historic lows.
This provides a powerful motivation for connecting the public sector with private capital to help address the challenges of urban regeneration under these new circumstances. The annuity funds of several major investment houses have billions of pounds of capital queued and awaiting deployment, as well as significant development expertise. Managing and mitigating construction risk is necessary to unlock the virtuous circle of social and economic benefits that stem from regeneration and employment activity in the construction industry.
We are already seeing the selective lowering of the traditional barriers to entry involved in the public procurement process, in order to expedite development and investment projects. Whilst this is to be applauded, it does come with counterparty risk that requires careful measurement and specialist advice. Even though close collaboration between the public and private sectors has become much more commonplace, bridging the business gap cannot be learned overnight. Working practices and requirements on both sides need to be fully understood to build the trust and create the confidence that is needed to make the most of this much-needed potential opportunity.