Dear Partners, Stakeholders, and Friends,
Given the recent market developments and unprecedented levels of global uncertainty, we wanted to take this opportunity to provide you all with a brief update on our operations, along with some colour on the Swiss economy and real estate market.
As Covid-19 continues to spread around the world, social distancing measures aimed to physically disrupt the contagion have also severed the flow of goods and people and stalled economies. For global markets, this is uncharted territory. While policy makers have been learning through previous financial and economic crises on how to deal with shocks to the supply side of an economy, this crisis has uniquely raised liquidity and capital risks in both the financial system and the real economy simultaneously – further raising the stakes. However, while painful in the short-term, there is no doubt that the global economy, as always, will recover. The focus at this stage is on the speed of such recovery process. In the short-term, this means gradually reopening the economies, for which antibody testing (which has just started in Europe) should help. In the longer term, current global economic stimulus measures aim to ensure that a ‘V’ or ‘U’ shape recovery will ensue – ultimately returning to pre-shock output levels and growth rates and avoiding any structural damage from the coronavirus crisis.
Focusing on Switzerland and Swiss real estate, for longer-term investors, we believe that the current uncertainty could offer selective attractive entry points and new opportunities that Stone Estate, as a major value-add real estate player in Switzerland, might ultimately benefit from.
We will keep this update short – briefly updating you on the impact Covid-19 has had on our internal operations and business activity, before providing some insights regarding the potential impacts of the pandemic on the Swiss economy and real estate sector. As always, we remain committed to the highest levels of transparency. We are happy to discuss the recent developments with any of our stakeholders and partners directly; providing the research that underpins our analysis and findings.
Stone Estate Internal Operations
Since the beginning of March, Stone Estate (‘SE’) employees have been working remotely. This is in line with government guidance and will better enable us to achieve the social distancing that health authorities believe is so critical to slowing the spread of the virus.
Such remote working measures do not present a major challenge to SE given the already dynamic nature of SE’s operations, more specifically, we are used to working together from multiple locations (SE’s offices are spread over three countries: Switzerland (Head Office), Munich, and London).
Stone Estate Business Activity
In terms of our current portfolio and asset management activities, SE has limited left-tail risk given the nature of its current tenants. A large share of our rental revenues is generated by public service tenants with expected limited exposure to the current market shocks (such tenants include a European Consulate and Mission to the UN and a major global NGO). SE has no hospitality or retail holdings in its current portfolio and relies on prudent levels of third-party leverage. Against this background, we do not expect any major disruptions to our rental and operational cash flows. More generally, we have robust business continuity plans and are in regular contact with our tenants to offer any advice and support we can.
As for our investment pipeline, SE is currently negotiating two major investment opportunities. This process is still on-going, albeit slower. We remain on alert to review, analyse and react quickly to any situation or opportunities that might arise.
Finally, in terms of capital raising, there is no doubt that equity raising discussions have generally been disrupted. Understandably, institutional investors are currently focusing on their current portfolios. However, we are in frequent contact with our existing and potential partners and we expect to be able to pick up all recent discussions as soon as the current restrictions will be lifted and there will be greater visibility on their mid-term economic impact.
Swiss Economy & The Federal Governments Response
Shifting focus to Switzerland more generally, statistics show that the country has been hit hard by the Covid-19 crisis (18,827 total cases as of 02/04/2020). However, recent stringent government social distancing measures are expected to start flattening the curve in the very near future.
The Federal Government has announced a CHF 40billion+ economic relief stimulus package to counterbalance the impact of the pandemic. The package includes a “Covid-19 refinancing facility” designed to provide cash-strapped companies with emergency loans. Furthermore, the Swiss National Bank has also recommended a temporary suspension of the countercyclical capital buffer that forces banks to set aside billions of Francs against possible mortgage loan defaults. This is to allow banks to release more capital which, according to Credit Suisse (March 2020), will play a major role in alleviating broad income shortfalls. It is worth noting that, according to the Swiss Federal Department of Economic Affairs, the Swiss economy still operates at around 80%, supported by key industries including pharmaceuticals, advanced industries, banking, and insurance. Further government economic relief measures are expected to follow, both at the federal and cantonal levels.
Overall, while the pandemic will undoubtedly be disruptive, the Swiss economy’s solid fundamentals and general competitiveness will likely translate into economic resilience and contribute to a speedier recovery. Such economic resilience is expected to be further supported by the ‘safe-haven’ nature of the Swiss Franc. Throughout previous crises and times of global uncertainty and instability, both economic (1997 Stock Crash; 1998 Russian Financial Crisis; 2000 Dot-com Bubble; 2008 GFC 2010 Euro Debt Crisis), and political/natural (2001 WTC Terrorist Attacks; 2002 SARS Outbreak; 2003 Iraq War; 2004 Tsunami; 2009 Swine Flu Outbreak), the Swiss Franc and economy have exhibited unparalleled resilience and proven to be a safe-haven destination to which not only Swiss institutional capital but increasingly also international capital was redirected.
Impact on Swiss Real Estate
While it is premature to accurately determine the full impact of this crisis on Swiss real estate, the current consensus is that the impact on non-hospitality and non-retail assets will likely be limited. According to Credit Suisse (March 2020), while the crisis will have some impact on real estate markets in the short run, “fears of an imminent crash are nevertheless unfounded”. The report outlines that, especially in the context of residential and non-retail rental assets, “the likelihood is that prices here will be only marginally affected by the crisis – even if the number of transactions looks set to fall sharply in the near term. The low level of construction activity seen in recent years is also likely to prove supportive.”
SE believes this is driven by three main factors: the availability of cheap funding (which will only likely be further extended as a result of this crisis), the low supply rates in the market, and the solid macro-economic fundamentals that currently support the Swiss real estate market and will play an important role in its rebound. While there is no doubt that Covid-19 will have a negative impact on capital values in the short run, the widening spread between prime real estate yields and the 10-year bond yields will likely further support the real estate market. Eventually, this will encourage further demand from Swiss and international investors searching for a secure rental income and positive risk-adjusted returns.
While the Swiss listed sector has been affected substantially, we believe that it was mainly driven by the general equity market movements and investor sentiment. It is worth noting that, comparing the relative performance of listed real estate indices vs. the all-equity market index, Swiss listed real estate indices outperformed, in relative terms, most other European listed real estate indices, including those of the UK, France, Italy, Spain, Sweden, and the Netherlands. Furthermore, the rebound of Swiss listed real estate market is likely to be substantial, supported by the relatively high implied yields at which many of the listed players are currently trading when compared to their historic averages.
Outlook and next steps
Moving forward, we expect the Swiss direct real estate market to remain resilient, supported by strong economic fundamentals and an accommodative monetary policy. We believe that current uncertainty could offer an attractive entry point and new investment opportunities – especially in the context of value-add situations and potential owner distress. The entire SE team is working harder than ever to preserve the value embedded in our existing portfolio as well as to analyse and react quickly to any situation or opportunities that might arise.
We hope to resume our face-to-face interactions as soon as the health authorities deem it safe for us all. In the meantime, we wish you and your families all the very best in these uncertain times.
Stay safe, stay healthy, and stay positive!
Rune Randrup-Thomsen and Thuqan AlHindawi