The Covid-19 outbreak is a real challenge for European Real Estate markets, after continuous gains in capital value and decline in prime yields for almost all those markets since 2013. Indeed, the fast expansion of the coronavirus worldwide has forced governments to take extensive containment measures, leading to a decline in GDP for European countries in 2020 to an extent unseen since 1945. Moreover, with air traffic down by 80% overall and borders almost closed, the fall in tourism will have some specific knock-on effects on retail real estate.

In the office market, many companies have successfully shifted to a forced "working from home" model. We believe this will lead to an acceleration of the remote working structural trend and will therefore reduce the office space needed for efficiency reasons. Conversely, the crisis has proven the need for less density in the office space for health reasons. Increasing square footage per person in office buildings will therefore partly offset the negative impact coming from remote working development.

We have carried out an econometric exercise in order to estimate the impact from the Covid-19 crisis on real estate valuations, by focusing on four continental European markets, namely Germany, France, Spain and Italy, as well as three types of real estate assets (offices, retail and residential).

European offices to suffer significant drops in capital values until end 2021

For the office market, we expect the take-up to decline by 30% to 35% from the levels reached at end-2019, in line with what has been seen in the previous economic downturns in 2002 and 2008-09. Indeed, despite the financial support packages announced by European governments, corporate insolvencies are still expected to increase. Euler Hermes forecasts an 8% increase for instance in France in 2020 while Coface expects a 25% increase in insolvencies worldwide and 18% in Western Europe. Furthermore, companies will give priority to restoring their business, hence postpone their real estate projects. Moreover, cross-border investment flows will fall, while they have been supporting valuations in European offices over the past years.

On the other hand, we assumed that the vacancy rate would rise more modestly than in the previous crises thanks to the current shortage of new office spaces, while deliveries could be strongly delayed going forward.

All-in-all, we expect European offices to suffer significant drops in capital values until end 2021. The Paris prime office market could lose 10% of its value, while the drop could amount to 20% for the biggest German and Italian cities. We believe that rents will also decline but to a lesser extent, by 5 to 10%, with Spain holding up better.

Retail Real Estate will be hit sharply by the coronavirus crisis

Retail Real Estate will be hit sharply by the coronavirus crisis. Firstly, population lockdown and closures of most shops in Europe obviously had an immediate dramatic impact on retailer sales.

At this stage however, it is very difficult to formally assess the number of retailers which will be in a stressed financial situation after the lockdown period. On the other hand, we can already see negative impacts on retail property owners. In France, for instance, landlords are now calling rents monthly and in arrears vs. a quarter in advance previously. Besides, the French government has encouraged retail property companies to cancel rents for a period of 3 months for very small companies whose shops had to close. Although in theory, lease contracts should protect lessors from losing rental income, many tenants, even large international retailers, have already requested some rent cancellation or variable rents during the coming reopening phase.

Furthermore, and without envisaging so far any "stop-and-go" measures of lockdown, we assumed a 15-20% drop in overnight stays in 2020 for big European cities due to the collapse in tourism numbers. We also expect a fall in private consumption stemming from Natixis' economists' forecasts. As a result, we expect significant yield expansions for all retail real estate markets over 2020-21, especially for shopping centers. According to our models, Prime yield expansion in High Street could go from +50bps in Spain to +130bps in Italy, implying up to 30% drop in capital values for the latter. As far as shopping centers are concerned, we expect a prime yield increase between 90bps in France up to 180bps in Spain.

In the longer term, some trends for offices will accelerate, and others will emerge. The future of physical retail again raises questions, such as will social distancing become the new normal in shops? And how to do shopping while respecting these new rules? Retailers together with their landlords will have to adapt, otherwise e-commerce will definitely take a great leap forward.

Residential real estate will be more resilient

The residential market will also be adversely affected by the pandemic-induced lockdowns and notable contractions in GDP activity. Yet, the impact on residential property will be less severe compared to other real estate segments, owing to its role of a consumption good providing shelter. We expect housing prices to drop by a maximum of 5% this year. First, there are practical issues such as a temporary halt in viewings. And second, there is an increasing lack of confidence in the market due to fears of a long-lasting economic recession, household insecurity about employment and income prospects and a turbulent stock market depressing household financial wealth.

All in all, we expect that buyers' confidence will improve along with a rebound in economic activity. Yet, it is important to note that the GDP level at the end of 2021 will be still below the level at the end of 2019.On a more positive side, monetary and fiscal policies will stay accommodative through 2020, which, along with looser macroprudential measures, should help residential markets regain strength in the second half of the year. Moreover, residential real estate is likely to benefit from flight to core investments and the development of working from home habits.

Valuation drops of 5% for residential, 10% to 20% for offices and up to 30% for retail real estate

To summarize, we expect the following hierarchy in terms of impact on real estate valuations: residential to be more resilient, followed by offices and retail. The order of magnitude of the decline in valuation is a maximum 5% for residential, 10% to 20% for offices and up to 30% for retail real estate.

In the residential market, we expect Germany to outperform other markets. In contrast, we see the office sector outperforming in Paris, while office properties in Italian and German cities will underperform. Meanwhile, in the retail sector, we expect Spain to outperform, particularly in High Street, and Italy to underperform.