Commercial property may never recover to pre-COVID, Singapore, Japan, Hong Kong hardest hit
By Lloyd Chan and Adam Slater
1. APAC commercial property prices were down around 3 percent on average in 2020, after a 1 percent rise in 2019. But the coronavirus-induced decline has been modest compared to past downturns, suggesting that the impact on banks’ commercial real estate loans will generally be much smaller this time.
2. Across individual markets, the pandemic’s impact on CRE (commercial real estate) prices is mixed. Singapore, Japan, and Hong Kong have been the hardest hit, whereas South Korea, China, and Indonesia have seen modest gains. Meanwhile, Hong Kong’s market is showing signs of a recovery after large price falls in recent years.
3. Office rents have stayed below the pre-crisis level of Q4 2019 in most APAC economies. Hong Kong and Singapore have fared the worst and retail rents in both cities remain under immense pressure, which could weigh on capital values. But industrial rents in Hong Kong have rebounded, supported by demand from tech and e-commerce players.
4. While credit risks in CRE loans have risen, APAC banks are generally well capitalized to cope with CRE-related losses. CRE loan exposures are also mostly not elevated. Policy actions offering relief for the sector and a global recovery should provide more support.
5. Still, banks will need to be vigilant about further price drops and the long-term impact of the pandemic. A key concern is whether the pandemic will trigger fundamental changes in demand for commercial properties, which could lead to chronic oversupply, depressed rents, and defaults.
The unprecedented nature of the coronavirus pandemic has led to prolonged travel restrictions and social distancing measures. These restrictions have taken a toll on economic activity in the region, with several economies in particular experiencing very large GDP declines.
While sequential growth has rebounded, output in many APAC economies remains below the pre-crisis level of Q4 2019. Given the highly cyclical nature of commercial property markets, we have assessed the impact of the pandemic on the sector and the potential spillover effects on banks, which are major players in the commercial real estate market.
Restrictions to curb the spread of coronavirus, coupled with the economic downturn, are having a negative impact on the CRE sector. Hotels are operating at a very low occupancy rate as international tourism has collapsed.
Retail units have been hit hard as virus fears and containment measures weigh on customer footfalls, while office rents have been pressured by challenging business conditions and the shift to telecommuting.
According to our index of regional CRE prices based on four main markets – Hong Kong, Japan, Singapore and South Korea – prices were down around 3 percent on average (a 4-5 percent drop based on median) in 2020, compared to around 1 percent growth in 2019.
But the pandemic-induced decline based on our regional CRE price index has been modest compared to past downturns. Possible factors supporting capital values include a relatively well contained COVID-19 situation in the APAC region and the low interest rate environment.
The modest price decline suggests that the region’s CRE sector has been relatively resilient, implying that the negative spillover effects on banks will likely be smaller than in previous downturns. Indeed, much larger property price declines were seen during the 1997-1998 Asian financial crisis and the 2008-2009 global financial crisis.
During the Asian financial crisis, for example, non-performing loan ratios jumped to around 15-25 percent in several APAC economies, where the share of property exposures in total loans and loan-to-value ratios were elevated at more than 25 percent and 80 percent, respectively.
Looking at individual CRE markets in the region, it’s clear the impact of the pandemic has varied.
Singapore, Japan, and Hong Kong have been the worst performers, with latest prices falling around 3-6 percent year on year, though this was better than the US and UK, where prices fell over 8 percent year on year in Q4 2020.
Meanwhile, South Korea’s CRE prices rose around 4 percent year on year, while China and Indonesia saw modest gains compared to a year ago.
Before the pandemic, the biggest price falls were also evident in Hong Kong and Singapore. Both cities were affected by a marked deterioration in the external environment amid US-China trade uncertainties, while the domestic political crisis in Hong Kong has exacerbated the fall in CRE prices.
Still, these price declines have been moderate compared to some of the worst falls historically. A sequential pick-up in Hong Kong office prices in H2 2020 despite rental declines also helped support overall CRE prices, which fell 3.2 percent year on year in Q4 2020, versus a 12.4 percent drop in Q2 2020.
Meanwhile office rents remain below the pre-COVID-19 level in many APAC economies, with Hong Kong and Singapore faring the worst, amid downsizing and caution over committing to new leases.
Office rents have also not seen an uptick in China, though improving economic conditions there could help to lend some support this year. Rental movements also show varied fortunes among the different subsectors in Hong Kong and Singapore.
Hong Kong’s office and retail rents remain under pressure, down 10.6 and 7.8 percent year on year in Q4 2020, respectively. But industrial rents picked up strongly in H2 2020, while still down 0.6 percent on the year in Q4 2020, supported by demand for storage and data centers amid robust growth in the tech and e-commerce sectors.
In Singapore, office rents fell 8.5 percent year on year in Q4 2020, while retail rents plunged 14.7 percent - the largest decline in the history of the series.
Steep rental declines will weigh on yields and potentially exert further downward pressure on CRE prices. While the credit risk of CRE loans has risen, APAC banks are generally well capitalized and should be able to buffer against CRE-related losses.
Loan loss provisions have also increased to account for asset quality weakness. In most APAC economies, the share of CRE exposures in total loans is also relatively low.
China, Vietnam, and Australia have lower shares of CRE exposures than they did several years ago, while shares in Cambodia, Thailand, and Hong Kong have been stable. While South Korea has an elevated share, prices have stayed resilient, implying that the credit risks of its CRE exposures appear to be contained
Policy support has also helped to cushion the pandemic’s impact on the CRE sector.
Singapore has rolled out loan relief measures for small and medium enterprises and extended the timeline for REITs to distribute their dividends. In Hong Kong, the loan-to-value cap on CRE mortgages was raised from 40 to 50 percent in August 2020.
China has also boosted infrastructure investment to stimulate the economy and support property developers. After a dire performance in 2020, a global economic recovery this year amid rising vaccination rates across the world should help to ease pressure on the CRE sector.
In addition, a more sustained relaxation of COVID-related restrictions in 2022 should provide impetus for a CRE recovery, although the pace of the rebound will likely be moderate as vacancy rates will take time to normalise.
The extraordinary effects of the coronavirus crisis could also mean larger and lengthier downturns in some CRE sectors, which could result in much higher loan losses. The long-term impact of the pandemic is also a concern, particularly whether the coronavirus pandemic will trigger fundamental changes in the demand for commercial properties.
While brick-and-mortar retail space has been affected by e-commerce trends since long before the pandemic, it could come under greater pressure from changes in consumer behavior induced by the pandemic.
It’s also still not clear whether work-from-home arrangements will become a permanent trend, which would sap demand for office spaces. It’s possible that demand for office, retail, and hotel space may never recover to pre-crisis levels, leading to chronic oversupply, depressed rents, and defaults.
*This report is prepared by Oxford Economics' senior economist Lloyd Chan and lead economist Adam Slater.