by Julian Roche MA (Oxon), MPhil, PhD, Chief Economist for Cavendish Maxwell
Famous pandemics of history
Plagues have marked human history, from the Black Death in the 14th century to the Great Plague in London in the 17th century and the successive waves that affected Islamic cities such as Baghdad and Alexandria in the 19th century. In more recent times, the most famous was the 1918–19 Spanish flu pandemic which infected 500 million worldwide, about 27% of the global population, killing anywhere between 20–100 million. Successive flu waves, Asian Flu 1957–1958 and Hong Kong Flu 1968–1969, were less devastating. SARS 2002–2003 was a coronavirus that originated from Beijing, China, spread to 29 countries, and resulted in 8,096 people infected with 774 deaths. In the last decade, the 2009–10 swine flu pandemic infected around 700 million, 11–21% of the then global population, killing between 150,000–575,000, whilst MERS in 2012 killed 858 people out of the 2,494 infected.
Chilling as these statistics are, we should remember that every year an estimated 290,000 to 650,000 people die in the world due to complications from seasonal flu. In comparison, towards the end of the first quarter of 2020, there were over 415,000 confirmed cases of Covid-19 with more than 18,000 deaths. The difference, orders of magnitude of scale, is stark: although this may change; as of March 2020 the world only faced a potential pandemic at the time of writing, despite the World Health Organisation (WHO) announcement.
Potential or real, the problem with trying to isolate the economic effect of Spanish flu, SARS or swine flu is that in each case it is overwhelmed by other economic factors: the end of World War One, the upswing in the global economy during the tech boom, or the beginning of the slow recovery from the global financial crisis of 2007–2008. The pandemics have not had the field to themselves.
Real estate and the pandemic
Whilst tourism and hospitality seem like the obvious sectors to be affected, what about the impact on real estate markets? We know that ‘usually, a downturn in median home prices doesn’t appear for about 18 months after a major stock market crash, the most well-known being that after the 1987 Wall Street crash. There are several reasons, most obviously that the first effect of a rapid fall in stock market prices on real estate, whether caused by a pandemic or otherwise, is to crush liquidity. This delays any evidence of declining price given that transactions are the lifeblood of real estate indices, even those based on valuation. Remarkably, from a contemporary perspective, stock market valuations remained largely insulated from the Spanish flu, which, as a result, had little effect on real estate prices, especially when combined with the macro-economic effect of the end of the war. The Land Registry’s long-term house price index for the UK shows no discernible impact at all.
SARS in Hong Kong seems to have had a similar limited effect. A price decrease of 1.6% was identified after the start of the epidemic for all housing estates, as well as an additional decrease of less than 3% for the average SARS-affected estate, i.e., those that were publicly known to have had SARS cases or were mentioned in the newspapers in relation to SARS. The lack of liquidity was the deciding factor in preventing a more precipitate fall.
Compare this to what happened to UK house prices during the swine flu pandemic of 2009[4]. They did fall precipitately. In a market much more dependent on lending, jobs were cut, incomes fell, houses had to be sold and the government provided only a very limited safety net by comparison to a similar market collapse in 1987. As a result, liquidity was not choked off and this helped achieve much lower achieved selling prices, reflected in house price indices.
But no one believes that the fall in residential prices had much to do with swine flu itself. The global recession which followed the 2008 financial crisis was a far more important factor: the pandemic was crowded out by a threat even bigger than itself.
Finally, it is worth observing that if valuations were to rely on Discounted Cash Flow, then short term falls in demand generation, pressure on landlords to cut rents, as at Hong Kong International Airport, demands for rent renegotiations, and invocation of force majeure clauses will all drive down short-term property values, especially of income-led property – even without actual transactions. So although in the US, real estate sales volumes showed no noticeable impact from either the 9/11 attacks or SARS, there was a massive fall in real estate sales around the time of swine flu, not an especial function of the pandemic, but rather a function of the looming recession, which crushed lending liquidity.
There is evidence that the crushing of liquidity has happened already: South Korea’s apartment market saw an average of just 458 deals per day nationwide in the first nine days of March, compared to 2,272 deals per day in December, whilst in the densely populated capital of Seoul, daily deal volume has fallen by 90% from 309 deals per day to just 31. Under these circumstances, transactions-based real estate indices will now become unreliable guides to actual prices, which become largely hypothetical in the absence of even the most basic market liquidity as investors postpone decisions and sellers cling on to their assets. Mostly, they flatline. Only if the pandemic is contemporaneous with a more significant recession do they demonstrate significant falls.
What sort of recovery?
In general, the pandemic effect is expected to be a short-term shock[ – either a very sharp (“V-shaped”) fall in stock markets and the economy followed by a rapid recovery, or a more gradual recovery (“U-shaped”). The evidence from SARS suggests that economies and real estate markets bounce back relatively quickly from pandemics, if they are not contemporaneous with recessions, both the 1918 pandemic and SARS demonstrated. Asian economies, and their real estate markets, rebounded both quickly and significantly after the end of SARS, within a single quarter.
In the current case, interest rate cuts initiated by worried governments and other measures such as the moratorium on mortgage and other debt payments introduced in Italy also mean that there could be a policy overshoot that could be advantageous to real estate investments, as a result of stimulus packages still creating an impact after they are no longer required. When combined with temporary construction halts, supply choke points could emerge and pricing could become highly localised. This is especially the case as there are some other economic effects such as the impact on exchange rates. The AUD, for example, has now reached depths against the USD not seen since 2003. The fall in oil prices will threaten carefully structured budgets and therefore quite possibly see infrastructure projects delayed. But transmission from the macro-economic environment to the real estate market is not all negative. Interest rates are now likely to remain lower, longer.
The most likely outcome is for a V or U-shaped economic recovery, relatively limited macro effects on the real estate market, and a return to the old normal. But Covid-19 will provide additional impetus from the crisis to the transition already under way to the new normal, with yet again residential real estate the big winner.
