What the past relationship between GDP growth and property total returns tells us about the likely impact of the COVID-19
19 Jun 2020
In a time of crisis, it’s human nature to look for comfort in simple rules of thumb or mantras that provide guidance with questions like ‘how bad can it be?’ or ‘when will this pass?’. In a global pandemic and with 2020 GDP growth being cut severely, are there any rules of thumb that may tell us about the impact of COVID-19 on real estate? If asked what my best guess for 2020s property returns or losses might be given the GDP outlook, how could I come up with an answer?
We know that occupier demand for real estate is a derived demand as offices, shops and industrial property are needed to generate economic activity. Real estate is a factor of production and so it is not a surprise to find that the return to that factor of production is highly correlated with economic output.
Over a decade ago just before the GFC (Global Financial Crisis) when I was delving into data looking for leading indicators of property performance, I noticed that GDP growth multiplied by four gave a pretty good fit with UK MSCI all property total returns. While this is a simplistic view of the world it is visually very strong (and more so in a downturn), as shown in Figure 1. This makes grim reading for 2020 as a significant fall in GDP is on the cards ̶ CBRE’s house view is for a more than 8% fall in UK GDP, which would equate to roughly a 32% fall in returns on this basis.
Figure 1: UK GDP growth against the MSCI all property total return
Source: MSCI, Oxford Economics, CBRE
Figure 2: USA GDP growth against the MSCI all property total return.
Source: MSCI, Oxford Economics, CBRE
The UK and USA have a relatively strong relationship between the economy and total returns, as would be expected given the mark to market inclination of their valuers. But how do things look for the UK’s continental neighbours? When examining MSCI data for France, Germany and the Netherlands, France and the Netherlands’ returns are correlated with GDP growth (88% in the Netherlands, 65% in France) and follow the movements of GDP, however not as closely on the downside as found in the UK and the US. For Germany, where valuation methods are different and more smooth, GDP and returns seem to have little relationship with a basic correlation on annual data of 22%. The data shows:
- Germany has only ever had positive returns on an annual basis even in the GFC
- The Netherlands saw only marginal losses in the GFC
- The losses in France seem modest compared to the falls in output during the GFC
The return data for the three continental countries shows little or no fall in returns during the GFC while the UK and the US saw losses of 20% and more. In 2009 Germany saw an economic contraction of 5% and yet still posted returns of 2%.
Where does this leave us? The economy matters but so do other factors. There is evidence that financial variables might matter as well as GDP growth. If we plot total returns against the annual change in corporate bond yields, we also get an interesting relationship. Corporate bond yields peaked in the GFC and rose in the early days of COVID-19 but after a brief spike they are back to mid-2019 levels. The lower level of indebtedness pre-COVID-19 relative to pre-GFC might also have an effect. This piece focuses on GDP growth, but financial markets will also have an effect. Perhaps 2020 will not be as bad for total returns as this simple four times GDP growth rule suggests.
Back to soothing mantras – this will pass and 2021 should be better and possibly much better for real estate.