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The good, the bad and the ugly of the EU’s funding package
Landmark €750bn EU package could boost real estate – if it can be delivered in time
Europe’s leaders recently concluded four days of arduous negotiation in Brussels to unite behind a recovery fund which is designed to support member states’ economic rehabilitation.
It is a genuinely ‘landmark’ moment. That is an often over-used description, but in this case it is fitting as the fund binds the bloc into a tighter fiscal union by €750 billion of debt at the EU level.
Called the Next Generation EU, this fund and what it means for member states, economies and ultimately real estate markets, is perhaps best analysed under three headings: the good, the bad and the ambiguous.
The fund demonstrates solidarity during an acute crisis which has the potential to be economically more severe than the Global Financial Crisis.
While the crisis accentuates and consolidates the wealth divide between North and South Europe, the fund bridges the conflicting priorities of the richer and poorer EU member states.
Essentially, the fund jointly raises debt on capital markets backed by the EU’s aggregate credit-worthiness. This vastly lowers debt costs for countries most severely affected by Covid-19, such as Spain, Italy, and France, which all have debt-to-GDP ratios way above 100% and whose individual borrowing costs would be much higher.
It is a cruel irony that many of the economically weaker countries pre-Covid have also been most severely affected by the pandemic, accelerating their economic woes.
Austria, Denmark, Sweden, and the Netherlands – known as The Frugal Four – were vehemently against debt mutualisation which has been a lightning rod for acrimonious euro division. The Next Generation EU deal has de-escalated much of the tension.
The agreement, combined with the concurrently approved €1.074 trillion seven-year EU budget, signifies, at least in the medium term, diminished risk of further euro fragmentation.
The new EU budget, which of course now excludes the UK, is the bloc’s greenest ever, prioritising EU climate goals by reducing carbon emissions and investing in the electric automobile sector and other sustainable technologies.
Accordingly, the self-congratulation has been flying among Europe’s leaders over the last week or so.
The markets’ initial exuberance following the announcement of the stimulus package saw the euro climb to its highest value against the dollar in almost two years.
However, the hubris was tempered by the publication of the EU’s Q2 2020 GDP figures. These were as bad as had been expected: -12.1% which had followed -3.6% in Q1.
Even with the new stimulus package, recovery is likely to be slow and uneven. In any case, it could be several months before the funds for the stimulus package can be raised and their distribution to the still-reeling nations and economies can begin.
For companies and households unable to work, or who have seen demand for their services collapse, the near-term liquidity crisis continues.
The fate of companies, their supply chains, and their employees are interwoven. Government furlough schemes will still need to support certain companies in the near term.
The degree to which companies and households can return to work will depend upon which sector they serve. So too will the extent to which demand loss is temporary or permanent.
The fund includes both grants and loans. Grants comprise €390 billion – scaled back from €500 billion at the insistence of The Frugal Four – with individual country allocations linked to GDP and unemployment forecasts.
More severely affected markets such as Italy, Spain, Greece, Portugal, Poland and France are thus targeted. However, these allocations are as yet unknown, so planning at the national level is currently frustrated.
The balance of the fund will be distributed to better capitalised nations in the form of low-interest loans. The official timeline states that 70% of the fund will be allocated in 2021 and 2022, with the balance in 2023, but economists at research firm Capital Economics warn that it could take much longer to disburse the money.
Checks and balances on the judicious use of proceeds were removed by dissenting nations in order to ensure an agreement was reached. However, this clearly restricts the level of oversight of the use of loans and grants. Furthermore, some bureaucratic wastefulness is also probably inevitable.
The system for distribution of EU grants/loans to companies and households is also unclear. In the UK, for example, the Bounce Bank Loan Scheme was deliberately conceived with light-touch oversight.
Companies do not have to prove their ability to repay nor is there much requirement to justify revenue/profit forecasts. This opens up the scheme to a degree of moral hazard. Companies could potentially use the grants/loans unethically, or simply shore up businesses that would have failed even without the intervention of Covid19.
But the EU was forced to make a rapid selection between least-bad options and whichever way it turned was bound to attract criticism.
If it had nothing it would have been pilloried; if it was locked in a stalemate it would have been criticised for not acting fast enough, and if it has conceded too much ability to oversee spending it will be castigated for profligate use of taxpayers’ money.
What does all this mean for real estate?
The Next Generation EU loans and grants will no doubt trickle through to real estate as they boost occupier cash flow, but timing is crucial.
In the property world dented cash flow means that some companies, both tenants and their landlords, will continue to have near-term liquidity problems.
Furthermore, any serious second waves of Covid19, which are anyway likely to occur at different times in different countries, will compel lockdowns that precipitate further bankruptcies or the creation of ‘zombie’ companies with legal protection against bankruptcy.
Meanwhile, a period of merger and acquisition activity could be expected among companies that believe being bigger in a weaker environment may reduce competition and help to trim operating costs.
Future trends in real estate transaction volumes will partly depend on the degree to which any second wave of Covid 19 manifests itself. But they will also be determined by investors’ confidence in the property markets. That will vary from country to country.
So far, Germany is the benchmark and it could be argued that its real estate market has been resilient because of the effective management of risk perceptions.
Investment activity – as well as household spending and broader business sentiment – is currently correlated to perceptions of success in containing the pandemic.
But, as we know, containment is fragile and if sentiment flips because countries are perceived to have lost control, activity likely to retrench and will do so rapidly.