The Bank of Korea (BoK) yesterday (March 16) cut the base rate by 0.5% bps from 1.25% to a historical low of 0.75%. The move – which followed the U.S. Federal Reserve cutting its rates to zero – was the third cut in the current easing cycle after the BoK lowered the base rate from 1.75% to 1.5% last July and then cut it further to 1.25% in October.
Base interest rate: US vs Korea
Source: CBRE Research, March 2020
The cut is intended to offset the economic impact of the ongoing COVID-19 outbreak. While the pace of daily new infections in Korea has shown signs of slowing since last week, the outbreak continues to weigh on Korea’s trade-reliant economy. Severeness of COVID-19 crisis is portrayed by Monetary Policy Board's interim meeting to cut the base rate, an occasion that only happened twice in history in 2001 after the 9/11 terror (0.5%p↓) and in 2008 during the global financial crisis (0.75%p↓). At the end of February, the BoK lowered its outlook for 2020 GDP growth from 2.3% to 2.1% but stated yesterday that a further downward revision is likely.
What does it mean for real estate?
Between January and mid-March of this year, Asia Pacific transaction volume fell to 40% of that of Q1 2019. In contrast, the Korean real estate investment market has enjoyed a strong quarter thus far, with transaction volume already eclipsing that recorded in the same period of last year. While travel restrictions are impacting activity among foreign investors to a certain extent, domestic investors – which account for more than two-thirds of total investment – are displaying robust demand and continue to pursue acquisitions.
Seoul commercial real estate transaction volume by sector
Source: CBRE Research, March 2020
Should the COVID-19 outbreak in Korea continue to be brought under control, investment activity will strengthen, led by domestic investors, which accounted for almost 80% of total investment in 2019. Foreign investors are also likely to turn more active once travel restrictions are lifted. CBRE’s Asia Pacific Investor Intentions Survey 2020, which was published earlier this week, ranked Seoul the 6th most popular city for real estate investment in the region.
Yesterday’s base rate cut is expected to improve market liquidity and maintain the relatively attractive yield spread in the office sector – which should have a positive effect on investment demand. While a prolonged economic downturn may lead to a slight decline in asset prices as landlords or companies with insufficient liquidity dispose of property holdings, the rate cut will strengthen owners’ holding power. Well-located prime core assets in Seoul will be resilient and are set to remain attractive defensive plays.
Logistics investment transactions totalled around KRW 2.0 trillion in 2019, an increase of almost 100% y-o-y. Interest in logistics assets is expected to intensify in the coming months given the shift to online shopping – particularly for fresh food and daily necessities – witnessed since the COVID-19 outbreak. This has led to surging demand for last mile logistics facilities, especially cold storage.
With tourist arrivals slumping and local shoppers advised to stay home, the brick-and-mortar retail sector has been hit hardest by the COVID-19 outbreak. The Consumer Composite Sentiment Index (CCSI) fell from 104.2 in January to 96.9 in February, while February’s y-o-y revenue growth rates for department stores and hypermarts were -30.6% and -19.6%, respectively. Further declines are likely in the event of a prolonged COVID-19 outbreak.
Aided by a government pledge to relieve corporate tax on 50% of total rent cuts, selected landlords have offered rental discounts or refunds to tenants to alleviate the stress affecting the sector. CBRE is aware of one landlord that recently agreed to a short-term rental reduction and relief scheme for a tenant upon request, with further cases likely to be witnessed in the coming weeks.
Investor sentiment for hypermarkets and entertainment-related assets (i.e. cinemas), along with hotels, is likely to weaken as these properties experience a short-term reduction in rental income. Public REITs’ disposal of hypermarkets may be also impacted.