• Private Equity and
    Real Estate
COVID-19 Insight:

Private Equity and Real Estate Valuations in a Time of Crisis

08 May 2020

Interview paperjam.lu du 08.05.2020

The COVID-19 crisis may revolve around public health, but the economy has also suffered during the pandemic. Edoardo Ancora (Corporate Finance) and Livio Gambardella (Real Estate Leader), partners at BDO Luxembourg, discuss how investors in private equity and real estate can assess values and opportunities during the outbreak.

Could you tell us how the COVID-19 crisis will impact the private equity and real estate industries?

Livio Gambardella (Real Estate): The first impact is that many players in the market are choosing to delay transactions due to a shift in valuations. Market value depends on rental cash flow. When tenants no longer have income to pay their rent, there is a resulting drop in market value. Hopefully, this will be a short-term issue, but it may change the way a tenant’s risk profile is assessed in the future, with those providing essential goods and services deemed to be a lower risk than those working in sectors that are less critical.

Edoardo Ancora (Private Equity): An honest answer is that nobody knows. It is essential to consider the impact on exits and returns, both of which are likely to drop in the short term, and fund-raising, the decline of which will probably be less severe this time around compared to the 2008 crisis. The opportunities for deal making are key however, and they will be plentiful. With the public markets depressed and potential corporate buyers holding onto their cash, private equity funds are well-positioned to be the buyer for any asset that comes up for sale.

In terms of valuation, what are the first effects to be seen on the market?

Livio Gambardella: Today, valuers are facing material uncertainties on how to value a property since the only reliable data is the property’s historical trend value. Even a comparison with similar transactions in the same or an analogous market is unlikely to help because very few transactions have been concluded during this period. As recently advised by RICS, when it comes to assessing a property’s market value during the crisis, it is more important than ever to undertake accurate due diligence, in particular with respect to the creditworthiness of existing tenants. To highlight such uncertainty, RICS regulated members are advised to include clear material valuation uncertainty declarations in their reporting. In line with RICS recommendations, I believe it may be useful to stakeholders to provide an alternative valuation that assumes the current circumstances and constraints do not exist.

Edoardo Ancora: Cash flow difficulties and deviations from previously drafted business plans along with extreme market volatility and uncertainty mean that buyers and sellers are placing different values on assets. One way of bridging the gap may be to implement ad hoc earn-out structures.

« In times of crisis, there is only one thing to do: go back to the basics. »

Edoardo Ancora,  Corporate Finance Partner,  BDO Luxembourg

How can private equity investors ensure that their valuations are accurate in the current climate?

Edoardo Ancora: As my first CEO told me 20 years ago, in times of crisis, there is one only one thing to do: go back to the basics. Private equity investors need to fully understand the core business of the portfolio company and how the pandemic will impact its main value drivers – turnover, margins, etc – as highlighted by the Special Valuation Guidance issued by IPEV Board on 31 March 2020. Be realistic; with respect to valuation inputs, avoiding a “double dip” is essential – as is being transparent in explaining the techniques and assumptions made in defining fair value definitions in order to gain the trust of all stakeholders.

What recovery and what changes should we expect to see in the real estate sector?

Livio Gambardella: Property is, and will remain, one of the most attractive investments for investors, especially now given the volatility of the stock market, continuing low-interest rates and the financial support measures some governments have put in place. This will all help the real estate sector recover quickly. Once the pandemic is over, I think investors should expect to see a change in lifestyles that will reshape the real estate sector. For instance, the increased popularity of online shopping may see an even higher demand for warehouse space at the expense of traditional retail outlets, while working from home may become more routine, leading to apartment designs incorporating office spaces, and office blocks changing to accommodate more flexible working practices. I would not be surprised if new lease agreements included a clause in case of future pandemic events, for instance, offering a certain flexibility in payment solutions.

« Once the pandemic is over, expect to see a change in lifestyles that will reshape the real estate sector. »

Livio Gambardella,  Real Estate Leader,  BDO Luxembourg

How can BDO help its clients during the crisis?

Livio Gambardella: We try to build long-term relationships with our customers. In times of crisis, it is more important than ever that you can rely on trusted partners. I believe that in a period like this, when added-value services and strategies to improve cost effectiveness become crucial to RE investors, BDO is the ideal partner for structuring deals and administering real estate vehicles.

Edoardo Ancora: In addition to the usual corporate finance services - valuation, transaction support, and M&A advisory - we have designed three dedicated services to support PE through the pandemic and beyond, namely:

1) Portfolio company optimisation: We help the PE industry analyse their portfolio companies to identify
    weaknesses and strengths thereby maximising value creation for investors.

2) Independent business review (IBR): We support the PE industry by independently assessing and
    reviewing the portfolio companies’ business plans to analyse key value drivers.

3) Distressed and Accelerated M&A: We assist our clients in the disposal and acquisition of distressed
    assets due to liquidity shortfalls.