The subject is topical, and not merely because it’s Halloween. The effects of the COVID-19 pandemic have raised the spectre of a new plague of businesses being kept afloat artificially. As we head into winter with the virus resurgent in many parts of the world, there is a re-emerging threat of effectively insolvent businesses, or zombies, being kept alive by cheap government and central bank money.
The pandemic revealed early on which real estate sectors were of most concern to investors – there were sharp sell-offs in retail and office real estate. In the first wave, many tenants skipped paying rent or asked for rent relief, particularly in the retail and apartment sectors, causing the risk of bad debts to mount.
Fortunately, as the initial outbreak receded, rent collection improved. However, the return of the virus has renewed investor concern about the viability of businesses with zombie properties. Here, the pandemic is leaving a visible legacy. All you have to do is walk through a high street or business park to see the evidence.
According to Haitian folklore, zombies are dead humans revived through magic. And it is easy to see how the term has been applied to businesses. Zombie companies typically generate enough cash to cover their running costs, and can often service loan interest, but not the debt itself. ‘Zombie company’ was applied to Japanese firms supported by local banks during the ‘Lost Decade’ after the collapse of Japan’s asset bubble in 1990. The term re-emerged during the 2008 financial crisis as US companies were bailed out by the government.
Coming into the pandemic, as many as 15% of the world’s companies were zombie businesses, according to a BIS report (see Exhibit 1). Zombie firms are usually less productive, deeper in debt and invest less. The proportion of listed zombie companies has been rising in most countries even before the crisis.
Extensive coronavirus emergency lending looked set to intensify this process. A separate study of figures from credit insurer Atradius published in Dutch economic journal Economisch Statistische Berichten (ESB) confirms this. John Lorie and Iulian Ciobica showed that government aid had supported companies that would have otherwise failed. They found that 40% of companies in France and the US and 25% of UK companies would have become insolvent without support. In contrast, only 3% of Dutch businesses were effectively being kept alive by government funding.
Dawn of the Dead, Malls
‘Zombie’ has not been widely used in the non-residential, commercial real estate sector. There are countless websites in the US with advice on how to flip zombie residential properties, typically aimed at small investors buying homes in the process of foreclosure. The term has been more often applied to non-listed REITs in the commercial real estate area.
Non-traded REITs in the US became popular, particularly with retail investors, after the financial crisis, but some of these REITs grew so fast that they became difficult to unwind, overpaid for properties or had trouble selling assets at a price that would make investors happy. Such funds became zombies, drawing investor anger in the last decade.
In Europe, non-listed open-ended funds have at times been likened to zombies. A number are currently struggling with mounting debts, unpaid rents and falling property values as a result of the impact of COVID-19. Indeed, UK property funds available to retail investors, with about GBP 13 billion of assets between them, were suspended in the third week of March. The crisis is the second major event in four years causing asset managers to gate funds.
The summer months have offered little respite for retail property owners in the public sector in Europe and North America. Despite the relaxation of stay-at-home orders, and a return of shoppers, listed retail REITs faced a wave of distress. Rent collections slumped at the start of the pandemic and have recovered only modestly over the last six months.
In Europe, a large shopping centre REIT went into administration, while two other large pan-European REITs have been forced to raise billions of euros to tackle balance sheet concerns undermining the value of the shares owned by their investors.
In the US, more signs of distress among mall owners emerged this month with news that one mall REIT will skip a debt payment, while another is asking for help from its lenders to avoid bankruptcy. Many of the properties owned by these REITs could be headed for idleness and end up as relics on Deadmalls.com, the site dedicated to extinct retail outlets.
Shaun of the Dead
The pandemic has provided an additional lifeline for zombie companies, but when the virus is finally dead, it will be clearer how many businesses are still going concerns. Economic history tells us zombie companies are wasteful and use capital that could be deployed more efficiently. Zombie companies require growing amounts of capital to survive.
In the public real estate markets, we are beginning to see bankruptcies in Europe and North America, so investors will need to pay attention as growing numbers of real estate businesses become increasingly hungry for the abundance of cheap debt and unprecedented levels of liquidity flooding the capital markets.
 Zombieland, 2009 film about zombies by Ruben Fleischer
 Reported in Financieele Dagblad, 29.9.2020
 Dawn of the Dead, a 2004 classic zombie film by Zack Snyder
 Source: Financial Times, 16.9.2020
 Shaun of the Dead, a 2004 horror comedy directed by Edgar Wright
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