REAL ESTATE: MORE THAN AN ASSET

from MIPIM 2022 Preview Magazine

LOGISTICS

Property’s prime directive

While a flight to quality continues to define the real estate investment climate, investors are aware that even their bestperforming assets will need to align with a low-carbon future. Doug Morrison reports

The resilience of real estate income has proven its worth to investors in the face of the economic fall-out from COVID-19 and, according to leading consultants, it’s the key reason behind the resurgent transaction activity across Europe over the past year. This shows no sign of tailing off, albeit such strong demand comes with important caveats around short-term macro headwinds, the long-term structural challenges facing real estate and an increasingly important environmental, social and governance (ESG) agenda. Knight Frank predicts that 2022 will be a record year for global cross-border real estate investment, with EMEA as a whole potentially capturing more than 60% of all cross-border activity. The firm identifies US investors as a major provider of capital, accounting for almost half of inbound demand. All sectors are likely to benefit from this influx of capital, Knight Frank suggests, while Europe’s largest and most liquid markets — the UK, Germany, France and the Netherlands — will remain the most popular destinations. According to Savills, European commercial and residential investment volumes recovered by as much as 9% to around €288bn in 2021, and the firm is forecasting a 2% increase to €295bn this year. In other words, overall volumes are back to pre-pandemic levels although the industry is far from complacent. Richard Holberton, CBRE’s senior EMEA research director, believes that the European Central Bank will keep base rates on hold until 2023 and accordingly the current outlook remains broadly favourable to prime property. Even if there were to be a modest rise in interest rates across the eurozone, prime property yields should sharpen in the near term as economic recovery drives rental growth, offsetting any small increase in the cost of capital. But Holberton concedes: “There are risks to this view.” The main concern is that the current, above-average inflation continues for much longer.

Nuveen’s jointly-held portfolio with Neinver — including Amsterdam The Style Outlets — won five stars from GRESB in 2021

Though some in the industry see it as “transitory” others are struggling to interpret the lasting impact of surging energy prices, supply chain disruptions and labour shortages on real estate. The other big economic risk comes from the recent Omicron surge — and the prospect of still more COVID variants — with further restrictions to business and travel. But there are also longer-term implications, warns Lydia Brissy, Savills’ European research director. As she says, the longer the health crisis continues, the more likely the structural changes imposed by the pandemic will become permanent. Given such uncertainty, Brissy suggests that “flight to quality will remain the investors’ leitmotif” although it is evident that quality in European real estate today is defined as much by adherence to ever-higher ESG standards as traditional criteria around location and strength of covenant. The ESG agenda is already opening up a yield-gap between environmentally good and bad properties — the green premium versus the brown discount — which Brissy says will incentivise investors to repurpose stock to achieve greener standards and embrace social values.

Even then, the ongoing narrative for the office sector is hard to assess. It remains the biggest draw for many institutional players and yet it’s a sector where the ESG imperatives — and the risk of obsolescence — are tangled up with the ongoing uncertainty around hybrid working and the general health of central business districts (CBDs). According to JLL research director Jeremy Kelly, CBDs have been showing signs of life lately after going ominously quiet at the start of the pandemic. Premium offices rents are generally holding up better than in decentralised areas. “There’s a new energy to be found, most notably in the CBDs of major gateway cities, and where there are solid amenities and accessibility,” he says. “Urban living is back in vogue, while tech companies, law firms, e-commerce firms are taking space in CBD locations.” With low vacancy rates in the major European CBDs, most agents are forecasting rental growth for prime offices in 2022. Investors, in turn, are expected to become increasingly selective and therefore further widening the gap in rents and values between prime and secondary assets. JLL predicts that as economies continue to recover in 2022, investors will begin to reconsider retail and hotels — as well as offices — after a difficult couple of years. Like most of its peers, the firm also believes that surging demand will continue unabated for those sectors that have been seen by investors to “offer resilience” consistently throughout the pandemic: residential, life sciences, data centres and logistics. Logistics, notes JLL, accounted for

23% of global real estate investment in 2021. Though sectors such as logistics appear to be safe bets for the foreseeable future, most investors and their advisers are advocating greater portfolio diversification — but not just in terms of assets and locations. The pandemic has prompted a re-appraisal of what constitutes successful, high-quality real estate investment, both financially and in an ESG context. “Increasingly, investment strategies will start to focus on diversification across various sources of risk rather than across different asset classes,” says Dragana Marina, CBRE’s sustainability research lead for Continental Europe. As Marina puts it, this shift in approach to investment is inevitable given the “real threat of value erosion on carbon-intensive assets”, due to increasingly stringent regulations but also pressure from financial institutions, stakeholders and occupiers. And the stakes are high, says Nuveen Real Estate. In its latest discussion paper, the global investment manager argues that “markets risk over-playing the property-type performance divide and underestimate the tremendous trend shift in the wake of the net-zero carbon drive”. Given European governments’ regulatory and investment drive towards a low-carbon economy, Nuveen suggests the winners will be those assets that rise to the low-carbon challenge and those real estate managers who regard it as an investment opportunity rather than a risk. “On the other hand,” the report by Nuveen concludes, “carbon-inefficient buildings running on outdated technology and asset owners missing this sea change will have to grapple with underperformance and stranded assets.”

Lydia Brissy, Savills’ European research director

“Increasingly, investment strategies will start to focus on diversification across various sources of risk rather than across different asset classes”

Dragana Marina

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