April 2020

Real estate investment in a time of crisis

Natural_disasterAs volatility dominates the markets, Alex Rolandi and Romil Patel look at the advantages and risks of investing in real estate during uncertain times. More than a decade on from the global financial crisis in 2008, Asia-Pacific real estate continues to produce strong returns, according to a joint report by PwC and the Urban Land Institute. A low interest rate environment on the continent – and globally – has seen investments into the sector explode over the past five years. Given the severity of the coronavirus, the Bank of England and US Federal Reserve slashed interest rates in March while the European Central Bank announced an emergency stimulus package in a bid to counter the economic impact of the outbreak. Thailand’s central bank also cut its key interest rate to a record low of 0.75% – and other Asian countries could also deliver unscheduled emergency rate decisions. Declining interest rates in 2020 could see continued investment into real estate and further allocations from long-term investors for future income – be they from insurance funds, sovereign wealth funds or family offices. “The big backdrop behind real estate investing at the moment is the lower-for-longer interest rate environment we’re in. This sort of big macro underpin has generally been good for real estate and infrastructure,” says Mark Versey, chief investment officer of Aviva Investors’ real assets arm. “With low rates in the market, it’s been quite hard for investors to get good enough yields elsewhere, so real estate and infrastructure have looked attractive.” Investors have been increasingly looking to the sector in a bid to find robust investments beyond material façade and sturdy foundation. Looking at the current environment, similarities can be drawn between both Asia-Pacific and European real estate – but there are also some fundamental differences. High allocations
Global allocations to real estate have been high across the world, explains Regina Lim, executive director of capital markets research at JLL Asia Pacific, but especially stronger in Asia-Pacific. “If you look at the transaction volume for 2019, it’s about 30% higher than 2014 – and you can’t say the same for the US or EMEA. So, obviously investors are recognising that in terms of demographics and long-term economic output, Asia-Pacific is stronger,” she notes. Douglas Rowlands, director of client portfolio management at Invesco, explains that more people are looking to real estate due to a number of driving factors, the performance of the asset class over the past ten years being a key one. “Historically speaking, if you look at the longest time periods, real estate slots somewhere between equities and fixed income in terms of performance,” he says. “But on an annualised basis, including the GFC [global financial crisis] until today, it’s tended to outperform – and that’s a function of quite a few things. “Real estate as an asset class produces steady contractually based income. On a global basis, long-term income averages are 5.8%, which in relative terms to fixed income, where obviously fixed income yields have been lower and even negative in some European countries – that’s clearly attractive for investors,” he adds. As always, there is risk involved – especially in the conditions markets presently find themselves in. Times such as these can really test the mettle of real estate as a long-term investment alternative. When factoring in recession risk, according to Versey, which areas of the market could be affected need to be considered – “it’s quite nuanced”. “You have to look very much at geographies and cities – what are those locations set up to do, is there a big industry around a certain city and could that industry be hit? Are these cities set up for the future?” he asks. Sector selection
But which sectors within real estate stand out for managers? Finding the right asset can be a challenge, particularly when prices are numb and markets are volatile, but there are identifiable opportunities as investors chase yield in this low interest environment. Real estate investors need to target markets that are sturdy. “The commodity now is not iron ore like it used to be once upon a time, it’s now talent. That’s the commodity of choice for a city. That underpins our city choice,” says Versey. “Then we have to look at which industries and sectors are exposed to recession risk, and the more you can focus on buildings which can be let to multi-use, that’s obviously very good,” he adds. “We do a lot of developments now which have residential as well as office, flexible working and retail, all in the same multi-use building, which is, I think, how people want to live in the future. We try to be future-proof.” Investors across the globe also have a penchant for student accommodation, given that it is a steady and recurring income. “A couple of the listed fund managers and entities in Asia – one in Singapore particularly – have been investing heavily in student accommodation across Europe, UK, US and Australia,” observes Jimmy Leong, managing director – funds Asia at IQ-EQ. Students, after all, are always going to need accommodation if they are living away from home. Sanjeet Mangat, investment director at Aberdeen Standard Investments, explains that the drivers behind sectors such as this are more structural. “They’re more sustainable through a cycle,” she says. “Sectors like student accommodation don’t struggle with the more structural challenges we see in the retail space.” While student accommodation is a traditionally popular area of investment, logistics and data centres are a growth area – particularly with the introduction of 5G, meaning that providers would need warehousing and logistics capabilities to operate. “Finding the right logistics asset has been quite challenging – people are looking to the third and fourth-tier cities to establish a presence and acquire assets,” adds IQ-EQ’s Leong. Meanwhile, the challenge for retail landlords is competing with the couch and an infinite inventory, warns JLL Asia Pacific’s Lim. “I can buy anything in the world. Why should I ever leave this couch to go to a retailer or retail mall?” she says. “Because of the efficiency and the increase in expectations, there is going to be a change in the way we provide that delivery to the consumer. It’s not just that we need more logistics, but what we need now is specialised, modern logistics that allow for efficient robotics, picking and the integration of artificial intelligence in terms of restocking at the consumer level right down to fulfilment.” As the world’s population continues to grow, urbanisation is also becoming an increasingly important theme for real estate investors. According to Chris Urwin, director of research at Aviva Investors, real assets, this is relevant because scale is important. Larger cities are more productive and bring more people together to the same space to share ideas and be creative – the talent pool is larger and more diverse. “What is a really positive story about many European cities is that they combine an urbanisation story – perhaps not as dramatic as some you see in Asia-Pacific – but a positive one, with supply constraints, so you get growing demand and a limit on how much new space can be built,” Urwin explains. “In London or in Paris, for example, there are very strict controls on how much new office space can be built in the centre of town. That’s an underappreciated positive for rental growth in European real estate. Global investors should have a better recognition of that in my view.” Deciding which office markets to target requires looking at which cities accommodate labour markets that are likely to stay robust for the long-term, the researcher explains. “We’re very mindful of technological change taking place and automating jobs resulting in a different type of occupier being the source of demand for office space in the future,” he says. For Tom Walker, fund manager and co-head of Schroders’ global real estate securities team, Asia is a key market. Looking at the index of the firm’s Global Cities Real Estate Income strategy, allocation is a battle between US coastal cities and the big cities in Asia. The growth outlook in Europe is slower, with ageing demographics playing a large part in this – and weighting toward Asian cities is only going to get bigger. He cites Asian metropolises such as Shanghai and Shenzhen as cities of the future. “You go to these cities, and you suddenly realise the difference between the city we’re living in [London], which is innovative and amazing in itself – but the scale of some of these Asian cities, particularly in China, is incredible. I always find it inspirational,” he says. Over time, Schroders’ Global Cities fund, which invests primarily in listed real estate, will be further increasing allocation to Asia, Walker believes. “Will Asia grow at the expense of Europe or the US? We don’t know yet, but my gut feeling is that it’ll be Europe – that seems to be what the data is saying, we just need to see it play out a bit longer.” The Covid-19 effect
The full impact of the coronavirus outbreak on real estate, at the time of writing, is still not known. Immediate risks involve liquidity and valuation uncertainty. Focusing on prime assets in core locations can help remove the risk of short-term volatility – “that can be an advantage of real estate in difficult times”, says Versey. “We have had a movement of clients into real assets as a result of volatility before, as the relative stability it can offer in long-term cash flows comes home in periods of uncertainty.” If the hit taken by sectors such as travel, hotels, hospitality and leisure become a long-term issue, however, this will have a knock-on effect on real estate pricing, the CIO believes. “You may have a delay as decisions are put on hold. That is going to have a short-term impact, but the long-term impact is less clear. Our main concern in real estate is tenants we have let to being badly hit by the effects, and that’s where we’re really focusing,” he says. “Changes in capital flows – I do think, down the road, we will be able to demonstrate a defensive quality in real estate and real assets more generally, which investors are likely to seek in difficult periods. We have seen this in the past, and we have seen flows into real assets as a result.” It’s not a time for complacency – staying alert is crucial. It’s a similar story across asset classes. Invesco’s Rowlands warns that real estate owners will need to be reactive over the short-term. This means engaging with tenants more on their day-to-day activities, ensuring assets maintain their function and cash flows, “but the long-term fundamentals of good property, in terms of quality of location and providing the space that tenants want to occupy, will be unchanged”. © 2020 funds global asia

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