Embracing change in European real estate
Real estate is typically a slow mover in the investment world. It tends not to be affected by the day-to-day rumblings in the equity and bond markets. Nevertheless, change is still afoot in real estate, with both short- and long-term trends affecting how we use properties and how we invest.
Real estate is now at a stage in the cycle where prices look stretched and risks are higher. As investors, we have been reducing risk over the past few years. This has involved selling risky assets, reducing loan-to-value ratios and extending lease lengths. At current property yield levels, there is limited chance of further capital appreciation driven by declining yields. Therefore, changing the focus to concentrate on preserving and enhancing income is also crucial.
It’s the longer-term trends that are changing how we use properties.
The real estate market has always moved in cycles and investors adjust their focus accordingly. But it’s the longer-term trends that are changing how we use properties. Disruption in the market is creating opportunities as well as challenges.
Retail is the sector facing the greatest change as e-commerce continues to pose challenges for shopping centres and high-street stores. Amid the negative headlines and high-profile shop closures, it’s easy to believe there’s nothing good to be said for retail. Yet, a price correction for retail assets could open up attractive long-term investment opportunities. In the meantime, convenience retail assets, such as supermarkets next to train stations, still offer opportunities. Retail parks that have a strong anchor or key store can still be appealing, particularly if rents remain modest.
At the other extreme, some of the most exciting long-term changes are happening in the logistics sector. Globalisation, a reconfiguration in supply chains and urbanisation are all contributing to the sector’s growth. But skyrocketing growth in e-commerce, which requires two-to-three times the logistics space of traditional store retailing, has ushered in unprecedented change in the logistics sector. We favour modern, flexible space in prime logistics hubs, where space constraints may lead to rental growth. We also favour logistics properties in urban areas close to city centres.
Although there is less long-term disruption taking place in the office sector, occupiers are increasingly looking for more flexible options when it comes to office space. Shorter leases and the option to use office space for alternative uses in the evenings or weekends is also a consideration.
Some of the more prestigious assets and prime locations in Europe are expensive, especially where there is little scope over the short term to enhance income. We favour centrally located assets in modern and flexible premises, close to public transport hubs. Properties with vacancies or short leases, particularly those located in strong rental markets, provide an opportunity to improve the quality of an asset and its income.
Residential assets are less affected by disruptive changes. In most European markets, residential real estate has historically delivered superior returns and lower volatility than other sectors. This has been fuelled by population growth in Europe’s largest cities and a shortage of new supply. Residential has a relatively low correlation with other real estate sectors, which offers attractive diversification benefits to a portfolio.
We are particularly interested in high-quality, purpose-built apartments. We are also keen on affordable housing and subsidised/micro-living/student housing. Higher risk strategies, such as converting offices to residential assets are also appealing.
The investment market tends to have a herd mentality, hence why some sectors become overpriced at the expense of others. At this late stage of the cycle, a change in strategy towards a more risk-averse approach with a clear focus on income helps to avoid getting sucked into the excess of an overpriced market. At the same time, structural changes in the retail sector will force it to evolve. This could mean that good-quality assets may come to the market at very attractive, risk-adjusted prices.
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