Navigating the road to recovery
The unparalleled economic disruption and acceleration of structural trends caused by the pandemic has focused investors on positioning for the long term. But what is the final destination? And with the journey unlikely to be smooth, could cyclical opportunities get lost?
Regional trends
Explore M&G's outlook for regional markets
Asia Pacific
Continental Europe
United Kingdom
A look ahead
Which key trends can we expect to shape the market and how should we think about investment?
The direction of travel for real estate portfolios
Signposts to look out for: structural and cyclical dynamics
Recovery: where are we now?
With vaccines now in our armoury, sentiment has shifted such that we can begin to plan for brighter days. Many people have accumulated savings while governments and central banks are pumping in substantial fiscal and monetary support. Could pent-up consumer demand rouse the ‘roaring 2020s’? Time will tell. But make no mistake, not all businesses will be positioned to expand. We would expect to see polarisation between different industries and geographies as any recovery moves into gear. This environment, in our view, is likely to expose both growth and contrarian opportunities that could allow real estate investors to add value.
In order to drive performance, it is up to investors to differentiate between what are likely to be structural changes versus cyclical trends. The changing nature of real estate takes time to evolve, yet extrapolation bias can depict current trends as one-way tickets, heading arrow-like in that direction. In reality, cycles exist and can turn quickly. Investors should prepare themselves and be on the look out for signposts pointing to such cyclical turns, which can often appear at short notice.
As people begin anticipating a recovery, the key question relates to the shape of future real estate portfolios. Accelerated trends have impacted investors’ course and created new opportunities. The goal might be to rebalance towards long-term growth sectors, but how could that look? Will ‘beds and sheds’ remain the prize, at the cost of relentlessly down-weighting retail? How might investors need to adapt, for Alternatives to become a bigger part of future portfolios? In our view, landlords will need to become more hands-on to fulfil occupiers’ requirements, with increasing focus on people and environment.
For Investment Professionals only. Not for onward distribution. No other persons should rely on any information contained within. This guide reflects M&G’s present opinions reflecting current market conditions. They are subject to change without notice and involve a number of assumptions which may not prove valid. The distribution of this guide does not constitute an offer of, or solicitation for, a purchase or sale of any investment product or class of investment products, or to provide discretionary investment management services. These materials are not, and under no circumstances are to be construed as, an advertisement or a public offering of any securities or a solicitation of any offer to buy securities. It has been written for informational and educational purposes only and should not be considered as investment advice, a forecast or guarantee of future results, or as a recommendation of any security, strategy or investment product. Reference in this document to individual companies is included solely for the purpose of illustration and should not be construed as a recommendation to buy or sell the same. Information is derived from proprietary and non-proprietary sources which have not been independently verified for accuracy or completeness. While M&G Investments believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions which may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. All forms of investments carry risks. Such investments may not be suitable for everyone. United States: M&G Investment Management Limited is registered as an investment adviser with the Securities and Exchange Commission of the United States of America under US laws, which differ from UK and FCA laws. Canada: upon receipt of these materials, each Canadian recipient will be deemed to have represented to M&G Investment Management Limited, that the investor is a ‘permitted client’ as such term is defined in National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations. Australia: M&G Investment Management Limited (MAGIM) and M&G Alternatives Investment Management Limited (MAGAIM) have received notification from the Australian Securities & Investments Commission that they can rely on the ASIC Class Order [CO 03/1099] exemption and are therefore permitted to market their investment strategies (including the offering and provision of discretionary investment management services) to wholesale clients in Australia without the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth). MAGIM and MAGAIM are authorised and regulated by the Financial Conduct Authority under laws of the United Kingdom, which differ from Australian laws. Singapore: For Institutional Investors and Accredited Investors only. In Singapore, this financial promotion is issued by M&G Real Estate Asia Pte. Ltd. (Co. Reg. No. 200610218G) and/or M&G Investments (Singapore) Pte. Ltd. (Co. Reg. No. 201131425R), both regulated by the Monetary Authority of Singapore. Hong Kong: For Professional Investors only. In Hong Kong, this financial promotion is issued by M&G Investments (Hong Kong) Limited. Office: Unit 1002, LHT Tower, 31 Queen’s Road Central, Hong Kong. South Korea: For Qualified Professional Investors. China: on a cross-border basis only. Notice to investors in Taiwan: Nothing herein shall constitute an offer to sell or provide, or recommendation of, any financial products or services. Japan: M&G Investments Japan Co., Ltd., Investment Management Business Operator, Investment Advisory and Agency Business Operator, Type II Financial Instruments Business Operator, Director-General of the Kanto Local Finance Bureau (Kinsho) No. 2942, Membership to Associations: Japan Investment Advisers Association, Type II Financial Instruments Firms Association. This document is provided to you for the purpose of providing information with respect to investment management by Company’s offshore group affiliates and neither provided for the purpose of solicitation of any securities nor intended for such solicitation of any securities. Pursuant to such the registrations above, the Company may: (1) provide agency and intermediary services for clients to enter into a discretionary investment management agreement or investment advisory agreement with any of the Offshore Group Affiliates; (2) directly enter into a discretionary investment management agreement with clients; or (3) solicit clients for investment into offshore collective investment scheme(s) managed by the Offshore Group Affiliate. Please refer to materials separately provided to you for specific risks and any fees relating to the discretionary investment management agreement and the investment into the offshore collective investment scheme(s). The Company will not charge any fees to clients with respect to ‘(1) and ‘(3) above. M&G Investments is a direct subsidiary of M&G plc, a company incorporated in the United Kingdom. M&G plc and its affiliated companies are not affiliated in any manner with Prudential Financial, Inc, a company whose principal place of business is in the United States of America or Prudential Plc, an international group incorporated in the United Kingdom. This financial promotion is issued by M&G Investment Management Limited (unless otherwise stated), registered in England and Wales under number 936683, registered office 10 Fenchurch Avenue, London EC3M 5AG. M&G Investment Management Limited is authorised and regulated by the Financial Conduct Authority. M&G Real Estate Limited is registered in England and Wales under number 3852763 and is not authorised or regulated by the Financial Conduct Authority. M&G Real Estate Limited forms part of the M&G Group of companies.
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Signposts to look for: structural and cyclical dynamics
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Disclaimer
Accordingly, such statements are inherently speculative as they are based on assumptions which may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. All forms of investments carry risks. Such investments may not be suitable for everyone. United States: M&G Investment Management Limited is registered as an investment adviser with the Securities and Exchange Commission of the United States of America under US laws, which differ from UK and FCA laws. Canada: upon receipt of these materials, each Canadian recipient will be deemed to have represented to M&G Investment Management Limited, that the investor is a ‘permitted client’ as such term is defined in National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations. Australia: M&G Investment Management Limited (MAGIM) and M&G Alternatives Investment Management Limited (MAGAIM) have received notification from the Australian Securities & Investments Commission that they can rely on the ASIC Class Order [CO 03/1099] exemption and are therefore permitted to market their investment strategies (including the offering and provision of discretionary investment management services) to wholesale clients in Australia without the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth). MAGIM and MAGAIM are authorised and regulated by the Financial Conduct Authority under laws of the United Kingdom, which differ from Australian laws. Singapore: For Institutional Investors and Accredited Investors only. In Singapore, this financial promotion is issued by M&G Real Estate Asia Pte. Ltd. (Co. Reg. No. 200610218G) and/or M&G Investments (Singapore) Pte. Ltd. (Co. Reg. No. 201131425R), both regulated by the Monetary Authority of Singapore. Hong Kong: For Professional Investors only. In Hong Kong, this financial promotion is issued by M&G Investments (Hong Kong) Limited. Office: Unit 1002, LHT Tower, 31 Queen’s Road Central, Hong Kong. South Korea: For Qualified Professional Investors. China: on a cross-border basis only. Notice to investors in Taiwan: Nothing herein shall constitute an offer to sell or provide, or recommendation of, any financial products or services. Japan: M&G Investments Japan Co., Ltd., Investment Management Business Operator, Investment Advisory and Agency Business Operator, Type II Financial Instruments Business Operator, Director-General of the Kanto Local Finance Bureau (Kinsho) No. 2942, Membership to Associations: Japan Investment Advisers Association, Type II Financial Instruments Firms Association. This document is provided to you for the purpose of providing information with respect to investment management by Company’s offshore group affiliates and neither provided for the purpose of solicitation of any securities nor intended for such solicitation of any securities. Pursuant to such the registrations above, the Company may: (1) provide agency and intermediary services for clients to enter into a discretionary investment management agreement or investment advisory agreement with any of the Offshore Group Affiliates; (2) directly enter into a discretionary investment management agreement with clients; or (3) solicit clients for investment into offshore collective investment scheme(s) managed by the Offshore Group Affiliate. Please refer to materials separately provided to you for specific risks and any fees relating to the discretionary investment management agreement and the investment into the offshore collective investment scheme(s). The Company will not charge any fees to clients with respect to ‘(1) and ‘(3) above. M&G Investments is a direct subsidiary of M&G plc, a company incorporated in the United Kingdom. M&G plc and its affiliated companies are not affiliated in any manner with Prudential Financial, Inc, a company whose principal place of business is in the United States of America or Prudential Plc, an international group incorporated in the United Kingdom. This financial promotion is issued by M&G Investment Management Limited (unless otherwise stated), registered in England and Wales under number 936683, registered office 10 Fenchurch Avenue, London EC3M 5AG. M&G Investment Management Limited is authorised and regulated by the Financial Conduct Authority. M&G Real Estate Limited is registered in England and Wales under number 3852763 and is not authorised or regulated by the Financial Conduct Authority. M&G Real Estate Limited forms part of the M&G Group of companies.
MAGIM and MAGAIM are authorised and regulated by the Financial Conduct Authority under laws of the United Kingdom, which differ from Australian laws. Singapore: For Institutional Investors and Accredited Investors only. In Singapore, this financial promotion is issued by M&G Real Estate Asia Pte. Ltd. (Co. Reg. No. 200610218G) and/or M&G Investments (Singapore) Pte. Ltd. (Co. Reg. No. 201131425R), both regulated by the Monetary Authority of Singapore. Hong Kong: For Professional Investors only. In Hong Kong, this financial promotion is issued by M&G Investments (Hong Kong) Limited. Office: Unit 1002, LHT Tower, 31 Queen’s Road Central, Hong Kong. South Korea: For Qualified Professional Investors. China: on a cross-border basis only. Notice to investors in Taiwan: Nothing herein shall constitute an offer to sell or provide, or recommendation of, any financial products or services. Japan: M&G Investments Japan Co., Ltd., Investment Management Business Operator, Investment Advisory and Agency Business Operator, Type II Financial Instruments Business Operator, Director-General of the Kanto Local Finance Bureau (Kinsho) No. 2942, Membership to Associations: Japan Investment Advisers Association, Type II Financial Instruments Firms Association. This document is provided to you for the purpose of providing information with respect to investment management by Company’s offshore group affiliates and neither provided for the purpose of solicitation of any securities nor intended for such solicitation of any securities. Pursuant to such the registrations above, the Company may: (1) provide agency and intermediary services for clients to enter into a discretionary investment management agreement or investment advisory agreement with any of the Offshore Group Affiliates; (2) directly enter into a discretionary investment management agreement with clients; or (3) solicit clients for investment into offshore collective investment scheme(s) managed by the Offshore Group Affiliate. Please refer to materials separately provided to you for specific risks and any fees relating to the discretionary investment management agreement and the investment into the offshore collective investment scheme(s). The Company will not charge any fees to clients with respect to ‘(1) and ‘(3) above. M&G Investments is a direct subsidiary of M&G plc, a company incorporated in the United Kingdom. M&G plc and its affiliated companies are not affiliated in any manner with Prudential Financial, Inc, a company whose principal place of business is in the United States of America or Prudential Plc, an international group incorporated in the United Kingdom. This financial promotion is issued by M&G Investment Management Limited (unless otherwise stated), registered in England and Wales under number 936683, registered office 10 Fenchurch Avenue, London EC3M 5AG. M&G Investment Management Limited is authorised and regulated by the Financial Conduct Authority. M&G Real Estate Limited is registered in England and Wales under number 3852763 and is not authorised or regulated by the Financial Conduct Authority. M&G Real Estate Limited forms part of the M&G Group of companies.
Economic highlights
We believe the UK reflects a value opportunity Investor sentiment to UK real estate has been risk-off for the last few years, creating a value opportunity, given relative pricing. This underpins a potential recovery play as the economy returns to growth and rental fundamentals improve. A return to a more risk-on attitude could sow the seeds for strong investor returns, in our view. This is particularly the case for investors who, selectively, move along the risk curve to value-add strategies. Investors continue to turn to real estate in search of yield Investors’ go-to response in a crisis is to flip the risk-off switch. Yet the impact of the pandemic on property yields generally has been mild. Similar to the post-Brexit referendum period, All Property average pricing weakened by around 50 basis points and is moving back in. This demonstrates investors’ search for yield, being that real estate has historically shown a healthy premium over fixed income.
The UK offers attractive value relative to other major markets
Economic recovery, combined with pro-housing government policies and low rates, should increase house prices and boost short-term returns, in our view. Higher prices are expected to elevate affordability pressures, raising long-term demand for the Private Rented Sector as the number of households in the UK continues to grow while supply remains restricted
Residential Private Rented Sector
The backdrop
All eyes on the London advantage
The unattainable housing dream?
Side-stepping the logistics yield trap
Strategy over cycles
Source +
Tread with caution
Longer term opportunities
London offices
Resilient
As Brexit uncertainty evaporates and rapid vaccination progresses, the UK’s biggest investment market, with its diversified occupier base and attractive relative pricing, we believe should see a rapid recovery. But high quality asset selection will be critical. Core assets with secure income are at one end of the spectrum, though value-add opportunities can also be found higher up the risk curve
The UK has pulled ahead in the vaccine race to normality
The UK’s market-leading jump on vaccine rollout should lay solid foundations for a recovery to economic health, albeit from a low base. The government’s furlough scheme has protected millions of jobs, and while unemployment may rise further as fiscal measures taper, job losses are expected to be more contained than once feared. As long as the labour market holds up, consumers are expected to play a key role in driving the economic recovery, since many people have accumulated year-long savings and are eager to spend. The UK economy may not, in our view, return to its pre-pandemic size until 2022, however, with Brexit, bankruptcies and redundancies to work through.
The recovery is expected to be polarised
As a potential economic recovery is set in motion, we believe that some industries are positioned for a faster recovery than others. A UK-wide investment drive towards innovative industries could boost tech firms with a focus on life sciences and clean technology, which will benefit from a new £375 million public-private initiative known as Future Fund: Breakthrough. But industries that are associated with an agglomeration of people have suffered tremendous damage and their finances need to be repaired; they are unlikely to expand for a long time to come. Travel restrictions, tougher testing rules and quarantining pose challenges for recovery in the hospitality and travel sectors. The International Air Transport Association doesn’t expect air traffic to return to pre-pandemic levels until at least 2024.
Real estate themes
Strategic calls
A shot in the arm for the economy
K-shaped recovery
Attractive long-term fundamentals continue to underpin the London market
A record level of global equity is targeting London owing to pent-up demand from international investors, who have been prevented from conducting due diligence in person. While some lingering questions remain regarding British dealings with the EU, Brexit uncertainty has reduced massively, resolving a major factor that has held back UK real estate pricing in the last few years. Combined with bright recovery prospects, London is at a current advantage versus other major global markets, in our view. While UK real estate is not immune to global structural changes, including the move towards flexi-working, London will continue to attract businesses and employees, who want to be where the action is. With a highly diverse and continually evolving occupier base, London has the infrastructure to reinvent itself – from a financial hub to a centre for technology and life science clusters. Office space will need to adapt to provide digitally advanced, amenity-rich workplaces, with sustainability and employees’ wellbeing at the centre. This creates a value add opportunity to buy and reposition assets to meet today’s office requirements, or even build to core.
Will the residential investment queue be as long as the queue for housing itself?
Build to Rent investment reached a record £3.5 billion in 2020 yet around ten times that amount is still looking to be deployed. Investor demand continues to outstrip supply, making the sector challenging to access. The housing market appears to be in good health, supported by government policy and low rates. But rising house prices are challenging for prospective first-time buyers concerned about affordability. This supports increased demand for both private rented residential as well as Shared Ownership. Institutional investors are ideally placed to fulfil this, in our view, though barriers to entry underline the value in partnering with an experienced operator.
At what price?
Logistics ended on a high in 2020 as online shopping became the norm for many consumers, and with businesses bolstering their supply chains in response. As shops reopen, e-commerce is likely to moderate but the intent to shop digitally post-COVID has increased. Further yield compression is anticipated as the chase for logistics property intensifies. Yet not all assets will benefit from the e-commerce boom, for instance warehouses tied to struggling retailers. The price premium for riskier assets is also eroding, but are they fit for modern logistics or last-mile use? In addition, investors should keep an eye on markets with rapid speculative development, particularly in distribution hubs, where pricing may be too keen.
Investors are increasingly targeting the three D’s
Many early-pandemic predictions foretold collapsing tenant demand in hotels and student housing, leading to a raft of forced sales. So far this has not come to pass, with limited distress seen in investment markets, despite sharp falls in revenue. Instead, investors seem willing to look through the current cycle and are thinking much more long-term about portfolio structures. This ‘future thinking’ is benefiting Alternative real estate across the spectrum – from defensive asset types such as private rented residential, to on-trend sectors like data centres and life sciences. We expect sustained interest to focus on investments where key drivers, including ESG considerations, converge. This will distinguish Alternatives that become embedded in investors’ portfolios, from those that remain niche.
Industrial pricing is now keener than London offices
• Healthcare • Tech • Public sector • Large firms
• Hospitality • Entertainment • Travel
Favourable time zone
High liquidity
Yield advantage
Deep pool of skilled labour
Dynamic and evolving tenant base
High transparency, world-renowned legal system
Urban greening
Brexit agreement
Housing need 340,000 p.a.
Capital targeting Build to Rent £34 billion
1
2
1. Savills, UK Build to Rent Market Update Q4 2020. 2. Knight Frank Residential Investment Survey 2020.
Diversification
Decarbonisation
Demographics
UK US EU South Korea Japan
0 10 20 30 40 50 60
Our World In Data, 9 May 2021.
% of population who have received at least one dose of COVID-19 vaccine (as of 9th May 2021)
London (City)
Amsterdam
Paris (CBD)
Madrid
Munich
Stockholm
PMA (data to Q1 2021).
2011 Q1
2012 Q1
2013 Q1
2014 Q1
2015 Q1
2016 Q1
2017 Q1
2018 Q1
2019 Q1
2020 Q1
2021 Q1
6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5
Prime office net initial yield (%)
Mar 2013
Mar 2014
Mar 2015
Mar 2016
Mar 2017
Mar 2018
Mar 2019
Mar 2020
Mar 2021
Capital growth index (Mar-13 = 100)
Industrial
All Property
MSCI (UK Quarterly Index to March 2021).
200 190 180 170 160 150 140 130 120 110 100
All UK Industrials
City of London offices
Mar 2012
9.0 8.5 8.0 7.5 7.0 6.5 6.0 5.5 5.0
Equivalent yield (%)
Non-Central Business District offices
Industrial ‘bad apples’
The nature of office buildings is changing. With more flexible working patterns becoming permanent, some space will become surplus and vacant. Demand from back office functions and smaller businesses, the traditional non-CBD office occupier, is set to soften. A correction in rents and pricing is on the cards, we believe
We believe 2021 is likely to be another year of resilient growth for the industrial sector, but pricing is very competitive and yields are reaching new lows. Investors need to be selective – occupiers will carefully screen space on offer, and not all assets will benefit from the e-commerce boom. ‘All that glitters is not gold’
Retail warehousing
Emerging Alternatives
As the retail sector moves from survival to recovery, retail warehousing is set to lead the pack. It has proved more defensive during the pandemic, is less reliant on tourism, and has growing alignment to omni-channel retailing. Following significant corrections in rents and pricing, some retail warehouses now appear attractive hold/buy opportunities
The pandemic has accelerated an already-emerging shift towards life sciences and data centres. We expect the convergence of favourable demographics and evolving technologies to sustain strong, long-term growth within life sciences. While our ever-greater reliance on data requires more real estate to house it
Shared Ownership
Getting a foothold on the housing ladder has been increasingly challenging for younger people, concerned about rising house prices and struggling to save enough for a deposit. Shared Ownership offers an affordable solution. Institutional investors can help fulfil this social need, whilst tapping into perceived stable and predictable cashflows
1. International Air Transport Association, November 2020
Real estate holds yield appeal Interest rates seem unlikely to budge in the medium term, with the European Central Bank renowned for being ‘slow and steady’. Despite the recent rise in fixed income yields, we believe spreads still look attractive and investors are likely to continue to turn their attention to real estate in search of relative value, diversification and income. Low vacancy should support the recovery Unlike previous recessions, the expected recovery should be offered a helping hand by the lack of market oversupply. Vacancy rates have increased, but remain well below the threshold for potential widespread rent falls. We expect rental incentives to fill the void, keeping tenants in place for longer.
Interest rates look priced to stay low
How low can they go?
Residential shifts gear
Rotating into new growth firms
Cultural habits die hard?
Soaring debt burdens have to be tackled
The European Union is set to deliver a €750 billion recovery fund this year , with a combination of loans and grants dished out to Europe’s economies to boost growth. Meanwhile, job support schemes have largely done what they were designed to do. These factors should form the building blocks of Europe’s recovery. But questions remain over how and when this debt is repaid, whether through tax rises or debt relief. Public and private debt has soared over the last year, with corporate balance sheets in certain sectors dependent on government life support. The road out of this pandemic is therefore likely to be choppy, with battered balance sheets needing careful and well timed support. If Europe is to stay on the right growth path, de-levering and addressing corporate vulnerabilities should be top of the agenda, as learned from previous crises.
European recovery is likely to be uneven
Vaccine progress holds the key to reopening Europe’s economies and the rollout is accelerating and beginning to catch up with the UK and US. Similar to post Global Financial Crisis, the recovery is likely to be uneven, meaning Europe offers both early and late cycle growth opportunities. This creates a compelling value add backdrop. Open market trading economies, like Germany and the Nordics, should lead the charge, with a boost from global market exports and the restart of Chinese trade. Southern Europe may lag its northern peers, but a late tourism boost, alongside major stimulus impact, could pave the way for a late cycle rebound. For investors, capitalising on these growth cycles means going back to basics and focusing on diversification.
Nothing in life comes for free
Back to basics amid an uneven recovery
In a low yield environment, the exit matters
With inflationary factors likely to be only temporary and interest rates set to remain low, the longer term question in real estate markets often turns to a familiar one: how low can yields go? Prime property yields are still significantly higher than 10-year government bonds – with wide risk premiums, core real estate pricing appears sustainable and offers attractive relative value to investors. Where rental upside exists, we believe yields could push lower. The pace of compression is though likely to slow and will not be even across assets. The pandemic has refocused attention on quality, with cash flow, location and sustainability now under close scrutiny. In many markets, pricing is yet to truly reflect ESG credentials. But for long-term investors, the exit should be just as important as the entry. Environmental standards five to ten years from now will be fundamentally different, and will likely test non ESG-compliant yields in ways not yet seen.
Residential has expanded its share of Europe’s investible universe
The rapid growth of Europe’s real estate ‘living’ sectors has stepped up further still. Institutional flows into European residential leapfrogged logistics to reach a new peak in 2020, reflecting its wealth of core attributes and the ability to grow income over the long-term. Inadequate housing supply and ‘out of reach’ house prices continue to drive Europe’s cohort of renters, while lifestyles are increasingly compatible with renting for longer. Yet customer demand, in terms of design, price and service level, differs by city and culture. While the social and professional prospects offered by city living continues to attract younger generations and skilled workers, families are increasingly targeting urban commuter suburbs like Potsdam in Berlin or Vantaa in Helsinki. For those willing to tolerate an extra 30-minute commute, the average renter can save anywhere between 10% and 40% of monthly rental costs.
Growth tenants of the 2020s
Calibre of income has become far more central than ever before, with all eyes on the occupier. Rotating into high growth or resilient industries will be key, in our view, to maintaining portfolio cashflow, as Europe emerges from this pandemic. New sectors develop following any crisis, while others fail to adapt and lose ground. Free stimulus money can sometimes muddy the water. The top growth tenants of the 2020s will likely, we believe, be driven by firms awash with new funding. The EU is planning to inject an extra €96 billion into Research & Development over the next seven years, with sectors such as health, climate, energy and transport at the front of the capital queue. Everyday ‘enablers’, primarily in the technology and finance space, are also likely to thrive. Real estate portfolios should look to adapt to this evolving occupier base.
European tourism is likely to fight back harder
Vacancy rates provide a cushion for rental values
Netherlands
Sweden
Finland
Germany
Italy
Greece
Belgium
Spain
France
Government debt
Non-financial corporate debt
Household debt
Change in debt* (% of GDP)
*Q4 2019 – Q3 2020. BIS total credit statistics, Feb 2021; European Commission, 2021.
50 40 30 20 10 0
Sep 2017
Sep 2018
Sep 2019
Sep 2020
European Commission Sentiment Indicators, March 2021; European Commission, 2021.
120 110 100 90 80 70 60 50
Early recovery
Late cycle
Eurozone average
Range
Paris
Berlin
Average
2002
2005
2008
2011
2014
2017
2020
JLL, March 2021.
25 20 15 10 5 0
CBD office vacancy (%)
2006
2010
2012
2016
2018
JLL, December 2020.
Investment flows (%)
38.0%
20.1%
16.3%
12.3%
6.6%
3.8%
2.7%
Office
Residential
Retail
Healthcare
Student Housing
Other
2019
2020 (e)
2021 (f)
2022 (f)
2023 (f)
2024 (f)
Europe
North America
APAC
Tourist arrivals index
UNWTO, Euler Hermes estimations, December 2020.
120 100 80 60 40 20 0
Growth sectors
Enablers
Exit
Enter
Strategic & last mile logistics
Core Europe food retail
Nordic multi-family housing
Pricing in core markets continue to plumb new lows, but best quality assets in strategic corridor or top tier last-mile locations offer good prospects for rental growth. Asset selection in this sector is critical
Grocery shopping remains an important part of daily life for many Europeans, meaning low online penetration in this domain. Long leases and low rents make hypermarkets across Europe an attractive long-term bet, in our view, while entry yields look particularly good versus other defensive sectors
Blending stable regulated income with open market potential, diversifying across the Nordic private rented sector offers many advantages. Fast growing populations and limited supply underpins the opportunity to grow income here, in our view
Non-sustainable offices
Shopping centres
CEE office markets
COVID has shone a spotlight on the office sector, with winners and losers set to emerge as we move out of the crisis. Global corporates are increasingly focused on sustainability, which means ESG-compliant buildings command higher rents. The pricing differential will eventually follow, in our view
Already under pressure prior to COVID, footfall in covered shopping centre assets has rebounded slower than open-air schemes. The step change in online consumption will likely hit this sub sector hardest, with both prime and secondary assets likely to see pricing re-rate further, we believe
Oversupply risks were already rising pre-pandemic, given lower barriers to entry and relaxed planning laws. COVID-19 has not helped, with rental values under pressure and risk-off sentiment adding to pricing concerns
Core Europe life science clusters
Southern Europe hotels
Student housing
Supported by increasing public and private investment, and resilient to home working, this sector offers strong upside potential. Life science clusters connected to top quality universities in Germany, France and the Netherlands will likely prove the most attractive bets, in our view
Down but not out, tourism and travel are likely to come back with vengeance. Cities with a focus on both domestic and international tourism will reap the benefits. Given the disruption in this sector, pricing opportunities are also likely, in our view
While travel restrictions have shifted learning online, face to face teaching and the university experience will motivate students to return as soon as possible. Europe remains structurally undersupplied with, we believe, early mover advantages for investors in this nascent sector
2001
2004
2007
2013
2022
2025
3 month EURIBOR fixings
Forward curve
Chatham House, Macrobond, March 2021.
%
6.0 5.0 4.0 3.0 2.0 1.0 0 -1.0
1. European Commission, Recovery Plan for Europe. 2. European Commission, 2021.
Economic sentiment indicator
1. European Commission (Horizon Europe), Feb 2021
The years following this pandemic will shine a light on trends that change structurally, and those that revert to relative ‘normality’. Will hybrid working remain? Pre-pandemic, European markets took a very different stance on home working, with less than 10% of Germans working flexibly, versus more than 30% of Swedes. We believe this gap will shrink, with a permanent shift across all cultures. But hybrid working won’t fully replace the office. From shops to online? Southern Europe joined Northern economies in jumping on the online bandwagon during lockdown, with online sales jumping by 55% in 2020. We expect accelerated disruption to materialise, as consumers develop a taste for digital and demand more. However, retailers will need to rely on both channels to maximise brand and sales. Is tourism dead? Highly unlikely. Travel, tourism and leisure form the bedrock of many EU cultures. Pre-pandemic, leisure spend was at an all-time high; we expect this to come back with a vengeance.
1. Eurostat, March 2020 2. PMA, March 2021
23% of European firms would have seen liquidity distress in 2020 without government support
Almost half of the EU recovery fund will be allocated to Spain and Italy
1. European Commission, Recovery Plan for Europe.
1. European Commission, 2021
M&G Real Estate.
1. European Comussion, 2021
APAC real estate reflects good relative value President Biden’s bumper stimulus package, combined with economic growth supported by vaccine progress and pent-up consumer demand, has triggered inflation fears. This has already driven US Treasury yields to spike. Could this spell the end of ‘lower for longer’ interest rates? Unlikely, in the near term, given the Fed’s dovish stance on inflation. The positive correlation between US interest rates and APAC markets also means some investors are concerned about implications for APAC real estate markets. However, APAC real estate reflects good relative value in a historical context, with room to absorb increases in bond yields. Property, as a real asset, also offers an inherent level of inflation protection over the long term, particularly with inflation linked leases.
Discipline in a crowded sector
The changing face of offices
New frontiers gain traction
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Developed APAC economies' recovery looks set to outpace Europe
APAC’s relative success in mitigating both the biological and economic impacts of the pandemic has placed the region at the forefront of the global economic recovery. China’s economy has already rebounded to pre-pandemic levels, driven by the recovery in domestic household consumption and business investment. This has stimulated growth in the region’s manufacturing and export-reliant countries, including South Korea and Singapore. Yet the path to a complete recovery remains uncertain, with disparity in the pace of recovery among developed APAC economies. In Japan, repeated lockdown measures have dampened business and consumer sentiment, which is likely to delay recovery until 2022, in our view. A slower vaccine rollout compared to the UK or US could also impede recovery momentum.
APAC’s innovation value chain
Following the disruption caused by COVID-19, governments and businesses globally are seeking technological solutions for the next growth phase. Artificial Intelligence, the Internet of Things, Big Data or Robotics, APAC economies are at the forefront, and home to a growing number of tech giants. In tandem, policymakers are moving to support these efforts through government support programmes, skill enablement and accommodative regulation. South Korea has unveiled plans to invest up to US$144 billion to create 1,901,000 jobs by 2025, with a focus on new digital and green industries. To support the movement, Korea's Pangyo Techno Valley will accommodate testbeds and launch pads for companies to pursue innovative ideas and house Research & Development capabilites.
Light at the end of the tunnel
Innovation is the solution
Demand for cold storage is likely to rise
Appetite for e-commerce continues to fuel the seemingly runaway train that is logistics investment. Transaction volumes grew by more than 15% last year and cap rates in Sydney, Melbourne and Seoul are down by more than 25 basis points. But caution is needed. Excessive speculative development or disappointing rental growth could derail the cyclical momentum. We believe long-term investors looking to raise their exposure to logistics should remain disciplined and focus on resilient, modern logistics space close to infrastructure or within populous catchment areas. Landlords seeking to stay one step ahead of structural trends should seek to capitalise on rising occupier demand for temperature-controlled facilities to store medical products and fresh groceries. These assets typically command higher rents and longer leases.
It's not just real estate, but a service
The results of the great work-from-home experiment are in: hybrid working, works – but the office will continue to be the mainstay. In APAC markets, remote working can be problematic owing to compact living space in dense cities, in addition to deep-rooted cultural emphasis on face-to-face interaction. Future workspaces will be a place for companies to cultivate culture and innovation; a hub for collaboration, as well as an efficient work environment. Indeed, APAC's expanding innovation clusters are synonymous with highly collaborative campus facilities.
COVID-19 has accelerated data centre demand
Alternative real estate sectors will be increasingly hard to ignore as APAC’s investible universe continues to expand. Rapid digitalisation of developed economies is generating rising data use by both consumers and businesses, in turn accelerating occupier demand for data centres across APAC. This structural shift reinforces the sector’s growing institutional potential. Similarly, Australia's growing population, combined with supportive government policy, promotes growth within the market's nascent Build to Rent residential sector.
To catch a falling knife or a falling sword?
The divergence between good and bad retail has further widened during the pandemic. Across APAC, convenient, suburban retail has remained resilient while poorly managed shopping malls saw further declines. Disruption has provided the catalyst needed to help reset rents to more sustainable levels, comb out weak retailers, and offer the opportunity for landlords to refresh tenant mix. Savings accumulated during lockdown also lend support to a strong consumer rebound, though retail will continue to face headwinds. At some point, we believe pricing dislocation will tempt investors to take a closer look at the higher returns on offer versus other real estate types. Focus will centre on better performing assets and well-located schemes that can be repositioned to serve as dynamic marketing points, maximising the role of destination retail in APAC communities.
Most markets reflect a higher yield spread versus bonds
Historically, APAC rents have kept up with inflation
Build to Rent: the future of Australia's multi-family sector?
Real GDP Index (Q4 2019 = 100)
Oxford Economics, Bloomberg, April 2021.
Q4 19
Q1 20
Q2 20
Q3 20
Q4 20
Q1 21 (f)
Q2 21 (f)
Q3 21 (f)
Q4 21 (f)
Q1 22 (f)
Q2 22 (f)
APAC Developed Markets
UK
Eurozone
US
China
110 105 100 95 90 85 80 75 70
Real estate yield spread to 10-yr govt bond (%)
PMA, March 2021 (spread average and range over 2010 to 2021).
Australia
Hong Kong
Japan
Singapore
South Korea
5 4 3 2 1 0
2021 F
200 150 100 50 0
Oxford Economics for Asia Pacific CPI.
Asia Pacific CPI Index
Asia Pacific Rents Index
Index (100=1999)
1999
2003
2009
2015
1,200 1,000 800 600 400 200 0
Online grocery spend per household (US$)
2025 (f)
Euromonitor, March 2021.
0 -4 -8 -12 -16 -20
Regional shopping centres
Sub-Regional shopping centres
Neighbourhood shopping centres
Australian capital value decline (%)
PMA, March 2021.
7,000 6,000 5,000 4,000 3,000 2,000 1,000 0
APAC data centre transactions (US$m)
RCA, February 2021.
72 70 68 66 64 62
1994
1995
1996
1997
Higher propensity in Australia to rent due to unaffordable house prices and desire for flexibility
Home ownership rate (%)
For Australia: Australia Bureau of Statistics; For United States: U.S. Census Bureau; For United Kingdom: Ministry for Housing, Communities and Local Government (1994-2013), Statista (2015, 2017).
United States
Future landlords' focus
Operational service provision
Amenities including flexible space
Prioritised occupier experience
Occupier health and wellness
Landlord-tenant partnership
Digitally-enabled products and facilities
Leader in Robotics, AI and Autonomous/ electrical automotive
Home to 5G, AI and Gaming industries
Investment springboard for Chinese and regional technology firms
Launch pad for access to Southeast Asia
Source of raw materials needed for future hardware including lithium ion batteries
Innovation clusters
Logistics in developed economies
Japanese multi-family housing
Innovation clusters, including in Singapore, Seoul and key Japanese cities, are likely, in our view, to see steady growth in demand from technology occupiers. High quality office assets in these cities are expected to perform well
Markets with large domestic populations and low availability of prime modern stock, including key Japanese and Australian cities, as well as Greater Seoul, will likely benefit from rising e-commerce, we believe
A diversified tenant pool, increased home working and continued preference for inner-city living should support outperformance, in our view
Hong Kong Central District offices
High street retail
Mounting headwinds, including office decentralisation trends, uncertainty around the new national security law and COVID-19, weigh heavily on this submarket's outlook, in our view
High street retail that is largely dependent on tourist arrivals and the sale of discretionary goods, such as Tokyo’s Ginza district, Osaka’s Shinsaibashi, and Seoul’s Myeongdong, could see further price correction in the near term
Data centres
Australian Build to Rent
Rising data usage amongst individual and cooperates has led to a surge in occupier demand for data centres across Asia Pacific. This has not only strengthened the investment case for investing in data centres but, we believe, also places the sector on a firm path to institutionalising
The nascent multi-family sector in Australia reflects growing institutional potential, backed by supportive government policy and rising investor interest. Early movers could benefit from higher risk-adjusted, long-term returns
1. Ministry of Economy and Finance, Korean New Deal: National Strategy for a Great Transformation, July 2020
1. Real Capital Analytics, Asia Pacific Capital Trends Report, Feb 2021 2. M&G Real Estate data
M&G Real Estate
