Finding value in a new era
As the depths of the pandemic become part of history and we progress on our journey of recovery, attention turns to what after-effects we face and what our post-pandemic world looks like. We highlight the challenges and opportunities that real estate investors may need to consider.
Global Real Estate Outlook
Regional outlook
United Kingdom
Continental Europe
Asia Pacific
Key trends
As economic recovery gains traction, a key issue for investors is whether the bumper fiscal and monetary response to the pandemic could lead to inflation, and what this might mean for real estate. We are already seeing higher raw material and construction costs, for example – though we believe this could be a temporary phenomenon. In our view, interest rates are likely to remain low for some time yet, supporting the relative value of real estate versus other investments, such as fixed income bonds. Even if fears of persistent elevated inflation were to gain legs, we believe that property, with its characteristics as a real asset, can offer inflation protection over the medium to long term.
ESG is in the spotlight. The route to net zero carbon begins in the planning, and we expect 2022 to see asset managers becoming increasingly immersed in the detail. Which measures are viable and how much do they cost? Do the required improvements stack up from a return perspective? To a large extent, strategic initiatives will reflect occupiers’ evolving demands, we believe. How closely these requirements can be met, will ultimately drive value polarisation between buildings that successfully deliver higher ESG standards, and those that lag behind.
As increasingly entrenched as online shopping is, in our view there is clearly a permanent place for physical retail. Renewed appetite for ‘retail therapy’ cannot be fully satisfied digitally, for one. Physical retail is also part of the e-commerce journey, for instance through click and collect services and the facility to return goods. We believe that, with cash to spend in an economy that has reopened for business, consumers are in a position to sculpt the new face of retail. Given the high yields currently on offer, and the rental rebasing that has occurred, parts of the retail market that we believe offer sustainable, long-term prospects, may provide an attractive value opportunity.
All eyes on inflation
The year of net-zero planning
Time to rethink retail?
The changing requirements of property have accelerated; office occupiers have regrouped, with a clear, long-term view on what they want from their space, while logistics operators’ need for efficient facilities, in order to meet rising deliveries, has intensified. Positioning buildings for the future is a top priority, and in our view, 2022 is likely to mark the year of detailed net zero planning. At the same time, growing the necessary resources to tackle health and climate issues is opening up new investment opportunities in alternative real estate sectors, such as science and innovation clusters, and their associated ecosystems. In this latest outlook, we address key areas of focus, including inflation concerns; potential growth sectors; and cyclical recovery opportunities, including in parts of the retail property market, which we believe could be reaching a turning point. With technology touching every aspect of our lives, you will also notice its growing imprint on real estate markets, throughout the report.
Global economies are showing signs of recovery as people adapt to living alongside COVID-19. Considering this backdrop together with the climate crisis, we believe the real estate investment market is entering a new era in which investors may need to be increasingly proactive.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Where past performance is shown, please note that this is not a guide to future performance. Information is subject to change and is not a guarantee of future results.
Find out more
about our real estate capabilities
Subscribe
to receive future insights
Home
Follow us
Home • United Kingdom • Continental Europe • Asia Pacific
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.
Recovery: where are we now?
Economic highlights
As the world becomes more acutely aware of environmental issues, buildings’ occupiers are increasingly ESG-focused in their decision making. It is becoming more commonplace for tenants to pay premium rents for ‘green’ buildings, or to demand a ‘brown discount’ for renting space with weaker ESG credentials (if they’re willing to take that space at all). Responsible investors are cognisant of these evolving tenant preferences, and are taking steps to proactively improve their portfolios, ahead of mandatory regulation. There is little more than a year to go before it becomes unlawful in the UK to continue letting a commercial property with the weakest F or G rated Energy Performance Certificates, and Minimum Energy Efficiency Standards tighten further to permit only a B rating or above by 2030. The most forward-thinking asset managers though, are already planning the route to achieving net zero carbon real estate portfolios. For existing buildings, this requires feasibility assessments and capex calculations. In our view, this will only lead to further value polarisation – which is already evident – between better quality assets which ‘tick the boxes’, and those that don’t. Furthermore, assets where improvement to the required standard appears prohibitively expensive could face the risk of becoming ‘stranded’.
Growing value divergence according to quality of assets
Occupiers demand it. Investors want it. Employees increasingly take it into account when accepting new job positions. We expect demand for ‘green’ assets, particularly offices in London, to grow in dominance and command premium rents and pricing. The capital already has a significant number of certified buildings, with the potential to create more via retrofitting and development.
ESG a big factor in value polarisation
Shopping for the best of both worlds
Retail resurgence?
Back to city living
Tech tech boom
Source +
Tread with caution
Longer term opportunities
Resilient
Last mile fulfilment centres, in close proximity to end consumers in big conurbations, particularly London, are likely to benefit from continuing occupational demand. With supply in such land-constrained locations struggling to keep up, rental growth prospects seem attractive, especially for assets whose specifications are best suited to modern hi-tech requirements.
The UK’s latest wave of cases led to only a muted rise in hospitalisation and deaths
The UK has been a trailblazer in making its population’s immune systems much better equipped to deal with COVID-19. The virus may not have been completely beaten, but as the government’s easing of restrictions and reopening of the economy shows, we have learned that we can at last throw off the shackles and live alongside it. Regained freedom, and what appears to be substantially reduced risk of economic repression, should provide the foundation for strong and sustainable recovery. The complete removal of restrictions and return to ‘normal life’, including a return to typical behaviour and sentiment (as opposed to fear and risk aversion), is triggering a release of pent up demand. Consumers, eager to spend their accumulated savings, are helping to drive the UK economy to what could be its strongest growth in 70 years, over 2021, according to consensus forecasts1. Next year’s growth is expected to keep pace with China’s, although issues such as labour shortages may pose risks to projections of such strength materialising as hoped. As a radically stronger economic environment replaces the dramatic recession earlier in the pandemic, we believe the scene is set for business expansion, boosting occupational demand and brightening rental growth prospects for real estate of all types. This could provide more fertile territory for cyclical recovery plays and growth-oriented strategies within real estate.
Government pandemic response drove record peacetime borrowing
Looking ahead from today evokes comparison with the era that followed the First World War, Spanish flu pandemic, and the economic upheaval that went with it. Their conclusion ushered in a culture of hedonism and extravagance, turbocharging economic growth. Yet the ‘Roaring Twenties’ a century ago did not manifest rapid price rises; the decade overall was deflationary. This did, however, follow years of high inflation through wartime when government borrowing soared. As the economy begins to roar back to life today, we look at the substantial accrual of government debt, massive fiscal stimulus and huge amounts of money pumped into the financial system and wonder whether it might flow through, ultimately resulting in high inflation. Such a scenario could quash lower-for-longer interest rates. We believe that many factors driving potential inflation are temporary and that – just as it failed to take hold following the Global Financial Crisis – runaway inflation is far from inevitable. But what if inflation were to persist? As a real asset, property offers some protection and has the potential to perform well in a period of high inflation. Real estate’s essential function commands a price – rent – from occupiers who require and attach real value to this finite supply of space. If general price levels in the economy rise over time, property prices, similarly, should stand to rise. This has played out historically, including during the high inflation period of the 1970s and 80s.
Real estate themes
Strategic calls
Unlocking the UK economy
Inflation in the ‘Roaring Twenties’?
The rise of hybrid shopping
COVID-19 has turned the retail industry on its head, with retailers closing their shop doors for a prolonged period, accelerating the shift to e-commerce. Logistics property has been a clear winner during the pandemic, and modern last mile fulfilment centres, in close proximity to end consumers, are likely to remain in demand. Capacity limits in the logistics sector, though, will require new solutions to meet prospective demand from digitally-savvy consumers, for whom 24/7 shopping is just a click away. Yet customers want the best of both worlds, which means that occupiers will need the right mix of industrial and retail to meet these expectations. Equally, the ‘raison d’être’ of bricks and mortar retail is changing; no longer just a physical space to browse and buy, it is now part of a seamless omnichannel network, fundamental for fulfilling e-commerce demand. Retail assets in conurbations that dovetail with online platforms, and tap into the click and collect market, are therefore best placed, we believe, to remain relevant as shopping habits continue to evolve.
While bricks and mortar retail faces the ongoing challenge posed by the e-commerce structural trend, it also exhibits cyclical dynamics. We believe that the sector is reaching a turning point in its cycle, moving from the substantial and protracted downturn of the last four years, to a cyclical rebound. Already there are green shoots – retail warehouses have seen capital values growing throughout 2021 as rental decline has subsided and investor sentiment has returned. Shops and shopping centres are lagging behind. However, this could present an opportunity to pick up high quality assets cheaply – prime yields are at multi-decade highs. As the economy – and retail spending by consumers – appears to benefit from a rapid revival, the downward pressure on retail rents may be replaced by stabilisation or even some growth going forward. We believe that investors, drawn by high yields, are likely to return to the sector as the downside risks abate. This could lead to a rebound in pricing, as is already being seen in retail warehousing. Caution is necessary, however; much of the retail sector still faces a very uncertain and, in some cases, bleak future. While secondary shopping centres saw a bounce post-GFC, their performance was still lacklustre at best. For many weaker assets, we believe terminal decline is on the cards. But for the best assets, which have a sustainable future as retail, we believe their attractive pricing could provide a contrarian opportunity.
City living has seen a resurgence in demand
While the focus of the last 18 months has often been the ‘escape to the country’, a return to normality is bringing a return to the city. Tenant demand is starting to rise, supply is starting to fall and affordability has improved, raising expectations of a rental rebound in inner London in particular. While this shift is partly reversing one of the trends seen during the pandemic, we believe other themes are likely to become more entrenched. In an urban setting, this suggests demand for more space for home working, whether translating into the need for another bedroom or a separate co-working space as part of the Build to Rent housing offer. Key to this is connectivity, both in technological and social terms, enabling tenants to shift seamlessly between workplace and home, gaining the benefits of both, without leaving the building. While urban living is seeing a resurgence, this is not the end of the shift to suburbia. Family-style suburban renting looks set to continue to grow, as greater working from home creates a choice that may not have existed so effortlessly before. As a result, we believe both city and suburban living are likely to co-exist in future portfolios, as investors look to expand the availability of Build to Rent housing for all ages and lifestyles.
Filmmaker Godfrey Reggio commented: “It’s not that we use technology, we live technology”. With technology and digitalisation increasingly driving all aspects of our lives, it’s no surprise that real estate and tech are becoming progressively intertwined. Even with our ‘heads in the Cloud’, we still need space to house our data. With global data creation set to continue rising exponentially, demand for data centres looks likely to keep growing strongly. Defensive and diversifying income streams also make this an attractive play for investors. Technology is also leading to the advance and evolution of the medical industry. Life sciences is a major growth industry, underpinned by tech (for example medtech, biotech, and digital health). We believe that life science property assets (and other properties in the associated cluster ecosystem) provide real estate investors with opportunities to tap into such growth. New space in the more traditional sectors is increasingly being built with technology in mind, while existing buildings are having to be retrofitted to avoid obsolescence. This shift in focus also goes hand in hand with the ESG agenda: technology is helping buildings to improve their sustainability credentials, whether it is a focus on wellbeing, or the environment via new tech ranging from lighting and sensors to temperature meters and solar panels. Whichever sector it touches, real estate needs to embrace technology in all its forms or it will quickly find itself being left behind.
Our World In Data, October 2021
MSCI (UK Quarterly Index to Q2 2021)
RICS Residential Market Survey, August 2021
Properties which fail to meet or keep up with Minimum Energy Efficiency Standards risk becoming stranded: unlettable and unviable for investors. Furthermore, with the ongoing e-commerce structural trend, secondary retail assets which fail to reinvent themselves to adapt to evolving customer and tenant preferences, risk terminal decline.
Investors continue to target Purpose Built Student Accommodation (PBSA), and for good reason. A strong global offer and growing domestic demand places UK Higher Education (HE), and the PBSA, in a robust position. However, growing supply pipelines, and increasing polarisation in student HE demand between tariff groups, mean that local level PBSA fundamentals remain key. Locations linked to a single, lower tariff university may struggle, as students focus on HE quality and value for money.
While occupational headwinds remain, going forward these are abating and investors may be able to pick up top quality shopping centres at their cheapest pricing in decades. A rapid rental rebound may be wishful thinking, but a contrarian approach may reap rewards at this low point in the cycle. Retail park values have already benefited by moving into a strong cyclical upswing.
An ageing population, an underfunded senior care sector, and pandemic-led awareness of the need for contact and community to combat elderly loneliness, are all underpinning the emergence of a new private senior living rental model. The demand for independent and assisted living, combining Build to Rent style services and amenities, with additional help to aid ‘ageing in place’, is poised to see significant growth, we believe.
With technology increasingly interwoven in everything we do, real estate opportunities abound. The growth in tech drives the fundamentals of some emerging property sectors, such as data centres and life sciences. More traditional asset types can also use tech to improve tenant appeal or efficiency.
With inflation concerns at the forefront of investors’ minds, real estate that offers the best inflation protection is likely to be in strong demand. Assets that are let to resilient tenants on long inflation-linked leases stand to hold up well.
1
1 Bloomberg, September 2021
New cases
Hospital Patients
New deaths (RHS)
Mar 2020
Jun 2020
Sep 2020
Mar 2021
Jun 2021
Oct 2021
70,000 60,000 50,000 40,000 30,000 20,000 10,000 0
1400 1200 1000 800 600 400 200 0
Daily new confirmed COVID-19 cases (rolling 7-day average), Patients in hospital with COVID-19
Deaths (rolling 7-day average)
30 25 20 15 10 5 0 -5 -10 -15
1900
1915
1930
1945
1960
1975
1990
2005
2020
Public sector net borrowing in fiscal year as % of GDP
CPI Inflation
%pa
ONS, Bank of England, MSCI (UK Annual Property Index), Land Registry (September 2021)
Property values have tended to keep pace with inflation
CPI Inflation All Property Capital Growth Average House Price Growth
1970s & 1980s 9.1% pa 9.6% pa 14.6% pa
2000s & 2010s 2.0% pa 1.8% pa 5.3% pa
London City Offices: Lower Yield
Regional UK Offices: Lower Yield
London City Offices: Higher Yield
Regional UK Offices: Higher Yield
106 104 102 100 98 96 94 92 90 88 86 84
Capital growth index (End-Q1 2019 = 100)
Mar 2019
Jun 2019
Sep 2019
Dec 2019
Dec 2020
100 90 80 70 60 50 40 30 20 10 0
Pre COVID-19
During COVID-19
During COVID-19 (no lockdown)
After the pandemic is over
How do people shop?
12%
23%
65%
14%
25%
61%
22%
46%
32%
42%
33%
All/mostly in physical shops
About half in person/half online
All/mostly online
BRC survey (1,003 Respondents) – UK shopping habits for non-grocery items, April 2021
Prime shopping centre total return index doubled in 8 years off its post-GFC cyclical low; this cycle has seen a more substantial rebasing
Prime retail assets have been offering their highest yields in decades
MSCI UK Quarterly Index to June 2021, CBRE (September 2021)
Shopping Centre total Return Index (Jun '07 and Dec '17 = 100)
2007-17: Lowest yield quartile
2017-20: Lowest yield quartile
2007-17: Highest yield quartile
2017-20: Highest yield quartile
150 140 130 120 110 100 90 80 70 60 50
2007/ 2017
2008/ 2018
2009/ 2019
2010/ 2020
2011
2012
2013
2014
2015
2016
2017
2021
1999
2003
2007
2019
Prime Yield
Offices: London City
Offices: Regional UK
Distribution Warehouses
Retail Parks (Open Use)
Shops
Shopping Centres
8.5% 8.0% 7.5% 7.0% 6.5% 6.-% 5.5% 5.0% 4.5% 4.0% 3.5%
London tenant demand, survey net balance
Aug 2017
Feb 2018
Aug 2018
Feb 2019
Aug 2019
Feb 2020
Aug 2020
Feb 2021
Aug 2021
50 40 30 20 10 0 -10 -20 -30 -40
The return to normality is driving renters back to the Capital
Renters leave London during the pandemic
New and emerging
Data centres
Life sciences
Self storage
Private Rented Sector
Retail
Logistics
Offices
Mature and evolving
Tech is becoming increasingly intertwined across sectors
Green buildings of London
Prime urban industrial
Inflation-linked long income property
PBSA in secondary locations
Unsustainable retail
Senior living
Prime retail assets
Tech-driven real estate
The hare and the tortoise Previously criticised for its sluggish vaccination roll out, the majority of Europe’s largest economies have already surpassed both the US and UK. This should provide a platform for a solid economic recovery over the next few years, we believe, as consumers and businesses regain confidence. Plenty of cushion in European property yields Short-term price pressures will, we believe, cause division over when the European Central Bank should look to raise rates. Regardless, European property yields look relatively well protected. Current spreads over 10-year government bond yields remain near record highs, providing some cushion if fixed income yields start to unwind. Healthy liquidity in the property market and improved prospects for rental growth, in line with the economic recovery, should also help to bolster real estate prices in the medium term.
The backdrop
There’s no ‘I’ in team
Following the science to Europe’s university clusters
Buying into the hotel recovery story
Slow and steady wins the consumer goods race
Europeans are sitting on cash
European consumers have been stockpiling cash like never seen before – some €500 billion over the last 18 months1. Household savings ratios have gone through the roof to nearly twice the long-term average, and significantly above both the global financial and eurozone crises. On the basis that these ratios return to more typical levels in the next few years, as per general market forecasts2, Europe may soon find itself in the midst of a supersized spending spree, as cash is released into the market. How and where this money is spent has big implications for real estate. We believe that experiences, be it restaurants or holidays, or home and lifestyle products, are likely to be the largest beneficiaries. This will not flow through to bricks and mortar retail rents immediately, but it should offer welcome relief to landlords and investors.
Cost of German production reaches new high
A rapid resurgence in demand, along with shipping route bottle-necks and disruption, have led to shipping costs between Europe and China more than quadrupling since the start of the year. Labour shortages in ports and factories have added to delays, meaning that manufacturers, and ultimately their customers, now face both empty shelves and higher prices. The German central bank has warned that inflation may hit 5% by the end of 20211. This has prompted some hawks – those suggesting that monetary policy should tighten – to shout a little louder, since the market accounts for around a quarter of overall Eurozone inflation. Though consumers may bear the brunt in the short term, typically, economists see the faster pace of price rises as transient. More to the point, while Germany faces its highest rate in decades, inflation in many other European economies seems less of a concern. Interest rates are likely to remain very low for the foreseeable future, setting the scene for higher real estate prices. This is unlikely to be even across all assets and sectors, however. As income yields trend lower, the lowest yielding assets may need to demonstrate higher rental growth potential in order to attract core investors.
Cash rich and ready to spend?
Pricing problems for supply chains
The European Commission’s target to reduce greenhouse gas emissions by 55% in the next decade1 will require a huge amount of team work – including among corporates and landlords, since up to 80% of a building’s total carbon footprint can come from occupier activities. Europe is a global leader in terms of tenants’ demand for greener buildings (70% according to a recent RICS survey)2. Some office tenants now demand fit outs that achieve top LEED or BREEAM standards, committing to 100% renewable electricity and strict air, water and waste targets. Significant progress has also been made in sectors where net gains are more challenging. A few logistics operators are now trialling fossil-free deliveries in the Nordics, aided by buildings which provide electric vehicle charging. Some leading supermarkets are also striving for greener properties, through the use of solar panels, light sensors and energy-saving refrigeration. These initiatives are welcomed by investors, but wider tenant engagement is still needed in order to drive down real estate’s environmental impact, in our view. One of the greatest challenges for ESG progress in the 2020s may arise from misaligned interests, whether due to higher expected rents or an inability to swallow costs. In our view, working as a team will be the first hurdle to overcome.
Venture capital gaining ground in European life R&D
Growing recognition of the social impact of people’s health, wellbeing and longevity, is helping to drive increasing investment into scientific research. Venture capital dedicated to health, science and research has more than quadrupled over the past decade1. This is on top of public sector programmes – the EU’s Horizon Europe has a near-€100 billion budget to pump into R&D (Research and Development) over seven years2. This seismic shift in funding mirrors an increasing focus on Europe’s top universities. Science clusters have long established themselves around globally recognised educational institutes, such as Heidelberg in Germany or Karolinska in Sweden. These clusters share many qualities like a concentration of skilled labour and fixed ecosystems built around knowledge sharing and commitments to technological advancements. For real estate investors, we believe these factors offer multiple avenues to tap into expected growth. Alongside high-tech or back office space for both smaller start-ups and larger global corporates, we see opportunities to invest across real estate sectors that facilitate people. High quality student accommodation, for example, or suburban housing catering to the growing workforce connected to these institutes. With funding increasingly targeting these micro locations, we believe top quality university clusters look set to enter a period of expansion.
Attractive value still in recovering hotels
As consumer spending bounces back, it seems that the thirst for holidays has not dissipated. Close to nine out of ten Europeans indicated they would take at least one vacation in 2021, with over 70% opting for staycations1. Air travel has been slower to rebound, but green shoots are now emerging – flight departures are expected to reach 80% of 2019 levels by the end of this year2. While uncertainty remains about the possibility of further Covid-related disruption in the short term, in our view, the longer term drivers of Europe’s tourism market have only pulled back temporarily. We believe therefore in the resilience of certain hotel accommodation and that demand is set to revive in many tourist destinations. The economic recovery should usher in a substantial improvement in both RevPAR (revenue per available room) and capital values. Hotel spreads over core real estate currently range anywhere from 150bps to 300bps, dependent on risk profile. From an investment perspective, particularly for those looking for alternative long term income streams, this may present a cyclical window of opportunity to enter the market at attractive prices. As travel recovers, we believe that the key challenge will shift back to keeping tourism and hotels sustainable. We expect to see a greater focus on reducing waste, single use, and energy consumption, with investors, operators and consumers all required to play their part.
‘Slow’ goods winning the retail store race
Europe accelerates its vaccination programme
European pricing spread may offer protection from rate rises
Eurostat (Q1 2021), Trading Economics forecast to Q4 2023
German Federal Statistical Office July 2021
PMA, Trading Economics, July 2021
Eurostat May 2021
The Nordics offer some of Europe’s most undersupplied rental markets. Waiting lists to get regulated apartments extend to multiple years, while the often lower, more affordable rental levels of multifamily housing can offer investors stable income with upside potential.
High footfall, steady sales, and rents at more sustainable levels make retail parks a resilient part of the market, in our view. Tenant line-ups may evolve further but relatively low space per capita has the potential to generate an attractive long-term income stream.
Investor demand for logistics continues to soar, but not all assets were created equal. Some sit the wrong side of the tracks, others have inefficient lay outs and lack modern day needs. With yields reaching new lows, we believe the exit strategy for these assets is critical and performance is not guaranteed.
Five to ten years from now, we believe the focus on sustainability from global corporates and investors will cast non-compliant office buildings in a new light, with larger discounts placed on subpar office space. Tangible evidence of valuations impacts is only just emerging.
In-store shopping is moving away from low cost items, to more considered purchases. We believe fast fashion will be the high street’s largest casualty this decade, as this part of the market increasingly shifts online.
Green shoots are emerging in Europe’s tourism market, creating a window of opportunity to enter the hotels sector at a cyclical low. Relative value and the ability to grow revenue per available room should provide attractive risk-adjusted performance over the medium term.
Retirees are increasingly looking for better amenities and community living, close to family in suburbia. With longer leases and a risk premium above typical Private Rented Sector accommodation, the non-care element of senior housing offers income diversification across the living spectrum, at relatively low risk.
Europe’s leading universities offer centralised ecosystems, focused on research and development and knowledge sharing. For investors, this offers multiple entry points to tap into these high growth submarkets, catering to real estate needs across the working and living spectrum.
Our World in Data, October 2021
A decade ago, European high streets were dominated by big fashion retailers, from fast fashion brands, through to more luxury products. While many of those stores are still visible today, the last 18 months has seen an accelerated shift in consumer mentality. Fast fashion and other low cost goods are moving to increasingly efficient ‘quick and easy’ online delivery platforms which offer next or same day delivery and free returns. Physical retail schemes therefore need to revamp their profile, with a slant towards ‘slow’ over ‘fast’ goods. Be it lifestyle, homeware or other more sustainable products with a shelf life of longer than one or two years, these are often goods that consumers want to get a feel for before buying. This refocus could mean a shift in the structure of property portfolios and tenant profile. Mass fashion brands are no longer the go-to anchor tenant. Instead, successful retail schemes will be those that offer a more diverse range of ‘slow product’ tenants, with a parallel focus on the shopping experience.
CBRE, August 2021
1 European Commission, European Climate Law, June 2021; 2 RICS Sustainability Report 2021
1 Deloitte, European consumers after the pandemic, April 2021 2 See chart
2
1 Deutsche Bundesbank, July 2021
1 Pitchbook, March 2021 2 Horizon Europe public funding programme, 2021-2027
1 Opinium Research & TomTom (7000 respondents), May 2021; 2 Eurocontrol, August 2021
Source: M&G Real Estate, November 2021
Eurozone household savings rate (%)
26 24 22 20 18 16 14 12 10
Q1 2001
Q2 2004
Q3 2007
Q4 2010
Q1 2014
Q2 2017
Q3 2020
Q4 2023
Producers price index (y-o-y % change)
1977
1985
1993
2001
2009
12 9 6 3 0 -3 -6 -9
Jan 2021
Apr 2021
May 2021
Jul 2021
Sep 2021
160 140 120 100 80 60 40 20 0
UK
US
Germany
France
Italy
Spain
7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0
Office yield spread vs. 10-year gov't bonds (%)
Hong Kong
Singapore
Milan
Tokyo
New York
Paris
Madrid
Stockholm
London
Munich
Copenhagen
Amsterdam
Seoul
Range
Q2 2021
Average since 2000
Drug discovery
Diagnostics
Tech systems
Biotechnology
Montioring
Surgical
Therapeutics
Pharmaceuticals
Other
Europe ex. UK venture capital funding (€ billion)
2010
2018
7 6 5 4 3 2 1 0
Hotel yield spread vs. CBD office (%)
0.0
0.5
1.0
1.5
2.0
2.5
3.5
3.0
Amsterdam Milan Paris German Big 5 Madrid Stockholm London
Management Contract
Lease
Eurozone in-store retail sales index (2015 = 100)
140 120 100 80 60 40 20 0
Food & Beverage
Outdoor & Recreation
Fashion
Household goods
Tenant-investor relations will be redefined on the road to net zero
Pitchbook, March 2021
Producers Price Index
Long-term average
COVID-19 vaccinations administered per 100 people
Top quality retail parks
Nordic multifamily housing
Fast fashion retail shops
Non-sustainable offices
Secondary logistics
University clusters (multi-sector)
Senior living in Germany & France
Hotels
No sign of distress Despite rising capital seeking distressed opportunities, access to prime real estate at distressed pricing remains limited in Asia Pacific, thanks to lowered interest rates and high volumes of liquidity. In Hong Kong, for example, even the combined impact of COVID-19 and social unrest, on rental values, has not forced local investors to part with properties. As economic activity normalises, we expect the cyclical recovery in occupier demand to follow. Facing a bull run on logistics pricing With the gap between property and bond spreads still wide, investors continue to look to real estate in their search for yield – and logistics property continues to benefit. A growing need to store and distribute goods that are bought online has created a bull run on logistics property pricing in markets with high e-commerce penetration, like South Korea, where yields have compressed by 135 bps since the start of 2020.
Investing in clean growth
Preparing for disruption
Bridging the logistics supply gap
A fresh take on high street retail
Low mobility in developed APAC markets has affected recovery in personal consumption
Major Asia Pacific economies have kept COVID infection cases relatively low by adopting strong control policies, including border travel restrictions. These restrictions, however, have impeded tourism – one of the region’s key growth engines. Spending by international visitors declined by around 75% last year1. Likewise, lockdowns and mobility restrictions have impacted domestic consumption, while reduced labour has lowered output in the construction sector, for example. Strict containment measures are therefore increasingly viewed as economically unsustainable. Reopening economies should help to normalise household and business activity; in turn stimulating a recovery in footfall within commercial districts, across markets such as Australia and Singapore. The region, overall, is forecast to grow by 5% in 20222, as APAC economies transition away from a zero-COVID strategy. Yet the threat of new, vaccine-resistant variants remains close in mind for governments globally, with the potential to derail economic progress. APAC growth must also contend with headwinds to the Chinese economy, such as imposed manufacturing cuts in the near term, in order to meet carbon emissions targets. In addition, new policies to limit leverage among property developers, we believe, could bring about a potential slowdown in China’s real estate sector.
Key government initiatives tap into the new green economy
APAC economies are among the most vulnerable – and instrumental – to climate change globally. Without any mitigation strategies, Tokyo, for instance, is expected to experience more frequent and severe floods by 2050, leading to the costs of real estate damage and destruction more than doubling compared to today1. The potential consequences of inaction are galvanising governments to roll out tangible plans to tackle these issues, as part of a green recovery. South Korea, for instance, has allocated up to KR 61 trillion won over the next five years, through its Green New Deal2, to bolster ‘green’ sectors and finance eco-friendly projects, which include smart city initiatives. While such fiscal plans to address climate change are often associated with high costs, they could also present economic opportunities. Creating a green economy could potentially create 14 million jobs in the region over the next decade, in the renewable energy, manufacturing and construction sectors3. Major private sector investment into green initiatives should also spur innovations that result in new growth industries or asset classes. Nonetheless, the best laid government plans could be waylaid by potential economic or political instability. Outsized projects to mitigate physical risks to infrastructure assets could also fuel short-term inflation pressures.
Lifting the barriers to recovery
Green shoots from climate action
Green technology investments are gaining traction across Asia Pacific
The push to decarbonise is expected to accelerate growth of Asia Pacific’s ‘green’ industries over the next decade. The region is primed to become a key destination for renewable energy development and investment, with the share of renewables in most markets set to double by 20301. An increased focus on the research and development of clean industries and green technology is attracting investment, and spurring the growth of innovation clusters across the region’s developed markets. Singapore’s CleanTech Park and Pangyo Technovalley 2 in South Korea are leading examples, providing testbeds for companies to develop sustainable solutions such as efficient water systems and electric vehicles. For investors, these innovation clusters offer opportunities to tap into clean tech growth and longer term structural changes relating to ESG, through direct investments in real estate facilities. There may be factors that could impact potential real estate investment returns, however, such as slower than expected growth of an innovation cluster due to a lack of suitable infrastructure or poor urban planning. Given the nascent nature of some clean tech sectors, a domestic skills shortage could also impact business viability. Yet governments’ commitment to climate action should help to drive innovation clusters’ long-term growth, we believe.
Green premium expectations in Japan highlight the potential upside for refurbishment to green strategies
The disruption inflicted by the pandemic has underlined the need to prepare for future impactful risks, such as climate change, or other potential virus outbreaks. As part of a cyclical recovery in occupier demand across Asia Pacific, we think that office occupiers will look for buildings that are more resilient to climate and health hazards. This is in line with the growing number of APAC occupiers that have net zero commitments that they need to fulfil in the coming years, which could accelerate a flight to quality, and increase the obsolescence risk of lower quality buildings. Currently there is a shortage of suitable office supply to meet this surge in demand, with half of investment property in prime locations across APAC more than 20 years old, according to JLL estimates1. Therefore the opportunity to refurbish older office assets, particularly in markets where working from home is less prevalent, such as South Korea or Japan, could offer rental growth potential. In order to achieve green certification, buildings will require energy saving measures, such as efficient heating and cooling systems; LED lighting that responds to sensors; and solar panels. Clean air technology and touchless systems will also become important to occupiers. Renovation may be easier to execute in some markets over others, however. In Japan, for example, ordinary leases, as opposed to fixed-term, allow occupiers to remain past the end of a lease term. Additionally, rising construction costs could result in a longer payback period for investors.
Escalating construction costs could weigh on development margins
Modern logistics supply, catering to e-commerce occupiers and grocers, lags demand across APAC markets, where an increase in total online sales is expected to account for more than 45% of e-commerce growth globally by 20251. This is being compounded by the reconfiguration of logistics supply chains, as online retailers compete to provide ever-faster delivery. To cope with increasing demands, logistics occupiers are seeking to leverage technology and automation for more efficient stock retrieval and parcel sorting. High specification assets that can accommodate these functions are currently lacking, however. As a result, yields for prime stabilised assets are compressing quickly. This could lend support to build-to-core strategies in select markets such as Australia and South Korea, where there is still a healthy spread between yield-to-cost and stabilised yields. However, development margins could become thinner if the recent rise in construction costs, as a result of rising commodities prices globally, were to sustain. Rising land prices across cities such as Sydney and Greater Seoul could also challenge returns. On the flip side, occupiers’ willingness to pre-commit to facilities should help to reduce leasing risk, while developing assets to e-commerce companies’ needs can help to lessen the possibility of obsolescence. This is increasingly likely to include amenities that can enhance workers’ wellbeing, from recreational facilities to day-care centres.
The reset of rental and capital values could bring about attractive opportunities in the high street retail space
As developed economies begin to open up, we expect people’s craving for face-to-face connection, experiences and travel to drive a recovery for the region’s high street retail sector. In the absence of tourist spending, the sector has suffered rent falls of around 16% on average across the region1. Hong Kong, Tokyo and Singapore were among the most visited global cities before the pandemic2. As tourism returns, the high street is likely to see upside, in our view, buoyed by growing Asian consumer affluence. As the wheels start turning, we believe the high street retail tenant mix could emerge better and more diverse than before. Consumers are looking for a shopping experience, and the resetting of high street rents could provide scope for new market entrants and innovative concepts. In Hong Kong, where rents have fallen by around 30%3, Legoland has opened a new indoor children’s theme park in Tsim Sha Tsui. A fresh take on high street retail may offer an opportunity for investors to revamp discounted assets. By expanding tenant mix and positioning flagship stores as a touchpoint between retailers and consumers, there could be the potential for more sustainable rental growth to develop. The risk, however, lies in the timing of the recovery. Rents could fall further in the short term, should the recovery in inbound tourism face further delay or if retailers struggle to pass on inflation to consumers. The relatively high yields though help to compensate investors for taking on these risks.
Cash seeking distressed opportunities is rising
Intense competition for prime logistics assets rapidly driving yields lower
Google Mobility Data, September 2021
Preqin, September 2021
PMA, September 2021 (n.b. Seoul’s High Street covers the decline from Q4 2019 to Q4 2020 as data is only available on a yearly basis)
Australian Bureau of Statistics, July 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).
Australia
United States
Japan
Japan’s Green Growth Strategy looks to invest in innovative solutions, from hydrogen planes and cargo ships, to developing the country’s offshore wind farm capabilities
South Korea’s Green New Deal focuses on developing the country’s capabilities in hydrothermal energy, clean air technology and recycling
South Korea
Hong Kong’s Climate Action Plan includes sizeable investments into clean energy and is expected to further promote its green financing market
Singapore Green Plan 2030 aims to position the city as a centre for green financing solutions and a research and development hub for new sustainability solutions, such as carbon capture
Australia’s National Hydrogen Strategy aims to position the country as a major global provider in clean hydrogen energy by 2030
Innovation clusters look set to become key growth engines within APAC economies, attracting major investment and creating new jobs. Various property types within these areas across developed markets, including Singapore and Seoul, should see strong demand over the long term.
Well located, high specification offices with outstanding sustainability credentials are likely to gain most from a cyclical recovery, given occupiers’ increasing focus on ESG.
The multifamily housing sector in Japan has remained relatively resilient throughout the pandemic. Occupancy rates are high, while investor demand has driven prices lower. As migration returns in key cities, the sector could see further growth.
Stranded retail assets
Poorly located offices
Poorly defined retail assets that lack a clear purpose, such as a marketing touchpoint for international retailers, are likely to become increasingly irrelevant in an omnichannel retail era, and will face difficulty in attracting both retailers and consumers.
The increasing adoption of hybrid working has sharpened focus on offices’ function as a place for collaboration. Poorly located offices that lack the vibrancy and amenities to attract employees run the risk of becoming obsolete.
Build-to-core logistics property could offer attractive returns, in markets where pricing for stabilised assets remains high – in Greater Seoul, as well as key cities in Australia and Japan, for instance. Submarkets that stand to benefit from increased infrastructure spending may provide a fertile home for new, high quality facilities.
Australia’s multifamily housing sector is well positioned to mature over the medium term, we believe, given newly introduced government policies, rising investor interest and favourable demographic fundamentals across key metropolitan cities.
1 Climate Risk and Response in Asia report, McKinsey Global Institute, November 2020; 2 Yonhap News Agency, July 2021; 3 United Nations’ International Labour Organisation
Japan Ministry of Land, Infrastructure, Transport and Tourism, 2019
Developed APAC’s burgeoning alternative sectors, such as data centres, life sciences facilities and senior housing, could provide an opportunity to tap into long-term structural trends and diversification benefits.
1 Travel & Tourism Economic Impact 2021 report, World Travel & Tourism Council, June 2021; 2 Oxford Economics, November 2021
3
1 Boston Consulting Group, January 2021
1 JLL, Unlocking Value in Real Estate report, April 2021
1 E-commerce growth globally between 2020 and 2025 (Euromonitor “Retail in Transition: Future E-commerce opportunities in Asia Pacific and Australasia”)
1, 3 PMA, September 2021; 2 South China Morning Post, April 2021
0 -5 -10 -15 -20 -25 -30 -35 -40
Change over Q4 2019 to Q2 2021 (%)
Capital value decline
Rental decline
Q2 2021 Change in prices of key construction material in Australia (%)
All groups
Electrical equipment
Timber, board and joinery
Other metal products
Concrete, cement and sand
q-o-q growth (%)
y-o-y growth (%)
30% 25% 20% 15% 10% 5% 0%
Expected rental premiums for green offices
% of Japanese landlords & tenants surveyed on rental premiums
0%
6-8%
0-2%
8-10%
2-4%
more than 10%
4-6%
other
14 12 10 8 6 4 2 0
Asia Pacific Venture Capital funding to green technologies, aggregate deal value (USD bn)
45 40 35 30 25 20 15 10 5 0
Dry powder available across APAC (US$ bn)
Opportunistic
Value-add
Core plus
Core
6.5 6.0 5.5 5.0 4.5 4.0 3.5 3.0
Developed APAC prime logistics yield %
Q4 2019
Q1 2020
Q2 2020
Q4 2020
Q1 2021
Average country mobility (% difference from pre-pandemic)
40 30 20 10 0 -10 -20 -30
Aug-21
Average Mobility since mARCH 2020
Developed APAC markets
M&G Real Estate from various government websites as of September 2021
PMA, September 2021
Almost half of investors and tenants expect rental premiums for green buildings to be higher than 4%
Japanese multifamily housing
High specification offices in key Central Business Districts
Innovation clusters
Australian Build to Rent housing
Build-to-core logistics
Alternative real estate sectors
Oxford Economics for Asia Pacific CPI.
