Real estate: resilient investment in a volatile market

This article was first published on 1 May 2021 in Institutional Real Estate 

With the world working from home, seismic shifts are afoot in the real estate market. The pandemic has transformed the dynamics of the sector, and new working models have fundamentally altered people’s expectations of the spaces they occupy. We explore what’s changed, what hasn’t, and where the opportunities lie when it comes to making stable, long-term real estate investments.

The COVID-19 pandemic is continuing to have a severe impact on European real estate markets. While the vaccine roll-out has given the world a much-needed boost, most of Europe still spent half the winter and most of early spring in lockdown. There is little doubt that this has slowed the economic recovery we were beginning to see. Fortunately, many major government support schemes have been extended and the response by the Central Bank has been sound. Both of these factors will go some way to stabilising asset prices in the short term.

The impact of the pandemic has been felt very differently in countries and sectors across Europe, however. Nations that have suffered a major public health crisis – such as France, Spain, Italy and the UK – have also taken a blow to their financial confidence. Investment volumes in Spain have fallen 69% year-on-year, for example, while the same figures in Germany are, astonishingly, up 5%.

As we continue to see lockdowns across Europe, downward pressure on rental income is likely to weigh heavily on capital values. However, if assets with real or perceived income risk see major discounts, this will create opportunities for astute investors to acquire mispriced assets. Unlike the global financial crisis, where the more mature markets with higher levels of liquidity like real estate recovered first, the COVID-19 pandemic is set to completely transform the fundamentals of real estate.

The emerging hybrid office

Nowhere is this more evident than when it comes to office space. Offices account for around 50% of average asset allocation by core investors in European real estate. We are currently experiencing the largest and most radical home-working experiment in history – and the results have proved that staff are capable of maintaining productivity without needing to be physically present in the office.

Despite the claims from some quarters, however, working from home is unlikely to become the “new normal”. It is more probable that a hybrid model will emerge that offers employees more flexibility. Physical offices will remain necessary in order to promote a company’s corporate identity and build its social capital. Occupiers may require less desk space, but they will need higher quality facilities designed to enable more meetings, better collaboration and positive social interaction.

It is important to note that, due to limited new development in recent years, vacancy rates have remained low across major office markets in Europe – relative to the usual cyclical fluctuations. We see more risk in Central and Eastern European markets, where new development has been less restricted. Vacancy rates in these regions are likely to rise more quickly as demand for office space recedes. In the interests of achieving resilient investments, we are therefore favouring office investments in the Northern and Western European markets, which are both large and liquid.

Strength in beds and sheds

As for logistics property, this sector has actually emerged as a beneficiary of the pandemic. In response to the surge in online sales, occupier take-up has been incredibly strong, and vacancy rates across the major European logistics markets are the lowest they have ever been.

The crisis has shifted the focus towards ensuring supply chain resilience, accelerating a trend that was already underway. This includes bolstering inventory storage and diversifying suppliers, in addition to increasing automation, the use of robotics and cold storage facilities. We expect to see a rise in demand for spaces in prime locations, and considerable investment being made in existing buildings – developments which in turn will benefit core investors.

Residential property has also been seen as a “safe haven” for investment, with prices and volumes for privately rented housing remaining stable. The sector’s pre-coronavirus drivers – a structural shortage of housing and growing urban populations – remain equally present. Considering its stable performance and the opportunities it offers for resilient income and diversification, this sector is certain to attract more investors looking to pursue additional yield compression.

There are short-term challenges, however. With the weak economic outlook poised to impact individual wealth and the affordability of housing, rental losses could become more apparent in the coming months. In spite of this, and in view of the numerous favourable structural trends and advantageous investment factors, we will continue to allocate significant investment to this sector as part of our core diversified strategy.

While logistics and residential property have shown remarkable strength and resilience, the opposite has been the case for brick-and-mortar retail. The pandemic has accelerated the structural changes that were already emerging as a result of the growth of e-commerce. With headline rents falling and retailers unwilling to commit to long-term leases, there will be continued pressure on valuations, and we consider it wise to treat this as an underweight sector.

Diversification is key

During times of volatility – of the kind we have experienced during the pandemic – a diversified approach is key when it comes to real estate investment in the European market. A varied portfolio allows investors to mitigate the adverse impact felt by the most affected sectors, while still profiting from the best of each region and asset class.

Diversification also allows us to react flexibly to emerging trends, such as the inevitable impact of demographic shifts and digitalisation. This agility ensures investors are on the right side of transformation, and can harness the power of change to their advantage. The result is long-term investment stability and consistent, resilient returns – whatever twists and turns the market takes.

 

Maureen Mahr von Straszewski - Senior Pan-European Fund Manager, Advent Capital Investments Ltd

Tom Duncan - Senior Associate, Research, Strategy and Risk, Advent Capital Investments Ltd