The inflation shock and interest rates, coupled with new hybrid working patterns, are changing the way investors approach property. Ahead of the MPIM real estate conference in March, experts talk about the outlook for this asset class, including ESG and offices.
A MILD CORRELATION TO INFLATION
Mike Bessell, European investment strategist at Invesco Real Estate
Global monetary stimulus in reaction to pandemic-driven supply disruptions and post-lockdown demand have brought inflation back into focus. The result has been increased volatility, particularly in bond markets. Direct and listed real estate have been mildly positively correlated to inflation, in contrast to the typically negative correlation seen in equities or bonds since 2010. Many European real estate markets benefit from indexation of rents, resulting in lease cash flows increasing in line with inflation.
Since it offers good diversification relative to stocks and bonds, we believe that direct real estate can be valuable for most portfolios. But liquidity considerations need to be taken into account. Even real estate fund shares cannot always be sold quickly. Arguably, it is largely the longer time horizon of almost all direct real estate investments that drives the performance difference versus listed asset classes.
Listed real estate offers a long-term return profile similar to direct real estate, but with the benefit of more immediate liquidity and at the cost of greater volatility. Both REITs and direct real estate funds own physical real estate assets.
As such, we regularly see listed entities selling assets to direct market funds, and vice versa. In the short run, however, listed and direct real estate represent very different types of investment and a different investor mix with different objectives and time horizons leads to very different profiles.
OFFICES: WHY A TWO-TIER MARKET IS LIKELY
José Pellicer, Head of investment strategy at M&G Real Estate
The shift towards hybrid working has been underway for several years in many parts of Europe and looks set to remain embedded in modern working culture. This could equate to less demand for office space per employee by businesses. However, flexibility means having the option to work in an office and often the proportion of days is based on personal and weekly circumstances. The long-term place of central office hubs we therefore believe in, though increasing occupier standards means a two-tier market is likely to open up between well-located offices with the right ESG characteristics, and secondary, potentially back-office space.
Creating an environment that defines an organisation’s culture and caters to first-time entrants to the workforce is likely to be crucial in attracting and retaining talent. This might include break-out coffee areas, innovation hubs, outdoor workspace, or even rooftop running trails, like Google plans to incorporate as part of its purchase and refurbishment of Central Saint Giles in London. For younger generations in particular, connecting with others both socially and professionally remains a priority and living and working in vibrant locations, we believe, is a deep-seated lifestyle choice. This should continue to rejuvenate cities globally.
ESG: CLIMATE REPORTING “NOT COMMONPLACE”
Christi Vosloo, Head of ESG at Mayfair Capital
Increasingly stringent legislation and industry-led initiatives are transforming the real estate market. There has been immense industry focus on net-zero carbon, brought about through increased public pressure for meaningful climate action as well as through the UK government’s commitment to net-zero carbon by 2050. Staying abreast of regulatory risks should be a key priority for all real estate investors.
Despite advances in reporting, accurately and comprehensively pricing climate risk into investment decisions is still not commonplace in the industry. In time, we expect the cost of mitigating climate-related risks will be routinely factored into asset appraisals and valuations. As tenants increasingly prioritise ESG factors in their occupational requirements, this will pose a risk to the current income and capital value of assets.
One of the most pressing industry-wide challenges is ESG data acquisition. Energy data, which is fundamentally important to understanding carbon performance, is often difficult to acquire due to the nature of the lease. This means that in portfolios with many FRI [full repairing and insuring] leases, there is no obligation on the tenant to share this data with their landlord. As a result, strong tenant and occupier engagement is vital, ensuring environmental and social issues can be managed effectively.