Repurposing Real Estate in the Pandemic
Tim Stocks, Managing Director, Ince Corporate Finance was invited to speak at a guest panel of the Otis Customer Advisory Board on the topic of Repurposing Property in January 2021.
Post-pandemic winners and losers in property will be decided by the allocation of capital.
Yield – ie. sustainable and growing – is critical. Environmental, social and governance criteria are to the fore for institutions’ asset allocation decisions. ‘Quality’ now includes carbon- and waste-neutral, amenity and home office working. Reliability of offices including elevators is also key.
Emerging asset classes include logistics with its renewable energy-powered big boxes full of IT and robotics, medical and life sciences centres, research centres including diagnostic testing and consultation services with attached retail or next to new ‘hubs’. Many of these will need hygienic rooms, clean air and secure data storage. Localism may well figure too.
Reliability may be correlated with supply chains: pandemic has exposed weaknesses in longer supply chains. New forms of finance e.g. vendor/lease finance and stock finance (perhaps insurance backed) will support increased stock inventory.
Quality attracts premium rents and values, which attracts premium yield, with attracts capital.
We are of the opinion that success is not dependent upon a local or micro focus and should consider global sector trends. It is in this context that we judge the re-purposing of real estate.
The Pandemic and the Money
UK GDP was impacted by the 2020 lock down. The Office for National Statistics (ONS) considers that between Q4 2019 and the end of Q2 2020 GDP fell by over 20%. In the USA GDP was down 33% in Q2 2020. In the EU, the fall in GDP in 2020 is expected to be 8.3%
To give some idea of scale, in the Asian financial crisis of 1998, GDP fell by: 19.4% in Malaysia; 18.5% in South Korea; 21.2% in Thailand; and 5.1% in Hong Kong. China grew its economy, overall in 1998, by 7.8% albeit it from a comparatively low base.
In the wake of the Asian crisis and based on mistakes/experience learnt from the 1930’s recession, the recipe for handling financial crises was written - namely to pursue expansionary monetary policies. Such policy responses are now the policy makers’ playbook for handling financial shocks and were again rolled-out in 2020 as the means to cushion the economic collapse resulting from the pandemic.
The expansionary policies now being followed dwarf anything that went before. In the UK it is estimated by the ONS that Government debt has increased by over a £173bn year-on-year. In the USA federal debt was $27.75 trn in December 2020 an increase of c$5trn year-on-year. Federal debt is now nearly equal to the size of the US economy. In the EU Government indebtedness reached an average of 86.3% of GDP across all EU members.
Expansionary monetary policies will continue for some time to come.
There is a countervailing trend which will step-in as the monetary stream slows. Households have been saving. In the UK, between April and June 2020, household savings increased by £55bn. In the USA, in April 2020, it is estimated that 32% of household income after taxes and spending was being saved in the banking system. The EU equivalent savings rate was 17%.
Banks and other savings funds have seen substantial inflows of funds that need to be deployed.
Real Estate as an Investment Class
This year and beyond will be a period of unprecedented opportunity and growth for the real estate sector. PwC predicts that by 2030 the total global stock of real estate held by institutions could amount to $69trn. The greatest relative expansion being in emerging markets.
The above analysis seems to be borne out by what is happening at ground level. CBRE expects investment in UK real estate in 2021 to be £48bn in total with an “All Property” return of 2.6%.
With expansionary monetary policies and savings looking to enter the real estate market with the consequent inflation risks, real estate will continue to be the “go to” investment class.
Offices in Central Business District locations will remain the asset of choice for investors where the assets are; high quality, well located buildings with a focus on “Environmental, Social & Governance” credentials (“ESG”). Offices in secondary locations will perform less well with a greater divergence of values between the two classes.
With the change to a green and digital world new sub-sectors of the real estate markets will emerge. For instance, logistics (“Big Box” and local distribution), research hubs (life science, AI), medical centres (research and primary health and a separation of the large hospitals from smaller elective units where infection spread can be managed), data centres, and electric charging and retail hubs.
To attract investment, developers and owners of real estate assets must position buildings to generate more attractive returns than the peer group. This involves, refurbishing existing buildings (for instance existing retail and shopping centre assets) or developing new buildings which attract tenant demand at premium prices per square foot.
Positioning Real Estate
Will there be a repurposing of buildings post pandemic given a perceived change in tenant demand? The evidence is currently anecdotal. But what are the “known, knowns”?
Being close to Governments and relevant regulators across the World will continue to be important. A developer, owner, manager or supplier to the real estate sector must be aware of public policy thinking as it develops and with an opportunity to influence the debate.
We can be fairly certain that new real estate development will continue to be strong. In this one needs to look at the global picture. New cities are being built and existing cities expanded. Today 4.5bn of the world’s population live in cities and this figure is predicted to increase to 9bn by 2050. New cities are being built in China, India, Gulf States. While in Brazil, Mexico, Nigeria, South Africa and Turkey existing cities are expanding rapidly.
This migration of population (1.5m people are expected to move in to Chinese cities in each month of the next decade) requires; city expansion, infrastructure, housing (affordable and other), schools/colleges, well-connected transport systems, factories/business parks, logistics, leisure facilities and office/work spaces.
Whether it is the drive for greater urbanisation in emerging countries or repurposing real estate in developed countries, high energy prices, Government regulation and the climate change agenda will have a far greater impact on shaping the future of real estate especially so as new technology accelerates the pace of change through the sustainability agenda. The result, a green or sustainability premium for real estate correctly positioned. We expect buildings to be given sustainability ratings by reference to zero carbon and waste targets. There will be a consulting activity developed around providing such accreditations. The outcomes will be solar panels, efficient heating systems, air quality systems, ample natural light in buildings and work places. All products needing to be sourced, supplied, installed and maintained.
By “technology” in this context we mean the way societies live and work. The need for physical space is shrinking. Entire retail chains have disappeared in developed countries across many sectors, books, clothing, home wares, department stores and leisure due to a dramatic increase in on-line shopping. Recently reported results for the Christmas period 2020 highlight this trend. Tesco announced on-line sales in the 19 weeks to the 9th January 2021 up 80%. BooHoo the on-line only fashion retailer announced 40% sales growth in the last 16 weeks of 2020. Compared with Primark (no on-line sales) which saw a reduction of £1bn in sales in Q4 2020. We expect to see shopping centres becoming a one-stop platform with an element of retail, but supported by restaurants, entertainment and residential – see the Active Entertainment deal announced on the 12th January 2021 for the firm to take 80,000sq’ of London’ Southside Shopping Centre.
This shift of consumers on-line requires warehousing (“Big Box” and local distribution) and the equipment to operate these hubs.
The demand to work from home supported by telecommuting, will impact on the requirement for office space. Goldman Sachs estimates that there will be a 4x increase in employees working remotely and a 15 % decrease (83% down to 68%) of the workforce working from offices. These changes are coupled with an increase the sqm of office space per employee to 12.5sqm from 10sqm, as person-to-person contact is sought to be reduced. To be attractive to tenants’, office space will require virtual meeting capability, short term work places as opposed to hot desks. Offices will need to be “liked”. Opinion formation will be led by social media and social networks.
For developers, technology means incorporating smart appliances, touchless operated elevators, smart metres and smart building management systems in to buildings.
Whilst retrofitting existing buildings will be expensive, the valuation impact (and impact on banking covenants) of not doing so outweighs the costs.
Providing services to developers and asset owners so as to demonstrate how technology is impacting on developments or assets is a new business opportunity.
To succeed over the next decade the following points are highlighted:
The decade following the pandemic will be one of opportunity for those involved in real estate whether as developers, investors or suppliers.
Easy access to capital/credit will drive asset prices and attract developers and bring more land in to development as returns for built assets drain away. Those who embrace the trends in the sector: green and sustainable, and new asset classes (logistics, medical etc.) will be the winners.
Asset owners embracing change will be able to charge occupiers a premium which will sustain investment yields at above average levels.
Suppliers to the sector can benefit from the rising tide and the opportunities to establish new business lines, for instance consulting, product/equipment/technology suppliers, and financing and leasing operations.
To find out more, please contact Tim Stocks at email@example.com