If Office Values Collapse, This Is How It Will Play Out, And 7 Other Takeaways From The ULI’s Emerging Trends Report
The Urban Land Institute and PwC’s Emerging Trends In Real Estate Europe report this year charts a property sector confident that the worst problems of the coronavirus pandemic are now behind it, but still one that is unsure how best to operate in a world that is changing rapidly.
Here are eight key takeaways from the flagship report, which surveys more than 800 real estate professionals from across Europe and interviews almost 100 more.
Confidence Is Back
Unsurprisingly, confidence is far higher in the autumn of 2021 compared to 12 months ago before the vaccine rollout in most developed economies started to push back against the rise in Covid-19 cases. Of those surveyed, 52% felt business confidence would increase in the next 12 months compared to 23% last year. About the same number thought profitability would increase (49%) and that headcount would rise (53%).
End Of The Stimulus — No Problem
Interviewees consistently pointed out that the speed and scale of government and central bank stimulus had played a huge role in helping avoid a prolonged pandemic-related recession, providing a floor beneath real estate rents and values. At the same time, there is little sense the withdrawal of these stimulus programmes will create economic issues for real estate. Just 30% of those surveyed were concerned about this issue, putting it fourth-bottom of a list of issues facing the industry. Cybersecurity, inflation and interest rate movements were the top concerns.
London Top Of The Pile
London regained from Berlin the premier position in the list of top cities for investment and development prospects.
“The UK capital has always benefited from the depth of its market and undoubted gateway status, but this year industry leaders believe it also offers better value than some of its rivals,” the report said. “There is a widely perceived yield gap of about one percentage point between London offices and their continental equivalent.”
Narrowing Focus
For investors looking for secure, stable income, the options are narrowing — an ever-increasing amount of money is flowing into logistics and residential assets because retail is completely redlined for investors and there is uncertainty about the future of offices.
“You’ve got a lot of core capital funnelling into a narrower channel of deployment,” one opportunity fund manager told the report. “And so that means rental residential or logistics or student housing — these other things get pushed up by just this wall of money because you think about the amount of money that went into retail and office that can no longer be deployed there. So if you want to deploy in core, you’ve got a fairly limited universe.”
Wanting To Buy Is One Thing. Being Able To Do It Is Another
Because the income is seen as secure and demographics in their favour, alternative real estate asset classes dominate the top of the table when it comes to investor preferences. New energy infrastructure, life sciences, data centres and healthcare are four of the top five choices by survey respondents. But there is a problem, particularly with the first three of these asset classes: liquidity. There are few schemes available to buy or even to build.
The Threat To Secondary Office Values
The general consensus from interviewees for the report was that the best-quality offices will maintain their rents and capital values, but for secondary assets, the future looks tough.
“If you’re in tougher real estate, in secondary locations, it is brutal,” one global fund manager said.
If secondary assets do see values fall, the rerating could be quick and dramatic. One opportunity fund investor outlined how secondary offices may suffer a decline in values similar to that of retail, working on the basis that overall occupier demand could drop 20% because of new ways of working.
“You might see 20 to 25% net rental declines for those buildings, and then you could see the cap rate shift up very quickly. You get the double whammy that happened in retail — rents 20% lower and 150 to 200 bps added to the cap rate — and your value is off 40%. And then if any of them have financing, they’re instantly [loan-to-value] under water, which is what happened in the whole retail sector.”
The Brown Discount Is Already Here
One of the factors differentiating the best offices from the rest is their sustainability credentials. If investors think it will cost too much to refurbish assets to meet government-imposed sustainability standards or self-imposed net-zero targets, they simply will not buy them.
“It is getting harder and harder to get a bid on secondary assets,” one value-add fund manager said. “Because people are fundamentally questioning the sustainability of cash-flow streams and the capex cost that’s going to be associated with sustaining cash flows — not because of the usual tenant incentives, but because somebody imposes a [sustainability] burden on them from outside, like the [energy performance certificate] in the UK.”
Time To Transform
The real estate industry knows it needs to overhaul the way it operates but doesn’t quite know how to go about it. Two-thirds of survey respondents say business transformation is a big priority over the next three to five years, with integrating technology into business practices and running an environmentally and socially sustainable business seen as the keys for a successful transformation. The existing culture of companies is seen as the biggest barrier to change.
“I think the biggest barriers to change for us as an industry is that real estate has done everything the same way for so long,” one respondent said. “You could look at the lease structures in some countries; you could look at the lack of diversity in the industry. I think there’s a movement to change lots of these things, but real estate has always been slower than other industries.”
