The 10 Key Questions For Real Estate To Grapple With In 2020

Could cap rates go below 2% for the best assets in big cities? Could some retail assets start to outperform their stellar industrial counterparts? Will climate change continue to rise in importance for investors?

Each December the strategy and research team at UBS Asset Management outlines what it thinks will be the key questions the global real estate industry will need to address in the coming year. At a point of big change for the sector, the future of real estate, how to allocate capital in an expensive market, what to do with a problem like retail and addressing the climate crisis feature prominently.

Here are the issues to get your head around next year if you want to succeed in real estate.

1. How low can cap rates go?

Central bank stimulus means bond yields in many countries are already at or below zero, and UBS said this means investors will continue to be attracted to real estate because of the yield it offers. The lowest yields in the world are in Hong Kong office and retail, where before the recent protests they stood at 2%; and Singapore luxury residential, which yields just 1.5%. As interest rates and bond yields continue to fall, cap rates in major global cities could start to approach the levels of these Asian cities, UBS said.

2. How should you position yourself for a downturn?

UBS is not predicting a recession, but real estate is of course cyclical and the current bull run has lasted more than a decade. So how to position your portfolio to withstand any recession that might come? In offices, core locations and assets that meet ESG requirements will perform best, UBS said. In logistics, urban locations will best withstand changes to occupier supply chains. In retail, a low allocation is best until the sector finds stability, although selling out right now is hard. Sectors supported by demographic changes like residential, senior housing and healthcare are expected to perform well, as will senior debt.

3. Can some retail start to outperform logistics?

“This answer may seem controversial, but 2020 could be the year that some retail starts a comeback,” UBS said.

The company said some retail assets could outperform the industrial and logistics units that have been the darling sector of real estate for the past five years or more. It predicted industrial returns would start to slow. As for retail, it caveated this prediction heavily. Selected assets would perform well, not the whole sector. This would primarily be in the U.S. and UK, where rents and values have fallen furthest. And retail parks/neighbourhood retail would be the best performers, UBS said.

4. Will climate risk continue to increase in importance for investors?

In short, yes.

“Year after year, ESG assessments in the real estate asset class are increasing in complexity and comprehensiveness, with social and governance factors now complementing a former energy-centric approach,” UBS said.

The list of reasons why is long, and particularly relate to the impact of climate change: increased flood risk from rising sea levels, dynamic or localised heavy rainfalls, as well as the impact of severe winds, tornados, typhoons, prolonged drought events, soil subsidence, freshwater shortages and devastating wildfires. Investors want to avoid these things affecting their property and help to avoid exacerbating these issues, too.

5. What will turn a bigger profit, core or value-add?

With asset values at record high levels and returns moderating, investors are trying to work out what level of risk to take on in the months and years ahead and still meet their return requirements. UBS pointed out that while returns from value-add deals might look better than highly priced core assets, these riskier deals typically do well when economies are growing strongly, which is not the case in most parts of the world.

6. How do you adapt your existing retail to a very different consumer landscape?

Everyone knows the world of retail has changed, but what are you going to do with your existing retail assets? UBS recognised that the terms have become a bit of a cliche, but said there is increasing evidence of experiential retail outperforming older formats, and retailers that have fused physical and online operations outperforming, too. It added that private equity firms are starting to undertake the transformation of old retail to new uses. In the UK that involves converting retail warehouses to logistics, while in the U.S. that involves retrofitting urban retail into offices and hotels.

7. Multifamily residential: threat or opportunity?

Regulation on rented residential has been ramped up significantly this year, with rent controls being increased in cities like New York and Berlin. This of course presents a challenge to investors in the sector. But UBS said the need for affordable housing in big cities around the world will continue to grow quickly, and become an issue of deep political and social concern to younger citizens in particular. Companies that can provide housing in an affordable but profitable way will be tapping into an almost unlimited pool of demand.

8. Will allocations to real estate remain high?

Because of the aforementioned low interest rates and bond yields, the urgency with which investors want to deploy capital in real estate is only set to increase in 2020. This will primarily be driven by pension funds and insurance companies, with big Japanese funds set to increase allocations alongside family offices from the Middle East and Asia.

9. What are public markets saying about valuations in 2020?

The correlation is not exact, but in general the value of real estate stocks in public markets is a decent indicator of where valuations are heading in the private market. So what are the public markets telling us right now? Retail values still have further to fall, the office sector should be cautiously optimistic, and the logistics and residential sectors will continue to outperform.

10. Will the growth of space as a service continue?

Forget about WeWork’s woes; the occupiers of real estate are only going to want more flexibility as time goes on, UBS said. The company predicts the flexible offering that has transformed the office and hotel sectors will come next to retail, where pop-up platforms will allow retailers to have more flexible portfolios to meet their needs; and industrial, where build-to-suit schemes will make way for build-to-serve units and plug-and-play sheds which will allow e-commerce businesses in particular to have more nimble supply chains.