BY DAN NATALE
MOORE’S GLOBAL LEADER, REAL ESTATE & CONSTRUCTION
The global real estate sector is experiencing changes that will redefine the concept of a core property portfolio. Emerging categories will attract more funds while some traditional segments fall from favour amid concerns over occupancy, value and underwriting risk.
The transformation of the asset class was already underway before the global pandemic struck and it has accelerated since then as certain property segments grappled with specific challenges, including offices and hotels and leisure.
Doom-mongers foretold the ‘death of the office’ as companies embraced remote or hybrid working. Their pessimism may have been overdone – just as it was with dire predictions for retail property when e-commerce began to take off more than a decade ago. While poorer quality retail properties have struggled, prime grade A retail property continues to attract global investors.
With offices, an exodus of city workers and a long-term shift to hybrid working has inevitably had some negative impacts on occupancy, yields and values but a nuanced picture is emerging. We see continuing demand for prime grade A office space in desirable global locations although the gap between what investors regard as prime assets and less desirable assets may be widening.
Investors are increasingly discerning over which assets they believe have greatest potential to maximise returns. With a wider spectrum of property types to choose from, they are rethinking the blend of categories that might constitute an ideal portfolio.
For example, in the industrial segment, there is growing interest in subsets such as cold storage facilities, self-storage units and data centres, each of which has different characteristics in terms of yield, value creation and risk profile.
Likewise in residential property, interest has widened from multi-family apartment blocks to purpose-built student accommodation and even single-family rental properties. That is a major shift in investor perspective and it is conceivable that what seems like incremental change today could ultimately mark the start of a more seismic shift.
Interest rate trends have had a huge impact on the sector and will continue to do so. Whether we are at or close to a peak in interest rates, questions remain over how swiftly rates will fall from current historically high levels, particularly if wage increases continue to stoke inflation.
High interest rates have increased the cost of capital, which means property owners may struggle to fund renovations, adaptations or new projects. Inflation has increased construction costs which means owners considering major projects such as converting office space to mixed use or residential, must weigh pros and cons extremely carefully.
Fluctuating yields and valuations are also contributing to stand-offs between vendors and buyers, with deals stalling as each side holds out on price amid uncertainty over future direction. Some vendors who borrowed when interest rates were low and property valuations high, are being forced to provide vendor finance packages to drive deals over the line.
A huge swathe of commercial property debt will fall due in the next two years, which could reverberate in several ways through the sector.
There are concerns over heightened risk of debt default, particularly in the North American market where an estimated $1.2 trillion of commercial mortgage debt will mature before the end of 2025. The Financial Stability Oversight Council listed commercial real estate as the first factor in its list of financial risks to the US economy. Refinancing issues will cast a shadow over the sector until they are resolved.
On a brighter view however, challenges present opportunities. There is a wall of money earmarked for real estate investment that is just waiting for an opportune deal and moment. Preqin estimates that private equity firms have $135.5 trillion worth of ‘dry powder’ – by any measure that constitutes significant pent-up demand which could result in a major inflow of capital and a resurgence in deal activity.
Digital innovation will also be a key theme, with Artificial Intelligence (AI) and Big Data being applied in increasingly smart ways from automated market research to real-time revenue optimisation, project planning to execution. There is exciting potential for AI-driven processes to slash traditional timelines, reduce expenses and boost profits.
While uncertainties remain, there are grounds for optimism that we will see the emergence of a more sophisticated approach, not only to constructing real estate investment portfolios but also to the way buildings are planned, built, funded and managed in future.
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