Guiding real estate capital into an uncertain future – reflections on PERE Europe 2022

In the words of the legendary Bob Dylan, ‘The Times They Are a-Changin'’ and that was the predominant theme at last week’s PERE Europe Summit in London. 

It was great to be there and hear many varied insights into the current market from elite real estate professionals, including a number of our own clients. The obvious macro-economic, geopolitical and socio-demographic factors have instilled a cautious tone and something of a “wait and see” attitude among investors. That said, there is confidence that opportunities will remain if stock is selected carefully and investors are fleet of foot and demonstrate flexibility.

Some clear themes emerged from the various panel talks, Q&A sessions and other discussions, highlights of which are outlined below.

Economic outlook and investment strategies

Interest rate rises and inflation will impact real estate transaction foundations, including financing levels and valuations.

Linked to inflation, the war in Ukraine and over-arching supply issues, amongst other factors, rising construction costs are affecting the fundamentals of modelling investment returns. The market is seeing an uptick in repricing of contracts, as contractors are not taking the risk and instead look to build in pricing buffers. The same goes for hedging.

The winners in the short-to-mid-term should be those with cash who are less reliant on debt financing. In addition, investors with longer-term strategies and investment horizons are likely to become increasingly prominent in this market, with pension funds, sovereigns and private wealth/family office investors likely to take up longer term and protectionist investment positions in real estate.

Investment managers will likely feel more pressure in their capacity as “stewards” of their investors’ capital and their associated pools of assets.  They will come under increased scrutiny to research sectors in depth and review investments with greater diligence. This is coupled with a need to remain agile and opportunistic in order to secure assets in a market that will remain competitive – a tricky balance to strike.

Sector focus

Sectors which are driven to support the population and driven by socio-demographic factors have been brought into sharp focus.

Life sciences continues to merit serious consideration, but there are risks in relation to divergent city performance and the research-heavy process of finding the right cluster of investment stock. This sector remains relatively nascent as compared to its US counterpart, but there are signs that the race to catch up is quickening its pace.

Logistics continues to be a mainstream asset class. The emphasis in the next couple of years is likely to be on rental rather than capital growth, as yields fall, but structural trends (limited development pipeline and excess demand) continue to suggest solid fundamentals.

Residential investments are likely to exhibit many notable examples of opportunistic investment trends, given the multiple sub-classes and investment strategies that are developing across the sector in general. Investors are increasingly pursuing a broad residential strategy, ensuring diversification of risk profile, operational strategy and geography – for example, student housing, senior living and BTR/PRS across London and the notable regional city and town centre hubs.

Senior living is perhaps at an earlier stage and less proven than other sub-sectors, but there is a growing expectation that the UK market could begin to mirror the US, especially given the increasing number of retirees with illiquid capital.

Traditional lenders are exiting some asset classes/investment strategies (notably, development loans), creating opportunities for alternative lenders who previously focused on equity but are now providing debt and offering more flexibility in terms of structures and covenants.

ESG

The last couple of years have seen a mindset shift and ESG is now viewed as central to maintaining the value of assets and a pivotal factor in investment screening. Institutional capital investors are very focused on responsible investing, paying particular attention to the fiduciary obligations as to the “stewardship” of capital they manage and of the climate and the planet as a whole.

However, the lack of a consistent market approach with regards to ESG continues to be an issue, with some lenders and borrowers, for example, still in a “box tick” mindset. However, by way of example of the mindset shift noted above, market participants are increasingly wary of the need to clamp down on “greenwashing” of investment materials.

The focus, as ever, is on the “E” of ESG above all else and we are likely to see more development and redevelopment as an obvious way of controlling this aspect of ESG compliance. However, the market has also seen an increased focus on the “S”, with many borrowers changing the ways in which they run their assets. For example, the need to offer better all-round experience and benefits to on-site staff and a focus on well-being and responsible customer service across occupational assets have each become more prevalent. However, the “S” and “G” still remain difficult to quantify objectively.