Three trends driving real estate investments in a post-pandemic economy: First Sentier Investors

Office real estate is undergoing a fundamental shift, while COVID-19 has accelerated a number of global real estate investment trends, according to First Sentier Investors.

In a client update, Stephen Hayes, Head of Property Securities, said: “COVID accelerated existing trends such as the continued growth and adoption of e-commerce, increases in data consumption and falling home ownership.

“However, new trends have also emerged, especially decentralisation of work. Since the pandemic proved the viability of remote working, we are seeing a shift from dense urban to more city-fringe and suburban locations. It’s part of a new emerging paradigm of living, working and playing locally.

“In line with this, we believe the office sector will experience a bifurcation between heavily disrupted sky rise office towers, in favour of modern “A” grade city fringe and suburban office buildings.”

Mr Hayes points out that serviced-based businesses are well-suited to the adoption of remote working practices.

“This brings into the question the need for high-rise office space which tends to be expensive, inflexible, congested and inefficient. By contrast, high-quality, low-rise suburban office buildings often have larger and more flexible floor plates and can offer greater amenity and more break-out space to drive collaboration. In many instances the difference in rent compared to high-rise CBD¹ offices is as high as 50%.

“As a result, we believe these traditional CBD buildings will be heavily disrupted, experiencing higher natural levels of vacancy and falling market rents and valuations. Concurrently, low-rise, city fringe and suburban offices will see increased demand.”

Mr Hayes said that until now, the split between city-centre and city-fringe tenants has been driven by industry sectors.

“Traditional professional services such as finance, insurance, accounting and legal, have been using “old world” work practices. Whereas the burgeoning technology, media and IT sectors have been defining the “new life” trends of a more decentralised workplace. However, we believe there will be greater convergence between the new and old sectors going forward.”

Mr Hayes’ analysis noted that while physical retail assets are under pressure, e-commerce is creating tailwinds for the logistics sector.

“Unprecedented levels of price transparency have changed the game for retailers, who can only compete on price and availability. Wholesalers, omni-channel retailers and e-tailers are investing very large amounts of money into their supply chains, and the total capital inflow is immense.

“The key for them to efficiently managing inventory: who can get the good from the manufacturer or wholesaler to the customer door or store front the fastest? This requires very modern logistical warehousing. New facilities in countries such as Japan, are being purpose-built up to five levels high, with high-tech robotic systems to move goods around, making modern logistical centres very valuable.”

A strong thematic identified by First Sentier Investors is the residential-for-rent, which includes apartments and detached housing as well as manufactured housing.

“The appeal of residential-for-rent has been highlighted during the pandemic. When there is economic expansion, these assets experience growing cash flows grow as household finances improve and rental affordability increases. Then, during economic slowdowns, they continue to provide stable cash flows as the desire and ability to finance home ownership deteriorates.”

Regardless of short-term conditions, the fall in home ownership is a long-term trend, Mr Hayes said.

“Affordability is one driver, but there are also cultural changes. Younger generations don’t always value home ownership like previous generations, and are attracted to purpose-built apartments with high amenity. The affordability and offering can be very compelling versus home ownership.”

Overall, Mr Hayes said cash flows for REITs have remained fairly stable over the pandemic, and the long-term outlook for the sector is positive.

“Rent collections have all remained well above +90% levels this year for logistical centres, office buildings, apartments and detached housing, data centres, self-storage centres and health care assets such as hospitals and medical office buildings. The notable exception is shopping malls, which have been materially impacted.”

“In the main, real estate is set to be a material beneficiary from the expected reallocation of capital across global economies and this will create significant opportunities that will likely cross decades.”