Uncertain times for Commercial Property opens the door to new choices
The global real estate market is big. Really big. It is the world's largest investable asset class. Commercial and residential property globally are worth a combined $228 trillion (source: Savills / HSBC July 2017) with residential property making up almost 75% of the total. Historically Pension funds, sovereign wealth funds and other institutional investors invest predominantly in commercial property attracted by by corporate tenants who lease the real estate producing historically reliable income yields and strong valuations underpinned by robust legal protections and, generally, upward only rent reviews.
Commercial property is owned by the likes of large institutions such as ADIA, APG, Allianz, Nuveen and Brookfield, who utilise directly and indirectly consultants, managers and advisors like CBRE and JLL to support the governance and title of the real estate. There are global standards in valuations and legal contracts backed by powerful PR machines keeping the real estate story going.
It is big business. CBRE, for example, has revenues in excess of $20bn annually and Brookfield manages over $540bn (source: Motley Fool) of real estate assets. However, in the last 10 years the valuations of some commercial property assets have started to struggle as, for example, the move to online shopping severely impacts retail companies/premises and on-line competition such as AirBnB eats into hotel companies’ profitability. Apart from Warehouses and some other niche asset classes, which are growing rapidly thanks to the likes of Amazon and other online delivery companies, many commercial property asset types are seeing rents start to fall which is adversely impacting related valuations (source: IPE).
Against this deteriorating backdrop, the Covid-19 pandemic couldn’t come at a worse time. It has accelerated these historical changes and ushered in new ones. For example,
Home working may become the new normal (who needs expensive offices? Who wants the hassle of commuting?)
Students do not need to go to physical buildings - they can be taught remotely
Gyms are likely to be viewed as unhealthy places
Music concerts and theatre productions can be viewed through Youtube
Food and other provisions can be delivered safely and speedily to your doorstep
The the Covid-19 pandemic challenges all of our traditional beliefs about the need for large office blocks, retail parks and hospitality venues. Most commercial tenants have long leases, so the reduction is rents will be felt slowly, however the adverse impact on valuations is likely to be felt more quickly. Commercial tenants are increasingly asking for rent holidays, deferred/reduced payment schedules and other devices to ensure covenants are not breached but time will tell regarding how many corporates are prepared to break their leases completely. Concerns over high leverage due to low interest rates after 2008 may indicate that there is the further possibility of an asset bubble in valuations too. Many insitutional investors are very pessimistic as a result (source: CNBC / Forbes).
How this landscape pans out depends on us, regulators and governments. It is an uncertain time in the world of commercial property, especially as some investor funds have gated themselves to both subscription and redemption, which is ironic given commercial property has historically been seen a place of safety and low volatility. (source: ThisIsMoney).
We all need somewhere to live
Commercial property represents only about 25% of the total real estate market - the rest is made up of residential property, namely the homes we live in. Most residential property is owned by individuals and families. Historically, direct institutional investment in residential property is minimal and there is little in the way of investment fund choice either.
“Imagine a market this big with few investment opportunities?”
Everyone needs somewhere to live and there is no virtual substitute for that. The economic effects of the Covid-19 pandemic do not seem to be challenging the residential property market like the commercial property market. Governments globally have put in place measure to protect jobs and incomes for both the employed and the self-employed. More and more people are renting, which makes it easier to value related properties on a “commercial” rather than traditional sentiment driven basis. History shows that portfolios of income producing residential properties are resilient to changing economic conditions. Despite direct investment into a portfolio of residential property being expensive for individuals, there is little in the way of intermediated fund choices for capital constrained investors. This will, and is changing. Money is looking to move away from the challenges commercial property faces - it likes the low volatility that portfolios of residential assets has to offer combined with rents that tend to be stable even during exceptional times like today.
Moreover, many countries have controls on residential related debt through loan to value, affordability and suitability restrictions designed to help curtail future residential property bubbles - lessons learned in the past (1987, 1991, 2001, 2008).
So whenever you read headlines about property prices or rents, read the small print and see if the article is talking about commercial or residential property. They may be bricks and mortar but they are quite different from an investment perspective.
The real estate world is struggling to cope with institutional ownership of residential property but it had better get used to it because end investors are already banging on the door of residential property. It is a new investment marketplace, a fast growing market, and the new world of Proptech is providing better ways to carry out due diligence at all stages of ownership.
Exciting times once the “new normal” is established.
Regeo is at the forefront of providing data on UK residential property and its algorithms can highlight, using over 500 factors, the most resilient hot spots. If you are a fund or investment house looking for immediate valuations and trading opportunities then please contact us at firstname.lastname@example.org