Melanie Collett, managing director, asset management, Aviva Investors Real Assets, discusses the resilience of real assets, prospects for rental and capital growth and underlying ESG factors.
How resilient are real assets in the current climate?
We anticipate low interest rates for the next five years, which will support investment into real asset classes. However, the largest risk is the significantly worsening economic environment and a lack of predictability around rental collections, and for further company voluntary arrangements. We are seeing more focus on turnover rent deals, which will have valuation implications in the retail, leisure and food and beverage sectors. We are working closely with our occupiers and taking a partnership approach during these unprecedented times. It is challenging.
Do you see turnover rents becoming more widespread, as the future of leasing?
We have been working to support our customers, offering monthly rent deals all the way through to turnover-linked arrangements to packages that measure in-store and online sales. We need to work closely with valuers to make sure we are embracing that change – and there has to be change.
How has COVID-19 changed Aviva Investors’ approach to asset management?
What became clear to me very quickly was the power of data and really being on top of your portfolio. Over the past couple of years, we have focused on business planning per asset. We have implemented a new system that allows us to slice and dice our income, slice and dice our risk profile per asset and really look at capital expenditure. That hasn’t changed the way we asset manage our portfolio, but it has been put into play in an immediate stressed environment.
Another area we have been very focused in is our relationship with occupiers. Throughout the pandemic, we have been in constant communication with them, doing all we can to work in partnership. Shutting down and reopening a portfolio and constantly being in clear communication has been the task. Asking questions like `How can we make you feel safe?’
There is a lot of attention on the future of real estate and cities as a result of COVID-19. What are your thoughts?
I genuinely believe there is no substitute for face-to-face interaction. A knowledge-based economy depends on collaboration to create ideas. I see Cambridge, for example, as a core knowledge cluster for the future. However, I don’t think there will be many chief financial officers who are not looking at a reduced cost plan. On average, office space costs companies more £10,000-£15,000 per person per annum for central London. That is likely to be further challenged in a cost-cutting environment.
How important will technology be moving forward?
We are focusing on the amenity of a building, health and wellbeing, air quality, environmental, social and governance (ESG) components, energy efficiency and enlivening the space. Technology will form part of that but getting people back into a collaborative environment and the use and design of space has perhaps overtaken the real smart-tech approach.
Which underlying ESG factors are important?
We are already seeing positive results for developments with BREEAM Excellent and Outstanding ratings, but I also expect to see a `brown’ discount for poorer-performing properties. While some investors cannot sell their oil, gas and coal interests fast enough, we may see the same trend in property, although it will be more difficult to achieve given the relatively illiquid nature of the assets.
What are the prospects for rental and capital growth in different parts of the UK?
The short-term outlook remains very uncertain. But over a five-year period we still think UK real estate offers great value for investors.
There is a wide scope of outcomes we have to factor in running scenarios
Our main scenario for all UK property is forecast to have an annualised return of around 7 per cent per annum between 2020 and 2024*, but clearly there is downside risk around that. A generalised outlook masks the wide disparity between sectors.
The outlook is very uncertain. Our main scenario for all UK property is an annualised return of 5.9 per cent per annum between 2020 and 2024, but clearly there is downside risk around that. A generalised outlook masks the wide disparity between sectors.
Shopping centres are forecast at returns of minus three per cent per annum level whereas London industrial assets are somewhere in the order of 13 per cent. We are open for business and underwriting new acquisitions, but there is a wide scope of outcomes we have to factor in running scenarios.
We are focused on income security, as covenant strength is significantly more important now than pre-COVID. Over the longer term, we feel positive real estate will continue to be an attractive asset class with five-year returns looking appealing, especially on a relative basis, thanks to low bond yields. The cyclical downturn will accelerate with structural change forced at pace.
Having good dialogue with occupiers is crucial.
What sectors and regions excite you?
Around 85 per cent of the assets in our portfolio are now in strategic locations: I feel positive about that. We are tapping into talent, we are looking at accessibility, and we are designing and building top-class, high quality assets where people want to come to the office.
In Cambridge, it has been great to work with major global companies, including from the tech sector, and we are seeing returns there that are almost double the MSCI benchmark. I still feel confident about our designer retail outlets and some of our large shopping centres. We are future-proofing them and making sure that they have the right amenities. Having good dialogue with occupiers is crucial.
We believe we have got the right strategy and it is now about fine-tuning that for the post-COVID environment.
*Forecasts are not a reliable indicator of future performance.
Source: Aviva Investors 2020 UK macro property forecast based on MSCI UK Quarterly Property Index. Estimates are forecasted quarterly (to year end) for a 5-year horizon.