Aviva Investors’ annual real estate finance conference addressed the challenges and opportunities facing the property industry at a time when our urban landscape is undergoing rapid technological, social and environmental change. Looking ahead thirty years, what qualities will a city need to be successful and how easy will it be for our industry to adapt?
In setting the short to medium-term economic backdrop for real estate, Aviva Investors’ chief economist, Stewart Robertson, struck a cautiously optimistic note. Concerns about recession both domestically and globally have risen in recent months as manufacturing has buckled under the pressure of trade wars. This has led to fears that the slowdown could radiate out to services and, ultimately, the broader economy via the consumer. But while there are signs that consumers are starting to rein in their discretionary spending, consumption overall is being underpinned by robust jobs markets. Furthermore, the fact that inflation is either at, or below, target in the major economies gives central banks the flexibility to respond to any growth setback with interest rate cuts. Therefore, any slowdown is likely to be moderate and, if there is a resolution to trade wars, we could even see upside surprises.
In this environment, Aviva Investors’ property team recognises that there is ‘late cycle’ risk but is encouraged that the UK market has more momentum than Europe. Moreover, with no sign of a drop-off in lending, it still appears to be a good time to be investing in real estate.
Looking over the next thirty years, we as real estate investors will need to be adaptable as environmental, social and technological change influence the urban landscape. Indeed, understanding the cities of the future and the trends that are driving their transformation will position us to make better investment decisions.
We believe the most important factor to appreciate is the nurturing of talent. This is the resource on which the cities of the future will thrive. The first successful urban developments were commercial centres with locations that facilitated trade. Then, in the industrialisation era, proximity to natural resources and a ready pool of labour marked the winners from the losers. Now, the successful cities will be those that attract the skilled and motivated individuals who have the ability and ideas to develop new industries. To help them achieve this, cities need to be places where people – to echo our property investment mantra - are happy to live, work, play and learn.
Having attracted a deep and diverse pool of skilled workers through accessible housing, good transport infrastructure and leisure and learning facilities, successful cities will encourage talent to cluster in groups to foster new thinking and drive productivity. The final stage is ‘scale’, where these clusters ultimately reach a critical mass that pulls in more talent wanting to participate in innovation and share in the success.
Investors in real estate over coming decades also need to be conscious of ‘substitution’ risk. As Richard Pickering, Head of Futures Strategy at Cushman & Wakefield explained, the phenomenon of the digital world usurping the physical world is a threat to which real estate is far from immune. But while offices, call-centres, doctors’ surgeries, warehouses and libraries may be vulnerable to the advent of digital alternatives, human beings still need to sustain their bodies in the physical world. As populations continue to grow, there will be an increasing focus on assets that meet our need for sleep, energy, food and medical treatment. There will also be an advantage for real estate with an emotional or experience-related connection to its users.
With the onset of new forms of ownership and occupation, the changing legal landscape also presents a mix of opportunities and challenges. Legislative changes that allow a building to become a multiple-use space will bring new complexity to lease agreements, and the apportionment of value. One solution is smart leases, which offer digital contracts with auto-execution ‘on the go’. However, associated benefits such as the automatic payment of rent and service charges could be offset by income reduction for service failures if, say, 5G connectivity was weaker than promised. Therefore, as well as having to cross into the unfamiliar territory of service-level agreements, industry participants from funders to valuers to real estate lawyers will need to be conversant with the new technology that is coming on stream.
Valuers will also need to look beyond traditional valuation metrics. Going forward it will be necessary to quantify the premium a building delivers where it offers well-being and productivity benefits; has positive environmental attributes; delivers additional societal benefits; operates ‘smartly’; differentiates for customers through experience; and is a necessity for human existence. We should also recognise how the changing profile of our urban areas is driving asset transformation. With research suggesting that up to three quarters of landlords are undertaking or considering the redevelopment of retail assets, future values of a significant proportion of real estate stock will need to be reappraised.
Whilst visions of flying cars raised by speakers at the Conference may seem too futuristic, the pace of change is increasing. As investors, we need our advisers to be alert to the social, environmental and technological changes that will impact on the role and value of physical assets, in order to manage future risk.
We are excited about the changes facing real estate and the opportunities that the transformation of our urban centres will create. We look forward to working with all industry participants to be an active investor, helping more places seize their chance of becoming a ‘City of the future’.