Real Estate Finance Conference 2019
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. We do anticipate, however, a shift away from long leases given the macro uncertainties that persist.
Looking ahead to, say, 2049, 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 sell themselves to 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 work, live, play and learn.
Having attracted a deep and diverse pool of skilled workers through affordable 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.
The road to this potential utopia is nevertheless strewn with challenges and numerous unknowns. Emily Williams and Paul Tostevin of Savills outlined the three trends that promise to disrupt the real estate market in the coming years. First is technology, and in particular the deep impact that the internet is having on brick & mortar retail and logistics. Second is demographics, which are likely to drive a fundamental switch rental housing to accommodate a relatively poorly remunerated younger generation and a burgeoning older population. The third trend is environmental and the need to respond to the legal, and increasingly physical, ramifications of climate change.
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, libraries and the like 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, such as luxury hotels, event venues, restaurants and bars.
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 allows a building to become a multiple use space will bring new complexity to lease agreements, with lawyers needing to understand the operational aspects of assets. 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, 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’ using smart leases, digitalised infrastructure and high-speed networks for access and deliveries; differentiates for customers through experience; and is a necessity for human existence. However, being prepared for 2049 is too late – as investors we will need this expert opinion from valuers well in advance of this date in order that the loans we write in the near future do not expire at a time and in a market place where our underlying capital is at risk due to the changing role and value of real estate.
We are excited about the changes facing real estate and the opportunities this creates in our Cities of the Future and look forward to working with valuation professionals to develop new approaches to identify property risk and value appraisal systems to enhance the property advice they currently provide.