The first 100 days: Five real estate investment trends in Joe Biden’s America

You have to grow to diversify

Commercial real estate portfolios have, to various degrees, been struck by COVID-19. “I think the real solution out of this is growth and diversification”, explains Martin Brühl FRICS, Chief Investment Officer, Union Investment Real Estate. “We have very robust funds, one is 14 billion Euros of assets under management, but 50% of this is office, and the other 50% is retail and hotels. To move the needle, to increase the proportion of logistics and multifamily, you’ve got to really find the right deals. These things are pretty granular: a shed is not the same as a CBD high rise in Japan or Tokyo. It’s going to take some time. It’s a rebalancing exercise that’s going on, and it’ll take years for this to find a new equilibrium in core investment strategies. Real Estate (RE) portfolios have traditionally used the classic food groups: office, hospitality, classic retail and shopping malls, but you can only diversify out of the currently structural issues, and you can’t do that in one market. The US is the most liquid, the deepest, the most transparent and efficient real estate market in the world. The interest is certainly there for cross border investment and for diversification through growth.”

Lemmings, beds and sheds: another bubble on the horizon?

“The irony is that we’re lemmings”, continues Brühl. “We’re jumping to the same conclusions; people are more sceptical about hospitality and discretionary retail, everybody seems to be buying beds and sheds now, which has seen an enormous over subscription in deals. We’ve seen cap rate compression to the point that one questions whether there’s an inherent risk in these so-called resilient asset classes. There’s also a discrepancy between the replacement costs and the capital values. At the point when everybody runs into beds and sheds you’re going to see price explosions and bubbles being created. Those areas which are overlooked may again get more attractive. Maybe at some point we’re going to be very happy buying more offices."

The pandemic has also had an effect on risk appetites. Sylvia Gross, Managing Director – Head of Capital Markets and Investor Relations, HQ Capital explains: “In general, I think it’s switched, or made certain asset classes core – those that were not core in the past. Industrial is certainly one of them. Logistics – it was not considered a core asset class. The way that it is now, it’s become a darling.” She continues, “I think the beauty of this is that in general real estate has become much more core – people don’t view it as risky or illiquid, there’s a demand in global markets. When we have inflation, multifamily is certainly the best hedge for inflation because of its one-year leases”. Martin Brühl agrees: “In the past it was a pain to manage – all those individual tenants. But today we praise the granularity of the cash flow.”

Headwinds and tailwinds

“If we focus on tailwinds first” says Will McIntosh, Global Head Research, USAA Real Estate, “there’s a lot of interesting things happening. We’re seeing a broader distribution of vaccines and a lot of economic stimulus being added to the economy. In the US we’re also looking at 6.5% GDP growth this year, trailing off to 4% next year, we’re operating at a low interest rate, we’re also seeing declining unemployment rates, and improving demand for commercial RE.”

“The headwinds that we need to be concerned about include supply chain issues and labour pool issues”, he continues. “Although the unemployment rate is coming down, there are a lot of people drawing pay checks that still aren’t coming back to work for a while. The supply chain issues are causing, at least in part, the inflation that people worried about. We’re also seeing price jumps across a number of items, and recently there was talk about major tax increases that are coming, so that’s certainly going to have an impact on demand for real estate in the US. Finally, I think the big overlying headwinds are demographic trends: the fact that our population is ageing in the US. We’re probably looking at a slow growth, low yield environment in the future.”

US secondary cities are growth cities

Investors are increasingly seeking investment in secondary American cities, notes Sylvia Gross. “We strongly believe that this is a trend that’s here to stay. That doesn’t mean that the primary cities are dead, it means that we have expanded the number of cities that have become prime targets for investment, domestically and from a global point of view. I used to say people invested where there were direct flights from Europe or Asia. Now people are investing in places with no direct flight. They have learned that people live there, and there’s tremendous growth. Those secondary cities that have a tech focus are going to do particularly well”.

“The secondary and tertiary markets are becoming a lot more interesting” agrees McIntosh, “in terms of growth, offering the ability to achieve a higher return, and not having to compete with the capital that has flown into the gateway and primary markets. You do need to be mindful that it could be a little more difficult to exit these markets because there still tends to be fewer investors so transaction activity and volume may not quite be so high. Although, that’s changing and they may not be as illiquid as they have been in the past, so there’s a lot of opportunity there.”

Future challenges: functional obsolescence and the end of stimulus

The pandemic has hit different asset classes in America in different ways. Some have been temporarily affected by the pandemic, some have been potentially changed forever, and others haven’t been affected. Says Martin Brühl: “Look at hotels. A year ago there was clear panic, but I think now people are more diverse in their opinions. There’ll be more tourism as soon as people are vaccinated, and airlines are getting a few planes in the air. But companies will definitely cut down on business travel. We have the biggest field study on mobile working going on, and with virtual conferencing, why fly to another city for a business lunch?”

Will McIntosh takes up the theme: “It’s going to be interesting to see how office in particular shapes out. There are different viewpoints on whether people will be coming back to the office completely, needing the same amount of space. There are going to be tremendous opportunities in the office sector because the type of office tenants is going to be changing. A lot of the office space that we have will require significant redevelopment or it may become functionally obsolete. We’ll need to figure out how to reuse it.”

Sylvia Gross adds: “I’m optimistic over the next 3-5 years. I think I’m less optimistic in the long term - not for the RE asset class itself - but for other general global headwinds. I think that the stimulus has been great, but after the stimulus is absorbed, how the next steps are handled is going to be key.”

“Investors are right to focus on upping their allocation of RE,” says McIntosh. “It can help meet investor demand for mixed portfolios: offering return, income and diversification.”