Recovery return reboot
The strong uptick in the global economy, and the lessons learned in ‘living with Covid’ are driving money into real estate. The rebound in investment volumes in the UK has generally not been centred around value-seeking distress, as the level of government support has protected large swathes of the real estate markets. However, the removal of support in late-2021 and early 2022 will likely increase the supply of investment opportunities, and in turn, liquidity in the market. Industrial and residential will continue to be the focus of investor interest, with question marks hanging over the offices and retail sectors.
During 2021, Global investment volumes saw a considerable increase on those seen in 2020 with Q3 in particular seeing strong investment volumes – 92% up on the previous year. This was driven by strong investment volumes in the US, while a number of markets including South Korea and a number of the Nordic countries have seen volumes well in excess of pre-pandemic levels. Those markets that are greater exposed to overseas investors – including Paris and London – have been impacted more heavily. Assuming an increase in global travel during 2022, this will drive an increase in investor interest in those cities.
TOTAL GLOBAL INVESTMENT BY REGION (USD)
The increase in global investment volumes during 2021 compared to 2020
Hodes & Weil’s Real Estate Allocations Monitor expects institutional targets to increase from 10.7% to 11%, the largest increase since 20141
The supply of QE in the system has helped fuel the recovery. While this is tailing off, investor demand will continue in 2022, off the back of ‘wall of money’ targeting real estate. Hodes & Weil’s Real Estate Allocations Monitor expects institutional targets to increase from 10.7% to 11%, the largest increase since 20141 - while Pitchbook’s Global real estate report2 suggests that there is still a large amount of ‘dry powder’ in the system – c.80% more than pre-pandemic.
In the UK, the rebound in investment volumes has generally not been centred around value-seeking distress, as it was post-GFC – although there are, of course, examples of this. As of mid-2021, the amount of funding available for distressed opportunities was just a quarter of what it was during 2019. The huge swathe of government support through furlough, the eviction moratorium, rates relief and other measures has generally protected real estate and a number of industries. 2021 saw a sharp decrease in the number of failing retailers, and the removal of support in late-2021 and early 2022 will likely increase the supply of investment opportunities, and in turn, liquidity in the market.
We will continue to see investor demand from a wide variety of sources – including private equity. Otherwise, European and domestic purchasers have been relative beneficiaries from travel restrictions which has meant that we have seen little activity from those investors without an office in the UK, and relatively little new entry to the market – although that will increase in 2022 on the basis that restrictions on travel remain relatively straightforward.
CENTRAL LONDON INVESTMENT VOLUMES BY PURCHASER ORIGIN
To use a hackneyed phrase, ‘beds and sheds’ continue to be the focus of investor interest, with big question marks hanging over the offices and retail sectors.
The industrial and BTR sectors currently make up 32% and 16% respectively of investment volumes, continuing the shift away from offices and retail whose share of investment volumes has decreased from 76% in 2007 to 46% as of the end of 2021.
The weight of capital targeting the industrial sector continues to increase, driving down pricing to previously unimagined levels, resulting in a 170bps gap offices, and indeed 40bps bps below central London offices. Demand continues to be driven by the structural fundamental shift in the sector, and the prospect for further rental growth, and yields are likely now so low that the prospect for further compression is limited – especially if we are to see anything other than a small increase in interest rates. As discussed elsewhere, investment into the sector is having the impact of increasing the amount of capital deployed outside of London.
Investment into high street and shopping centres remains muted, although we expect the markets to find their new ‘values’ during 2022 and 2023 and become a target for asset recovery and sale. Retail parks are undergoing something of a renaissance off the back of relatively low vacancy and robust footfall levels – and in a number of cases, the residual value of sites. This has driven a 200bps shift in pricing in the sub-sector, but while it is more insulated than other parts of the retail sector against the structural shifts in retailing, it is not immune. While there is investor demand for good covenants from discount retailers and supermarkets (and residual value), there is a question mark over the upside for significant rental growth for retail parks due to the oversupply of retail space across the UK.
TOTAL UK INVESTMENT BY SECTOR
UK AVERAGE EQUIVALENT YIELDS
The impact of hybrid work will continue to cast a shadow over investor demand for offices, although the number of buyers still targeting the sector remains relatively broad and diverse. In Q3 2021, investment volumes in the Big Nine were up to pre-pandemic levels, while central London investment was 13% below the ten-year average. Confidence in the market has no doubt been bolstered by a steady but definitely slow increase in the number of people returning to the office that we have seen during the back end of 2021. There is still a perception that the UK is in fact relatively good value compared to other comparable cities – with the yield gap created at the point of the EU referendum still holding up.
OFFICE YIELDS SELECTED EUROPEAN MARKETS
2022 will see a greater focus on the ‘value’ of real estate. UK real estate remains relatively good value although towards the end of 2021, downward pressure on property yields and a rise in bonds and equity yields, saw that comparative value lessen. Expectations around a rise in interest rates in the short-medium term will put upward pressure on bond yields, and may act as good news for real estate, where there is scope for improvement via asset management. As mentioned elsewhere, the potential rise in interest rates – assuming a marginal increase – is unlikely to have a major impact on the market.
2022, however, is likely to see a continued evolution in the way ‘value’ in real estate is considered. The pandemic has expedited a number of existing trends – the universe of operational real estate has increased significantly as turnover rents have become normalised in the retail sector, with an increasing number of examples of total occupancy cost rents; the desire for flexibility with regards to hybrid working is having an impact on the number of flexible and short-term leases, while office and retail landlords who were impacted by non-payment of rents over the last two years are driving a reanalysis of covenant risk.
ALL PROPERTY VS GILT YIELD GAP
PRIVATE SECTOR SOCIAL HOUSING STOCK
When it comes to risk, landlords and investors (and indeed occupiers) will spend 2022 focusing energy and capital on the sustainability of their portfolios. From a value protection perspective, the change in Minimum Efficiency Standards creates a huge obsolescence risk that will need managing, while the bifurcation in the market – and demand for real estate that facilitates companies push towards net zero will drive innovation and progress (and leave laggards behind). In the office market in particular, tenant expectations will continue to drive the market and we will see large amounts of capital directed towards refurbishment, redevelopment.
2022 will also much more focus put on the ‘S’ in ESG. The investor and developer universe in particular is putting greater stock on social value in development and operation of real estate – and how these real estate impacts communities and cities . 2022 will see the evolution of consensus building in this sphere, but as volumes of impact investment increase, we will see investors look to put money into assets with a community focus. This will drive significant volumes into the different parts of the healthcare sector, but also in real estate that houses emerging technologies that help solve some of the UK’s biggest social problems. The agenda will also drive further interest into forms of social housing. Private investment into social housing has been increasing at a rapid rate over the last 5 years – and this will only increase.