– The pandemic has brought significant shifts in key areas of the real estate market, such as offices, and accelerated trends in others, such as retail and logistics.
– Dealing with this changing environment means assessing deals individually and on their own merits.
– Effective management of individual assets, particularly around environmental, social and governance (ESG) considerations, and ensuring they remain future fit and sustainable, will become increasingly important.
The real estate market was a mixed bag in 2020. While industrials, particularly logistics and certain alternatives, did well during the year, there were also pockets of weakness, particularly within the high street and office markets. It would be tempting to expect the same again in 2021, but the reality may be more nuanced.
Jason Baggaley, manager of the Standard Life Investments Property Income Trust, says commercial property investors should expect change and that this will undoubtedly bring opportunity. He has been careful not to respond hastily to the shifts brought about by the pandemic and believes it is important to adapt the portfolio to the new world as it emerges from the post-pandemic era: “We have used the period for some very deep reflection. That means challenging ourselves and our assumptions.”
What will emerge? In the short term there will be economic recovery, which will ease the pressure on rental payments. Baggaley says: “Our real focus over the next stage is not rental collection but assessing sustainable levels of rents. Within areas such as restaurants and town centre cafes, there has been a decline in rental values because they had become overstretched and now there is less demand. In offices, we can be fairly sure there will be less overall demand but offices themselves will need to adapt to accommodate greater flexibility of working practises. We want to ensure the rental income generated by the trust is sustainable in the long term.”
Adapting to agile working
The office market is perhaps the area subject to the greatest change. The pandemic has ushered in a mass agile working experiment. There is now a real consensus that the work-life balance is unlikely to return to where it was before, with long-term implications for the office market. Craig Wright, head of real estate European research at Aberdeen Standard Investments, says: “We don’t believe in the death of offices, but we do believe that tenants will be much more selective about what constitutes an office ‘fit for the future’. Investors have to respond to that as well and be more selective in the properties they’re targeting.” This includes assessing flexibility, amenities, technology and sustainability.
While the office market has been particularly hard-hit by the pandemic, there are potential changes for all real estate markets. In the surging logistics market, for example, Evert Castelein, manager of Aberdeen Standard European Logistics Income, says that in spite of the strong year in 2020 the team is continuing to focus on the expansion of e-commerce and changing supply chains across Europe. He adds: “It has become clear that long-distance supply chains are susceptible to external shocks. Take Jaguar Land Rover, for example. It was struggling to finish its cars because parts were still stuck in Asia. The nearshoring of such operations and deglobalisation of manufacturing is becoming an important trend – for many companies the labour cost arbitrage of having production offshore is starting to become less pronounced now that wage costs are rising in Asia. We see some manufacturers moving back to Europe. We believe this trend will continue in the years ahead.”
New real estate assets
There are also new opportunities across real estate markets as different types of asset are packaged up into an investable format. Emma Scott, multi-asset investment manager at Aberdeen Standard Investments, says: “We’re investing more in alternative areas of real estate. That includes investment companies benefitting from long-term, inflation-linked cash flows – GPs surgeries, social housing, logistics, supermarkets. We look to them for long-term stable cash flows.”
She says that yields often compare favourably with other asset classes on offer. The income available is higher than listed equity and private equity, and more akin to infrastructure and asset-backed securities.
Looking under the bonnet
Aberdeen Standard Investments believes the most compelling way to deal with this changing environment is to assess deals individually and on their own merit. Baggaley says: “For each property we assess, we ask whether it is going to meet our investors’ needs in the future.” This nuanced approach is reflected in how he has re-engineered the portfolio in the wake of the crisis.
For Standard Life Investments Property Income Trust the area that witnessed the highest level of sales was in industrials, despite the sector performing well during 2020, says Baggaley. “We sold some multi-let estates, which we thought could be much more at risk in an economic downturn. Perhaps surprisingly, our only major purchase was a retail asset: a B&Q warehouse. It may be retail, but it has been posting very strong figures and the unit has fantastic credentials.”
Castelein is doing similar in-depth research for new European logistics options. As the real estate business is a local business he can call on Aberdeen Standard Investments’ team of transaction and asset managers based in local offices across Europe: “This network of feet-on-the-ground experts gives us access to off-market opportunities, where we are not bidding against other buyers in an open market. This is a key advantage for us in this ‘in demand’ sector as it allows us to negotiate good terms.
“We always want to know that a building has good optionality for the future if the tenant were to leave the building. We are one of the largest real estate investors in Europe and have local offices across Europe in Amsterdam, Paris, Frankfurt, Madrid.”
He continues: “We also believe that effective management of individual assets will become increasingly important. That means ‘green’ buildings that suit people’s changing lifestyles. Properties need good showers for people cycling to work and green areas for them to eat their lunch to aid employee well-being, plus the energy efficiency and renewable energy sourcing (e.g. solar panels) that helps tenants and satisfies our increasingly ESG-focused investors.”
Castelein adds: “We want to protect our future cash flows and that means future-proofing by focusing on ESG characteristics. This is really important for us and really important for our tenants.”
Wright is clear that the commercial property sector still has some short-term risks to get through: recovery is vaccine-dependent and increasingly divergent between countries. However, monetary and fiscal policy will remain supportive for the sector, and real estate has historically performed well in a climate of recovery. It can still fulfil its role in delivering stable, inflation-adjusted capital and income returns in a portfolio.
Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.
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Risk factors you should consider prior to investing:
• The value of investments and the income from them can go down as well as up and you may get back less than the amount invested.
• Past performance is not a guide to future results.
• Investment companies are specialised investments and may not be appropriate for all investors.
• Investment companies can borrow money in order to enhance investment returns. This is known as “gearing” or “leverage”. However, the use of gearing can result in share prices being more volatile and subject to sudden or large falls in value. Where permitted an investment company may invest in other investment companies that utilise gearing, which will exaggerate market movements, both up and down.
• There is no guarantee that the market price of the Company’s shares will fully reflect its underlying net asset value.
• As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices – the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
• Investing globally can bring additional returns and diversify risk. However, currency exchange rate fluctuations may have a positive or negative impact on the value of your investment.
• The ordinary shares may trade at a discount to the net asset value per ordinary share, and shareholders may be unable to realise their investments through the secondary market at the net asset value per ordinary share.
• There is no assurance that the Company will be able to secure suitable logistics assets. This may affect the Company’s ability to meet the target returns and may have an adverse effect on the Company’s performance, financial condition and business prospects.
• The Company may hold a limited number of investments. If one of these investments declines in value this can have a greater impact on the fund’s value than if it held a larger number of investments.
• Property values are a matter of the valuers’ opinions and can go up and down. There is no guarantee that property values, or rental income from them, will increase so you may not get back the full amount invested.
• Property investments can take significantly longer to buy and sell than other investments, such as bonds and company shares. If properties have to be sold quickly this could result in lower prices being obtained for them.
• The Company invests in a specialist sector and it will not perform in line with funds that have a broader investment policy.
• Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends, and certain investors may be subject to further tax on dividends.
• Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss.
• The Company may invest in alternative investments (including direct lending, commercial property, renewable energy and mortgage strategies). Such investments may be relatively illiquid and it may be difficult for the Company to realise these investments over a short time period, which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
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Issued by Aberdeen Asset Managers Limited, which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.