Jason Baggaley, manager of the Standard Life Investments Property Income Trust, on what to expect the real estate market in 2021 and beyond.
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 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 ecommerce 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 near-shoring of such operations and de-globalisation 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 benefiting 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, more akin to infrastructure and asset-backed securities.
Looking under the bonnet
At Aberdeen Standard Investments, we believe the most compelling way to deal with this changing environment is to assess deals individually and on their own merit. Jason 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 he says. “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.”
Evert 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 Investment’s 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.
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 wellbeing, plus the energy efficiency and renewable energy sourcing (e.g. solar panels) which helps tenants and satisfies our increasingly ESG-focused investors. Evert 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.”
Craig 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.
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