Emerging Trends in Real Estate®: Europe 2021 - An uncertain impact

Emerging Trends in Real Estate® Europe is a joint survey by PwC and the Urban Land Institute. Now in its 18th edition, the report explores two shifts which are, as one interviewee puts it, 'not on the same wavelength': a cyclical downturn juxtaposed with long-term structural changes to real estate.

This year’s Emerging Trends in Real Estate® survey presents a sector in flux. The COVID-19 pandemic; government responses; the environmental, social and corporate governance (ESG) agenda; and push towards net zero and the acceleration of blurring of previously distinct asset classes are all driving significant change.  

Real estate is generally still seen as one of the few investment asset classes to generate acceptable returns at a time of low or negative interest rates. However, the pandemic has forced millions to work from home, closed retail stores and accelerated structural changes impacting three mainstay sectors of the real estate world - office, retail and hospitality. 2020 poses immediate challenges to the security of income from these sectors.

'That approach of only specialising in shopping centres, offices, or industrial just feels and sounds really outdated to me now.'

Investment manager

The uncertainty has shifted priorities within the sector; this year’s market beneficiaries include assets operating in areas which have been minimally disrupted. Logistics and housing are particular beneficiaries, with data centres, life sciences buildings, energy infrastructure, and industrial property or warehouses benefitting from relatively stable demand. Communication towers/fibre have also benefited as life continues to shift online.

There is subsequently a growing requirement to look more closely at the value that can be derived from demand shifts and newer, emerging asset classes, as well as the connections between different types of Real Assets.

As one interviewee says, such uncertain and at times conflicting market conditions can lead to 'imperfect decision-making', making the overall industry outlook for 2021 one of caution.

'COVID is a game changer to the property industry, like the global financial crisis was, but even more disruptive. As well as introducing uncertainty, it will continue to impact our prospects by accelerating a lot of things that were going on in our business anyway.'

Director,global asset manager

The survey reveals a significant degree of pent up capital, with investors waiting for some resolution of 2020’s uncertainty. It also reveals an emerging bias towards domestic markets, as investors increasingly favour locations where they have more existing expertise, rely less on local experts and can more easily assess potential investments when travel restrictions are in place.

Amplifying this domestic focus, is the clear expectation that we will see a deals-led recovery with ample opportunities emerging over 2021 within domestic markets without perhaps having to venture overseas.

The prioritisation of stability has also helped Germany gain favour, with Berlin topping the city rankings this year. The relative health of Germany’s economy, combined with its effective handling of the virus, has helped the country through this period.

The survey also highlights a growing focus on environmental, social and governance concerns, including net zero strategies and diversity and inclusion. These topics feature prominently as part of an ongoing re-evaluation of real estate’s place in society and how it impacts the very fabric of how people live, work, consume and spend our leisure time. The pandemic has reinforced the importance in the minds of many industry leaders of the need to consider how the sector can reduce its carbon emissions, and the importance of the ESG agenda in general.

Trends highlighted in the report include:

Capital is plentiful but paused

A positive observation from the survey this year is that capital remains plentiful. Unlike the 2008 global financial crisis, after which capital receded dramatically, this time most investment managers report the existence of pent-up capital, often raised before the pandemic, which still needs to be deployed.

The low interest rate environment supports asset values and fuels demand, although the research and interviews conducted in July and August 2020 revealed a sense of suspended animation with two key drivers.

The first is the COVID-19 pandemic itself, which has put economies on pause. Analysts are understandably cautious about when normality might resume and how it might look when it does. Accelerated trends, changes in demand and newly desired outcomes means the landscape could be harder than ever to navigate. The survey shows a marked decline in business confidence for 2021, with almost half of all respondents expecting a fall in profits.

The second is the government response. Governments across the world have introduced mitigation measures, such as tax and insolvency deferrals, to stave off the worst effects of the pandemic and in some cases even instigating deferrals or moratoriums on rent collection. And, in the United Kingdom (UK), whilst the government has committed to “build, build, build”, details of the programme are yet to be published.

As a result, a great deal of capital is awaiting deployment pending a clearer view of the future path of policies such as these. This year’s full report offers insight into the range of views on how long-lasting and consequential these interventions are likely to be.

Investors are turning towards domestic markets

Globalisation has been a constant backdrop to the market for the last decade or so, bringing with it an expectation of high and rising levels of cross-border investment. The Emerging Trends in Real EstateⓇ Europe survey reveals that in 2020, this is changing.

Investors are increasingly turning to domestic markets rather than looking overseas. North American capital is finding its domestic market more attractive than Europe, and the survey revealed a strong expectation that European investors will play a greater role in their domestic markets than in previous years.

One reason is the difficulty of doing adequate due diligence on properties overseas. Cross-border investment has traditionally relied on international travel to view assets and manage investment logistics. As one respondent puts it, "without ‘boots on the ground,’ deploying millions of euros on an uninspected building can feel risky."

Many Asian investors are newer to Europe and lack local teams and so investment flows from Asia have been particularly hard-hit by the reductions in travel. The survey showed 40% of respondents are concerned about deglobalisation.

Shifting fundamentals

One of the more challenging trends to emerge from this year’s survey is the recognition that fundamental market shifts are still playing out. Fear of the unknown has put the brakes on development for most of the industry and plenty of respondents say it is too early to assess what office or retail rents are likely to look like even a year from now.

The pandemic is also highlighting the role of real estate in the health and wellbeing of societies, and this is expected to drive further change. A number of key reasons emerge for this. Many more people are working, shopping, and socialising from or nearer to home. If this becomes a permanent shift, it would strike at the heart of how the industry serves its customers and conducts its business.

Some respondents this year highlight how radical this development has been, with one saying that "the shift from physical to online retail has condensed a decade’s worth of change into a couple of years." Whereas some respondents expect working from home to reduce demand for office space, others expect it to increase in certain areas even long-term, as companies increase the space they allow per employee to allow for permanent social distancing.

The policy response to the pandemic is another variable which may alter market fundamentals. While nobody expects measures such as rent or insolvency deferrals to be permanent, these government interventions have upended the perception that real estate provides secure returns. In the UK, for example, a government-approved moratorium on rent payments has, in the words of one institutional player, “threatened the sanctity of income.” This perception threatens the stability of real estate as an asset class. One respondent comments that the sense that offices and retail property were safe investment ‘seems old fashioned now.’

Uncertainty surrounding the future policy landscape has raised further questions. One private equity player quoted in the survey argues that "as long as the government keeps intervening, allowing tenants not to pay rent, and encouraging banks not to enforce terms, the market standstill could last for a long time."

Changing priorities

Repurposing assets is high on the agenda: nearly three quarters of respondents say that repurposing assets from one sector to another is on their agenda for the next five years. One European respondent explained that “the game going forward will be to make sure that whatever you invest in can be repositioned and repurposed.”

Another explained this shift as a natural response to the current uncertainty, saying, “I think occupiers are going to figure out that the way we use space is going to change and it’s easier to change something that hasn’t been built yet than something that’s actually up there.”

This year also sees a significant rise in concern about assets becoming obsolete, for example due to perceptions that the fall in demand for office space is permanent. Indeed, 41 percent of survey respondents – up from a third last year – are concerned about asset obsolescence for 2021. Nearly half believe the problem will worsen over the next five years.

In response, the sector must consider how it can deliver or repurpose assets quickly, and improve their operational resilience and flexibility. The need to embrace new skills and technology and the levels of automation and artificial intelligence seen in other sectors will enhance operations and make them future-fit.

Net Zero

The built environment has always played an outsized role in society: it is after all part of the physical world in which our lives play out. This year’s survey revealed a growing perception that as societies rebuild after the pandemic, they must do so in ways that minimise harm to the planet. Many governments have already set targets to reach net zero emissions of carbon, and many respondents reflect a growing awareness that the real estate sector must make a contribution to those goals. Climate change and the environment are named by industry leaders as the factor likely to have the biggest impact on real estate over the next three decades.

Nearly 80% of respondents think that energy efficiency, carbon emissions and climate adaption will increase in importance in their portfolios in 2021. Over a five-year time horizon, that number increases, with many believing that the pandemic has provided renewed impetus to the push for sustainability. Some within the sector are turning their attention to what can be done to make retail and office assets more sustainable when they are repurposed.

The shift towards net zero is also driving the attractiveness of buildings which are as self-sufficient as possible, for example generating their own power or processing their own wastewater. This is likely to be a growing area of interest in the coming years.

Regional hotspots

Global map of emerging trends in real estate.

Germany has emerged as a regional beneficiary of the flux this year. The relative health of Germany’s economy – combined with low vacancies for office, residential, and logistics property in its major markets – has boosted investors’ confidence that income will be resilient in the face of the crisis.

Berlin has moved up to take the number one spot in “Overall real estate prospects” index (Table 3-1), particularly because of the stability of its office market and the upward potential in rents. Germany’s three other major markets - Frankfurt, Hamburg and Munich - remain firmly cemented in the top 10.

'The theory is that Germany is in better shape than most of the other economies. And therefore, in a way, if you’re going to buy anywhere, you buy in Germany.'

Pan-European fund manager

Respondents took the view that the events of 2020 are likely to lower the value of megacities, with contagion adding to the expense, complication and crowdedness of big city life, which may be headwinds on demand.

Despite short term concerns, investors are clearly optimistic about the investment opportunities in London and Paris for the year ahead. These capitals are commended for the relative liquidity they offer investors and their overall prospects in 2021.

Overall real estate prospects

Overall rank Overall prospects
 1 Berlin 2.20
 2 London 2.12
 3 Paris 2.09
 4 Frankfurt 1.87
 5 Amsterdam 1.86
 6 Hamburg 1.77
 7 Munich 1.77
 8 Madrid 1.55
 9 Milan 1.25
10 Vienna 1.24
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