M&G’s Global Real Estate Outlook report forecasts strong underlying recovery but uneven growth rates across markets

Jose Pellicer, Head of Investment Strategy at M&G Real Estate

In the wake of unprecedented global economic disruption and the acceleration of certain market trends following the COVID-19 pandemic, M&G’s Global Real Estate Outlook report offers key insights into how investors may actively reposition their real estate portfolios for long-term recovery.

The findings reveal the boost to economic sentiment following the implementation of global COVID-19 vaccination programmes and how a previously cautious approach to investment is giving way to a release of pent-up demand. In many markets, consumers have accumulated significant savings and this, combined with governmental and central bank fiscal stimulus, is creating a climate for an economic boost and business expansion.

The research suggests that structural life and work-related changes are beginning to impact how real estate portfolios are being constructed – with some rebalancing towards long-term growth sectors and alternatives such as residential and student accommodation. However, investors should not forget that both growth and stagnant sectors are also subject to cycles.

M&G’s research shows that APAC’s relative success in mitigating the wider impact of the pandemic has placed the region at the forefront of the global economic recovery. China’s economy has already rebounded to pre-pandemic levels, driven by the recovery in domestic household consumption and business investment, stimulating growth in the region’s manufacturing and export-reliant countries, including South Korea and Singapore.

Key trends include:

A permanent shift towards flexible working across all cultures seems likely, even though hybrid working will not entirely displace the office. In APAC markets, expanding innovation clusters are synonymous with highly collaborative campus facilities.

Allocations to alternative sectors are set to increase, with a record volume of institutional capital targeting residential property. Limited supply and high house prices will continue to drive Europe’s cohort of renters. For example, key workers account for around 40% of Denmark’s workforce, yet affordable homes make up just 20% of the country’s total housing stock.

Logistics will remain in high demand, backed by a structural shift in the way people shop, with yields reaching 3% in Germany. Yet not all logistics will prove resilient – in a low yielding environment, asset selection is critical.

The retail sector continues to face structural headwinds but could see a recovery in parts as households release savings into the market and investors react to significant repricing.

Real estate continues to reflect a wide risk premium over bonds, despite low property yields across Europe. M&G predicts that inflationary factors are likely to be temporary and interest rates will remain low. Combined with low vacancy rates in Europe, core real estate pricing appears sustainable and offers attractive relative value to investors.

Jose Pellicer, Head of Investment Strategy at M&G Real Estate, says: “It feels as if the sheer scale of consumer demand waiting to be unleashed may trigger a phenomenon not too dissimilar to the so-called ‘Roaring ’20s’ a century ago. We are already seeing early signs of sustained economic growth following a period of severe restrictions, which is likely to have wider positive benefits for many societies across the world.

“Quality of income has become key for investors, with the primary focus on occupiers. Rotating into high growth or resilient industries will be key to maintaining portfolio cashflow. The top growth tenants of the 2020s will be those driven by sectors such as health, climate, renewable energy, transport and technology. Everyday ‘enablers’ – primarily in technology and finance – are also likely to prosper.

“Not all markets are positioned to take advantage in the same way, so recovery is set to be uneven depending on regional circumstances. However, assuming that the spread of the pandemic is contained and halted, our data suggests that the next few years will be characterised by a new wave of ambitious investment and levels of confidence not seen for a long time.”

Other key findings:

Open market trading economies such as Germany and the Nordics are likely to lead Europe’s recovery, following a boost from global market exports and the restart of trade with China.

Supported by increasing public and private investment (and resilient to home working), the life sciences sector offers strong, long-term potential. Life science clusters connected to top universities in Germany, France and the Netherlands are likely to offer the most attractive opportunities.

Multi-family, private rented housing across the Nordics is an investment which blends stable, regulated income with open market potential as fast-growing populations and limited supply underpins the opportunity to grow income.

While travel restrictions have shifted much learning online, face-to-face teaching and the wider university experience will motivate students to return as soon as national restrictions are lifted. Continental Europe remains structurally undersupplied, with the provision of purpose-built student accommodation just a fraction of the total number of students and proportionally much less than in the UK. This provides an early mover advantage for investors in this nascent sector.

The UK represents a value opportunity, given relative pricing. Brexit uncertainty has already reduced substantially, resolving a key issue which was previously holding back UK real estate pricing in recent years. However, the recovery will be ‘K’ shaped. While investment in innovative industries is likely to boost tech firms with a focus on life sciences and clean technology, people-intensive industries (leisure, hospitality, travel) have suffered tremendous damage during the pandemic and are unlikely to expand for some time.

London is advantageously positioned compared with other major global markets, with its tightly diverse and continually evolving occupier base and the infrastructure to reinvent itself in the future – from a financial hub to a centre for technology and life science clusters.

Recovery across Southern Europe is likely to be slower, but a boost in tourism – alongside the impact of major national economic stimulus programmes – could pave the way for a late cycle rebound.

Food retail grocery shopping remains an important part of daily life for many Europeans, meaning relatively low online penetration in this sector. Long leases and low rents make hypermarkets across continental Europe an attractive long-term bet, while entry yields look particularly good when compared with other defensive sectors.

Appetite for e-commerce continues to fuel logistics investment across Asia where transaction volumes grew by more than 15% last year. However, the report suggests that excessive speculative development could derail this cyclical momentum. Long-term investors looking to raise their exposure to logistics should focus on resilient, modern logistics space close to established infrastructure or within populous catchment areas. Landlords looking to stay one step ahead of structural trends should capitalise on rising occupier demand for temperature-controlled facilities to store medical products and fresh groceries with these assets typically commanding higher rents and longer leases.

Pellicer continues: “We believe yields could push even lower for assets with rental upside potential, though the pace of compression won’t necessarily be even. The pandemic has refocused attention on the quality of investments, with cash flow, location and sustainability all now under scrutiny. In many markets, pricing is yet to reflect ESG credentials. But for long-term investors, the exit should be just as important as the entry.

“Environmental standards a decade from now will be fundamentally different and will likely test non-ESG compliant yields in ways not seen to date. It is not yet clear if the ‘beds and sheds’ phenomenon will continue to remain attractive investments over time at the cost of relentlessly down-weighting retail. However, investors will need to adapt if Alternatives – including residential and data centres – are to become a bigger part of future portfolios. Some landlords will need to become more ‘hands on’ to fulfil occupier requirements as businesses place increasing importance on their employees and their environment. Tenants should become customers.”