Core Real Estate Investment Is Dead
The days of traditional buy-and-hold core real estate investment could soon be over, according to a white paper from UBS Asset Management.
In its paper "Core real estate in a disruptive environment," UBS outlined how changes in society are rapidly feeding through to the way people use real estate, and that this poses a challenge to traditional core institutions investors like pension funds and insurance companies.
“Until now, core portfolios have been rather static and could be described as buy-and-hold strategies with occasional adjustments,” UBS said. But given the changes to the way people use real estate, “the traditional buy-and-hold-and-collect-the-rent-strategy is unlikely to be successful in the future”.
The changes it highlights apply to all sectors. In offices, leases are getting shorter, and occupiers want more flexibility and a better working environment. In retail, if shopping centres don’t offer high levels of experience and a focus on wellness and constantly refresh their offering, they will become defunct.
Industrial occupiers are changing their space requirements and demanding more flexibility and technology like robotics and driverless cars, which will have a big impact on the sector. Alternative sectors like student housing or senior living and indeed all forms of rented residential are continuing to grow in prominence, supported by demographic tailwinds.
As a result, core investors are going to have to change the way they invest in three ways, UBS said.
First, they will have to take an interest in the operational side of real estate, rather than just leasing space and collecting rent.
“Occupying a real estate space is a financial liability for a tenant/company, and companies may put more pressure on real estate investors to share the business risk,” UBS said. “In the retail sector turnover rents are becoming increasingly popular. In the hotel sector and in most alternatives managing contracts are common. Similar developments could be anticipated in the office and logistic sector as well.
“Consequently real estate assets are likely to become more asset management intensive and core income streams may face increased volatility. On the upside, successful active management may identify new income streams by providing additional services to the tenant which increases the asset's income stream and thus the property's valuation.”
Linked to this will be the need to invest more in assets.
“Traditional underwriting standards for core strategies usually calculated with modest [capital expenditures] only,” UBS said. “Tenants’ needs are getting more flexible and diverse real estate assets may depreciate faster. Therefore core strategies are likely to become more capex intensive.
“High transaction costs limit the ability of core strategies to rotate the portfolio actively. Therefore the future for core strategies is more likely to be buy-and-manage.”
Then there is sector allocation. UBS points out that data from both MSCI and Real Capital Analytics show office and retail have steadily shrunk as a proportion of all real estate investment since 2001, with logistics and alternative sectors filling the void. Since 2005, the allocation to retail has shrunk the most, from 34% to 25%. UBS said that figure could shrink to below 20%, with logistics growing to more than 15%, and residential also continuing to increase.