While the coming year is likely to be a challenging one for real estate, asset managers with the right skill sets should be able to lock in long-term value for their portfolios, ­according to experts across the industry. Yet the next couple of years are likely to look quite different from the past decade of opportunities fuelled by cheap finance and the prospect of yield compression.

Protecting and boosting returns with new strategies and old virtues

“It’s no secret that it’s going to be much harder to drive returns using financial levers alone,” notes Charlie Wade, Managing Director EMEA at proptech firm VTS. “The next twelve to eighteen months are going to require good, old-fashioned asset management to stabilise and drive rental growth. This will increasingly derive from excellent customer service and working more closely with tenants.”

While previous forecasts predicted that 2022, the third year of the global pandemic, would most likely mark the start of post-Covid recovery, geopolitical tensions changed everything. The outbreak of war in Ukraine in February 2022 baked in many global supplychain issues that had arisen during the Covid crisis, deepening the anti-globalisation manufacturing and migration movement, and driving up inflation. Real estate markets, which looked initially resilient to the conflict in Europe, were soon sucked into a growing energy security crisis, and as centWhile property values have already started to fall, yields are likely to rise further throughout 2023, reflecting tighter financial conditions, according to research from Fidelity. Yet the data doesn’t hint at a recessionary cycle along the lines of the 1990s, nor that prices will sink to the lows of the global financial crisis. Fidelity’s experts note that there are still plenty of buyers in real estate and, given that private market investments have become a key part of many well-diversified portfolios, there is unlikely to be a wholesale withdrawal of capital from the space.ral banks responded with interest rate rises they saw lending rates soar. 

Only when transparency is in place for us are we able to validly evaluate and optimise our properties in terms of sustainability. We have been using EMS systems to create that transparency since 2018.

Leveraging innovative digital solutions to increase efficiency

What will change is the way the industry generates returns in a climate of higher risk and recession. Adds Wade: “Taking a proactive and deliberate approach to tenant management will improve the relationship and sentiment of your customer base. Happy customers tend to be loyal to a brand or building and are less averse to an increase in rent over time. 

“While the industry has seen an improvement in the approach, frequency and way they manage tenant relations over the past decade or so, now it really matters. Technology isn’t the silver bullet, but it will be a part of assisting asset managers with the insights and workflows that will enable them to do more for their tenants. Proptech can create efficiency, generate data and offers the possibility of automation, all of which are going to be crucial as teams are asked to do more while maintaining the bottom line.”

Tenant management is becoming more important across all asset classes

Laurent Lavergne, Global Head of Asset Management & Development at AXA IM, also identifies an industry in evolution. “Today, tenants have greater service expectations and a desire for flexibility right across the board. We saw changes in the retail real estate industry in the past in line with this trend – now it affects nearly all asset classes. Take hospitality, which has moved from a focus on fixed rents to management contracts. If you’re entering into a management contract, you need to understand how the hotel works and how revenues as well as operating costs are being generated in order to meet target returns. In residential, we are also seeing an increase in expect­ations around amenities that can help differentiate the offer, although potential rent rises in continental Europe are often limited by rent controls.” 

Transparency is a prerequisite for optimising sustainability

Volker Noack, member of the Management Board and Head of Asset Management at Union Investment, agrees that retail and hospitality are two of the most demanding asset classes when it comes to asset management. In the race to secure the best results, he identifies the rising import­ance of tenant relationship management (TRM) and having a well-functioning asset management team. He flags incorporating sustainability into risk management as a broader part of promoting transparency and longtermism in financial and economic activity. “Only when transparency is in place for us are we able to validly evaluate and optimise our properties in terms of sustainability. We have been pursuing the creation of transparency with EMS systems since 2018, because as owners we would otherwise not have transparent access to the actual consumption in the building,” Noack says. 

He adds: “How are the latest risks managed? Among other things, the industry is dealing with rising energy and construction costs (with their significance for refurbishments, for conversions in the portfolio and also new builds), as well as dealing with space reductions, declining purchasing power and labour shortages. “As rising energy costs affect tenants, here we focus on optimising consumption and further raising awareness of user behaviour, which we had already addressed in the context of climate neutrality prior to rising energy costs. Only now is there a chance that tenants will also be under pressure to act and create more transparency about their consumption metrics, which gives us an opportunity to support them.”

When you are more dependent on rental income than solely on capital values, tenant retention is more important than ever. So, our challenge for 2023 is to make sure that even more of our spaces are ESG-compliant.

ESG challenges are increasingly driving asset management

Another firm that has placed environmental improvements at the heart of its asset management strategy is Germany’s HIH Real Estate. With an avalanche of requirements from EPC ratings to the Sustainable Financial Disclosure Regulation accelerating across Europe, the next few years will bring huge opportunities for those who can get ahead of the changes, and risks for those that get left behind. “We try to anticipate legislation in order to prepare for future disclosure requirements,” explains Anne Böker, Sustainability Manager at HIH Real Estate. “For me, the starting point is data. We need to be able to report on so many different matters in considerable detail, which comes on top of actually taking care of environmental, sustainability and governance (ESG) issues. Other recent regulation requires the add­ition of solar-powered roofs to newly built car parks as well as the installation of charging stations for electric cars. These are new and cost-intensive requirements that require clever solutions.”

Despite the industry potentially tightening its belt this year, Böker is confident that ESG will remain a priority in management budgets. “When you are more dependent on rental income than solely on capital values, tenant retention is more important than ever. So, our challenge for 2023 is to make sure that even more of our spaces are ESG-compliant. This also aligns with our internal aspirations to prioritise energy transition, given the problems Europe has faced since last year, and our broader goals around decarbonisation.”

Finally, while asset managers remain focused on making the most of their portfolios in a challenging year, there is also a view that headwinds may already have peaked. “We believe that inflation has reached a turning point, and the pressure on cap rates will ease. There is also opportunity in obsolescence: secondary offices, for example, are ripe for conversion into multifamily or student accommodation,” notes Lavergne. 

Opportunities beckon for long-term investors

Although signs of recovery will probably remain elusive in the first half of the year, investors can look forward to wielding the greatest negotiating power over deals in the ongoing climate, with rational pricing likely to make a comeback in 2023 as vendors gradually accept value changes. This creates the potential for more differentiated returns between sectors, property types, and locations that active real estate investors can take advantage of, according to a Fidelity briefing note, which concludes: “Instead, we expect the upcoming cycle to be relatively short. If interest rate levels begin to stabilise, we believe that most valuations will readjust by the middle of next year. As the market moves closer to the bottom, there will be some interesting opportunities for investors with long-term capital to deploy.”

By Isobel Lee