Thinking outside the box

Since economic, geopolitical and late-cycle trends have been making it considerably harder than ever for real estate investors to forecast the future, the current European roller-coaster has gathered consensus around one investment strategy: mitigating risk, while seeking secure and stable income. While the industry remains largely positive about economic prospects in Europe, the hunt for assets which provide a regular cash-flow – while maintaining their value across property cycles – is increasingly taking investors out of their comfort zones.

The result has been a veritable explosion of interest in alternative real estate, which are assets that combine long-term stability in terms of financial performance, while also ticking the boxes of scale and liquidity.

“Alternatives are real estate assets that are employed for purposes outside the ‘traditional’ uses of office, retail and logistics,” notes Martin J. Brühl, CIO and Member of the Management Board at Union Investment Real Estate, GmbH. “Examples include student housing, hospitality, health care, ‘living’ (private rented sector, multifamily housing), leisure, car parks and automotive, self-storage and data centres,” he further mentions. “Alternatives generally have a higher exposure to operational risk.” With the prices of core assets at record levels in many European cities, it is clear that many investors are also more and better prepared than ever to embrace development risk, which dovetails well with the alternative sector’s need to create its own future by building and planning new stock.

Highly diverse sector follows trends

Whilst many of these types of properties would have once been the realm of a few niche and specialist funds, a desire for more stable income-generating assets and the quest for higher yields – as sectors such as retail brace against the headwinds of change – have reinforced the importance of diversification. Themed funds have arisen across investor portfolios to reflect this. The range and diversity of the assets is striking: at first glance, it is hard to see how they can be considered part of a single trend. However, according to global advisory firm JLL, this richly diverse sector is providing confidence in the midst of a constantly evolving economic environment, often by plugging into demographic and generational trends. “The core fundamentals supporting alternatives are continuing to bolster the sector’s credentials as a strong investment opportunity, especially in the midst of economic uncertainty,” says Ollie Saunders, lead director, alternatives at JLL. “Structural and demographic changes, such as population growth and an ageing population, are driving demand and the need for more supply,” adds James Kingdom, head of JLL alternatives, alluding to “living” sector alternatives that supply core residential needs, from student homes, through private rented sector schemes, to senior living.

Union Investment Real Estate’s Brühl suggests that a combination of scarcity of traditional product, late-cycle cap rate compression, excess demand in a low interest rate environment and a shrinking investment universe due to geopolitical shifts have all influenced the investor shift. “At Union Investment we are very selective and will only invest in property types outside the traditional uses if we can establish sufficient liquidity in the respective market and if we are satisfied we can manage and mitigate operational risk,” Brühl says. “We will always seek a satisfactory risk-adjusted return when accepting additional operational risk.”

Investor interest rose significantly

According to PwC’s annual Emerging Trends in Real Estate 2019 report, in 2015 just 28 percent of European investors said they would even consider investing in alternatives. This year almost 60 percent of respondents are already investing in alternatives in some way and 66 percent wish to increase their holdings. Hotels, student housing and flexible offices are the sectors where current exposure is highest, while student housing tops the wish-list going forward.

Analysts warn that we have seen this trend before: it used to be the custom that as each market peak was passed, the enthusiasm for alternative sectors waned and investors reverted to the traditional sectors of office, retail and industrial. However, the PwC report suggests that is changing for good. “All the signs are that the need for sustainable income and the push into alternative real estate – or ‘demographic investing’ as some call it – will continue long after 2019,” notes the research. Nearly half of PwC’s survey respondents in fact expect the availability of suitable assets to worsen over the next five years, while many more are phlegmatic about the fact that asset uses will continue to evolve and landlords should remain flexible about the types of occupiers that may emerge.

The "living" revolution

JLL’s latest research finds that the incipient “‘living”’ sub-sector is in particular gaining traction, which covers student housing, co-living, multifamily and healthcare real estate assets. Investment in these assets is predicted to achieve 30 percent growth this year across Europe, with eight in 10 investors looking to broaden their horizons. The shift could inject as much as €40 billion of new capital into the living sector, which last year reached €69 billion.

Based on current investment allocations, multifamily is the most popular sector within living, although 75 percent of survey respondents expect investment volumes for co-living to increase at the fastest rate. The most in-demand markets for new investment are France, the Netherlands and Sweden, closely followed by Spain and Ireland, JLL says. Around 82 percent of investors have opted for direct investment into living as their route to market, while 38 percent use private real estate funds.

The JLL report also reveals investor commitment to socially-conscious real estate assets. Sustainability is set to influence living investment decisions, with 80 percent of respondents agreeing that capital allocations will have greater exposure to sustainable assets. PwC’s Emerging Trends report agrees, finding that attention to these assets is also part of a bigger shift to embrace social responsibility by thinking about community when investing in real estate. Brühl is not surprised that so many of the “successful” alternative segments are in the “living” category. “Firstly, a bed and a roof over one’s head is a basic human need – this helps with demand for the underlying real assets and associated services,” he says.

Alternative real estate vs. secondary assets

“The market for ‘living’ or ‘anything with a bed’ is relatively mature and transparent, so the risks that come with the operational business can be better quantified and managed than in, say, the sector of data centres,” Brühl adds. “Finally, demand in this sector is high, which provides for a ‘deep’ market with sufficient liquidity to allow exit at any time.”

The data centre industry has evolved 
enormously from its telecommunications base, and today is cloud and data driven.

PwC’s emerging trends report also finds that the shift to alternatives in this cycle has substituted to some extent the move into secondary property that occurred during the last cycle. As uncertainty reigns on the investment horizon, alternatives now look less perilous than secondary assets in secondary markets – even when factoring in development risk. A look at the supply-side dynamics underlines that many investors in alternative assets need to be ready to build their own stock. This in part depends on the maturity of the asset type. For Brühl, care homes are a relatively mature segment, while nurseries, data centres, serviced apartments and self-storage can be considered semi-mature. In contrast, car parks and automotive assets, retirement living, cemeteries and crematoria are all on the less mature end of the spectrum, giving first movers an advantage.

Expertise required

As with the traditional asset classes, alternatives require operational expertise and an active management approach. Whether skills are outsourced or developed in-house, they are another argument for creating portfolios of scale, to justify the use of specialist teams. “Without the relevant industry expertise it would be bordering on negligence to invest in alternative/operational assets,” says Brühl. “Such expert knowledge can be provided both in-house or through external partners,” he adds. “At Union Investment Real Estate we have dedicated in-house teams for hospitality, micro-living, shopping centres and logistics. In the multifamily business we have gone another route and acquired a stake in a leading German residential platform,” Brühl adds.

A race to scale asset portfolios has also been one of the hallmarks of the flight to alternatives. A few years ago the student housing sector, for example, was dominated by a few niche specialists, such as UNITE in the UK and German developer Unique. However, the last few years has seen major global funds moving in to mop up portfolios, from Singapore’s sovereign wealth fund GIC to London-headquartered Round Hill.

US fund Greystar has become one of the big rising names in Europe this year for student housing and purpose-built residential solutions. The firm’s expansion play in France has been bold and long-sighted: However, the fund also unveiled a multi-family strategy in the UK earlier this year, focusing on raising €850 million for a PRS development fund. The UK is an interesting market for funds with big PRS ambitions. The rise of purpose-built rental accommodation across the country reflects a demographic and financial shift for a new generation which expects to rent for most of its life. It’s a significant shift from the past where home ownership was a mainstream aspiration, aligning today’s market with models already present in Continental Europe.

Beyond living, there are plenty of other niche alternatives for the imaginative investor. Most of the “alternative” segments are actually “spin offs” from traditional asset classes of residential, office and hotels/leisure, in evolution for social, economic and generational reasons. Accordingly, the concept of business premises has broadened to include both data centres and science parks as the requirements of modern industry and the service sector evolve.

Race to scale data centres

Data centres, in particular, represent a fascinating reflection of our technology-forward society. “We’ve actually been monitoring this sector for around 20 years and have seen incredible changes over that time,” says Mitul Patel, head of EMEA data centre research at CBRE. “This industry has evolved enormously from its telecommunications base, and today is cloud and data driven. The growth of the digital economy and the digital world in the last few years has been exponential across Europe.”

The market for ‘living’ is relatively mature and transparent, so the risks can be better quantified and managed than in the sector of data centres

New CBRE research shows that major investors in this segment are now in a race to scale asset portfolios, with stock in the four largest European territories of Frankfurt, London, Amsterdam and Paris forecast to grow by 21 percent over 2019. These four key cities – known as the FLAP markets – are the focus of current research into the procurement of data centre capacity across Europe. The German city in particular is a current hotspot, recording nearly 50 percent of total European take-up in the first quarter of 2019. According to the figures, in the past 12 months the hyperscale cloud companies alone have procured over 100 megawatts of colocation capacity in the four FLAP markets, equating to a capital investment of $800 million. The growth of leisure-focused assets has seen the alternative sector expand to include entertainment venues, which many investors regard as being less affected by economic cycles.

Alternative investments against Brexit risks

Real estate asset manager Yoo Capital Management has recently created a joint venture with real asset specialist Astarte Capital Partners to explore niche property opportunities across London, teeing off with the £400 million (€463 million) Yoo Capital Fund II. This will seek to invest in edge of prime real estate ranging from entertainment venues to hospitals and schools across the UK capital, acquiring properties that can be transformed into “institutional quality core”. “Given that Brexit is just around the corner, we are trying to get into assets which will be in demand in London, no matter what,” says Astarte managing partner Stavros Siokos.

Indeed, while the future may still be uncertain across Europe, the most imaginative investors are demonstrating that the real estate sector still has everything to play for.

By Isobel Lee