Alternative Asset Classes: What’s hot (and what's not)?

When it comes to existing and emerging asset classes in the Real Estate sector, there have been some clear winners and losers resulting from the events of the last year. Arguably the pandemic has simply acted as a catalyst for changes anticipated by many for some time, but doubtless it has played to the strengths and preyed on the weaknesses of particular uses on an extreme level that we wouldn’t otherwise have witnessed. Even more so in times of global economic uncertainty, investors seek out opportunities that deliver stable rental growth and there are clear signs that this will involve turning their backs on some of the sectors that have thrived in previous decades.

First up, a couple of the casualties…

• Retail
  
  No-one can pretend that the retail industry didn’t have issues before Covid-19; the high street, in particular, even allowing for the spurious potential advantage of people working from home and being forced to shop locally, has been struggling to deal effectively with changes in consumer behaviour for many years. Prolonged periods of enforced closure would be tough for any retailer with a physical presence to deal with, but has proved to be the nail in the coffin for many, particularly seeing the reluctance of consumers to return to shopping centres and high streets post-lockdown. Consumers are increasingly looking for a unique shopping 'experience', a challenge that, so far, hasn’t been fully met by either the high street or by purpose-built shopping centres. Unfortunately, the number of current retail CVAs indicates that we’re likely to see more insolvencies, ultimately resulting in reduced diversity of tenants for retail premises and consequent reduced appetite for investment. That said, the flip side is that there’s an exciting opportunity here for landlords looking to repurpose their real estate, with a number attracted to the resilience of residential income.

• Office
  
  We’ve heard a lot about the future of offices and whether the shift to home-working will result in the death of office space as a dominant asset class. It will be interesting to see whether the same types of investors who have invested in trophy city buildings will start to shift their focus towards the less glamorous alternative assets we see emerging. There’s likely a need for office owners and occupiers to reconsider how office space is used, with greater focus on the collaborative and social benefits, which may (or may not) result in reduced space requirements from occupiers. See also our thoughts on key considerations for office occupiers elsewhere in this publication. 

So, what type of alternative assets are starting to fill the retail and office shaped hole in the market?

• Logistics
  
  Not only are people working from home, they’re also shopping from home. The shift of retail from street to sofa has been accelerated by government restrictions and an understandable reticence to visit shops packed with customers. As a consequence, retailers require more warehouse space to store, sort and distribute goods to consumers. There is a conventional view of logistics premises as 'sheds'. This is, however, to ignore the complexities of developing the sort of logistics space needed to serve contemporary e-commerce. Occupiers – especially the established operators – have increasingly exacting specifications including critical dimensions and suitability for key plant and machinery. Another challenge is the 'last mile': the final (and most complex and expensive) leg of a parcel’s journey. Smaller urban logistics facilities are scarce and present a different set of challenges to purpose-built industrial parks. Canny developers are already repurposing tired city retail sites to meet this demand.    

• Data Centres
  
  Interest in data centres has been growing for a number of years but recently the demand for them has, for obvious reasons, been catapulted into the spotlight and looks set to continue to grow at pace. The move from owner-occupied data centres to investment in data centre portfolios is demonstrative of the security and long term income streams these assets can offer (data storage migration is tricky, so occupiers tend to stick around). Unsurprisingly the benefits don’t come without hurdles; ESG concerns, liquidity risk, complexity of operation and high capital expenditure requirements to name a few but, with proper understanding and advice in relation to the risks, we’re starting to see new and increased investment (both debt and equity) as well as development in this area. 

• Digital infrastructure - telecommunications towers
  
  Linked to the above as another category of asset in the digital infrastructure space and resulting from the same prolific growth in data usage (this time arising out of the race towards ever better connectivity and communications networks), telecoms towers (which may be greenfield freestanding structures or smaller rooftop installations) also appear to be emerging as an alternative or additional asset class for investors looking to diversify or future-proof their portfolios. The traditional model of operators owning the towers which their active infrastructure occupies has, in many cases, fallen out of favour. Operators are encouraged by regulators to share sites where possible in any case, and operators are increasingly wanting to realise the value of their passive infrastructure and reinvest it back into the network. Individually, communications towers are a much less expensive option than data centres from an investment perspective, but it’s a volume game and significant numbers are required to achieve profitability.

So, what do these emerging asset classes all have in common? Arguably the key desirable feature is the same thing that has previously driven the success of the traditional commercial real estate asset classes touched on above; the prospect of a long term, stable and predictable income stream. If investors can no longer find that in, for example, retail or office space because the demand for those assets is dwindling, they will inevitably start to look elsewhere and there’s no shortage of options for finding the next holy grail.