Best of times and worst of times: a two speed recovery for the real estate market?

An upended market is often a harbinger of a flight to quality. The real estate market has certainly been upended and investors are showing signs of flight. The demand for quality is strong across real estate asset classes. Take logistics and offices: each experienced the pandemic differently, but investors in both are willing to pay a significant premium for the top stock. As part of the post-pandemic rebound, the market will need to ensure a continued supply of premium product and devise strategies for secondary and tertiary space. However, the rebound is not without challenges – for example could strained supply chains and a brewing real estate crisis in China suffocate the flickering flame of recovery?   

Logistics

It's hardly a ‘hot take’ to say that logistics is doing well. Drive along any British motorway to see shiny new sheds rising from the ground: their structural steels the flying buttresses on cathedrals of contemporary consumerism. 2021 has been a vintage year for industrials and logistics and demand for high-grade premises looks set to continue outstripping supply.

How does this shortage play out in the investment markets? Institutions have previously targeted completed assets, preferably fully-let on a decent covenant. Fund managers have been wary of taking on too much development risk. But this trepidation is giving way to speculation. Funds are investing earlier in the construction – or even planning – phase, seeking to capitalise on healthy demand and beat their peers to the party. Forward funding and joint venture structures are increasingly common, as capital and developers work together to meet occupiers’ needs.

A squeeze on demand might suggest a seller’s market, but this doesn't mean developers can be complacent. Occupier expectations are high in terms of size, spec and sophistication. Consumers are impatient: online delivery times are enough to tempt them from one retailer to another. Intelligent supply lines, including automated distribution centres, become vital. Demand is also coming from new players beyond the traditional retailers and hauliers. Space for high tech manufacturing and assembly is also coveted and examples are eclectic: from modular buildings to electric vehicles. 

Offices 

Traditionally more glamorous than windowless warehouses, offices have long been seen as a steady source of rental income. They are the factories of a services-driven economy. The mass experiment of home working necessitated by the pandemic has indicated that – by some measures at least – productivity does not suffer if employees stay away from the office. The qualitative effects on businesses are less equivocal: from individual mental health to socialising new joiners into a shared corporate culture. However, if employers are to tempt staff back into the office, they need to offer more than a desk and an Anglepoise. Correspondingly, if developers and landlords are to persuade tenants to stay, they need to offer top quality space (at the right price). 

As with logistics, the premium end of the market is hot. There is a dearth of top quality stock, particularly in central London. Investors – both UK and overseas – have been quick to snap up trophy assets, often at record low yields. 

Tired, aged office stock is abundant. Canny developers and investors are already sensing opportunity and a strong discourse of “repurposing” has emerged. Unsurprisingly, urban logistics has been touted as a viable alternative use, capitalising on the shortage of last-mile facilities. The complexities of vehicular access through congested urban streets and 24-hour operations in residential areas will need to be addressed, but the trend seems set to continue. 

What, then, are the key challenges to bringing more quality stock to market?

Supply chain 

The past year has shown how much airtime broadcasters can fill with footage of lorries queuing: almost as much as images of a vessel wedged in a canal. Attention has been focused on supply chains and their apparent fragility. The construction industry requires materials: often lots of them; and seldom where they are manufactured. An interruption in the supply of these materials means two things: delays and increased costs. 

As ESG metrices become more holistic, end users will also be interrogating supply chains: How much carbon is expended in smelting and shipping the structural steels? Does the glass manufacturer pay a fair wage? Such scrutiny should be welcomed but will not be without its complications. 

China and the global outlook

Evergrande, the behemoth Chinese property developer is saddled with debt and feared to be on the brink of collapse. For now, a slump in Chinese property may seem remote, but so did subprime Floridian foreclosures: we must not forget the entanglement of international markets. Around one third of global growth is generated by China and nearly a third of that emanates from the Chinese property sector. It may be too early to predict the likely consequences of a Chinese property crisis on the UK real estate market but there is potential for it to be significant. The Ever Given was freed from the Suez Canal by a rising tide and expert intervention. Let’s hope the banks, bondholders and Chinese government are as successful in salvaging Evergrande.