July 20, 2023
By James Maydew
In a post-pandemic, digital world, traditional real estate assets like commercial and retail are less defensive than before. It’s time to diversify into ‘necessity’ real estate – property that reflects the evolving economy.
Shopping malls and office buildings have been the mainstay of managed real estate investing in Australia for many decades. Historically, occupying physical space was a baseline business requirement for distributing goods, bringing workers together or running operations, ensuring sustainable cash flow for landlords and investors.
But in a hybrid work world, where online channels are BAU, office and retail leases have effectively become more discretionary than a necessity. As investors make investment decisions by pricing future cash flow – and with disrupted supply and demand fundamentals impacting income streams – valuations on these traditional portfolio staples look less appealing in a disrupted economy.
The iPhone generation, comfortable with ordering online and working via Zoom, are increasingly becoming the most influential driver of real estate trends and demand.
As investors, this next generation won’t want the same portfolio allocation as their parents. And why would they, when there’s a world of alternative real estate assets out there – from multifamily rental shelter to eCommerce industrial, healthcare, life science, data centres and towers? These assets all share one common trait: they are essential to modern life.
As listed real estate investments, this new breed of real estate assets are also accessible through publicly traded equities – effectively democratising what has traditionally been an illiquid and capital-intensive investment.
Following the US lead
The US is the largest and deepest real estate market in the world, and it’s typically where market trends and cycles begin. In the US, we’ve seen institutional capital shift away from shopping malls and office towers. Investors have become more comfortable with other forms of real estate as they understand how to price their cash flows. Those cashflows are typically relatively stable – because demand continues to outstrip supply as the demand is inherently structural in nature as opposed to just a cyclical upswing.
Shelter, healthcare, logistics and digital economy assets are also essential necessities in our modern world – regardless of the economic environment, we still need these things.
According to recent MSCI data, the value of assets benefitting from long-term structural tailwinds have soared.1 Logistics, thanks to the almost exponential early growth trajectory of eCommerce, and residential assets, thanks to the soaring cost of buying a home. Younger generations are now likely to rent for longer – and professionally managed long-term apartments run with institutional efficiency are emerging as an investible opportunity. In the US, Canada and parts of Europe, the multifamily sector is relatively mature – it accounted for 46% of property investment in Germany in 2021, and around 40% of the US rental market is institutionally owned.2
In Australia, the build-to-rent phenomenon is only just beginning. It’s likely institutional capital will play an increasingly important role in funding necessity real estate assets – and it’s in the interest of governments to encourage this, presenting a once in a generation style opportunity in the build-to-rent sector.
It’s likely institutional capital will play an increasingly important role in funding necessity real estate assets – and it’s in the interest of governments to encourage this.”
–James Maydew, Head of Global Listed Real Estate
Four sectors to watch
The combination of demographic shifts, digitalisation of the economy and decarbonisation has created a supply/demand imbalance in four key areas – all of which could be described as necessity real estate.
1. Beds
US home ownership is in decline, and future generations are more likely to become lifelong renters. As countries like Canada and Australia open their borders to more migrants, there will be further pressure on chronically undersupplied rental housing – and multifamily housing, or build-to-rent, is proving a viable solution.
Distribution of investment by asset class in 2021
Source: Savills Research, May 2022
2. Sheds
From last mile delivery warehousing to cold storage and self-storage units for Generation Rent, there is still strong demand for logistics assets. We see significant growth potential in the Asia region where supply is still limited and warehouse stock is ageing – yet eCommerce growth in the region is expected to outpace all other regions as it plays catch up with other global markets.
Modern logistics in real estate space per capita (sqm)
Source: JLL, Morgan Stanley June 2019
3. Meds
Australia’s population is ageing – and as we get older we are far more likely to use medical real estate. 80% of people aged 85+ will visit a hospital in any given year – compared with just over 20% of those aged 15-64.3 With this long-term demand and constrained supply, medical real estate has generated strong returns in recent years – and has low correlation to other types of property assets.
Property risk and return sample period: last 10 years ending Dec 2021
Source: HealthCo Health and Wellness REIT – IPO Presentation and 1H23 Investor Presentation
4. Data-leds
The digital revolution is underpinned by real estate in the form of data centres and telecommunication towers. Demand for 5G data transmission speeds will make towers a critical real estate asset – by 2024, 42% of mobile connections are expected to use a 5G network, up from just 2% in 2020.4 As these assets have low capex needs compared to other sectors,5 they can free up cash flow for defensive growth.
Pan-European Annual Capex Reserve
% of Net Rental Income
Towers have low capex requirements compared to other sectors. Source: Green Street, June 2022.
Investing in shelter
Investors are inherently cautious until they understand an asset, the sector it sits in and the supply and demand dynamics. Shelter is one sector where we continue to see a significant undersupply, and speculative development can no longer be relied on to fill that gap.
Housing affordability is a global crisis, with the World Economic Forum estimating over 1.6 billion people could be impacted by 2025.6 Part of the solution may lie in the experience of developed markets already grappling with a surge in immigration – including Canada.
The Canadian government’s ambitious population growth plan calls for an additional 500,000 permanent residents every year by 2025,7 and they are likely to be seeking rental accommodation. Our analysis suggests a long runway for above-inflation rent growth, high occupancies, and highly profitable development opportunities for Canadian apartment owners. Public landlords also benefit from Government-supported financing, keeping debt costs relatively low. Our Global Listed Real Estate strategies are therefore overweight in Canadian multifamily assets at the time of writing, particularly in rapidly urbanising cities like Toronto, Montreal, Vancouver and Calgary.
This is just one example of how capital allocation to real assets can have profound and long-term upside – not just for investors, but also for society more broadly. That’s an idea that is likely to appeal to the next generation of investors, who understand they live, work and play in a very different world to their parents.
Author
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1 MSCI, Real Estate Market Size 2021-2022 p.4
2 Savills Research, May 2022
3 AIHW Data, Australian Census, Macquarie Asset Management
4 Green Street, 2022
5 Macquarie Asset Management Research
6 World Economic Forum, 2022
7 BBC, 2022