Asset owners face significant challenges — but equally significant opportunities — from a number of global megatrends driving change in real estate markets and underpinning the emergence of new and diverse new sectors.
The Investment Magazine Real Estate Forum, held in Melbourne on Tuesday, heard that social and affordable housing, data centres, senior living and purpose-build student accommodation (PBSA) are among new areas of real estate investment already attracting capital and likely to receive significant additional attention in coming years.
At the same time, upheaval in the banking sector is creating issues in private debt and real estate credit that asset owners must navigate to maximise returns and mitigate risks.
Emi Adachi, the Chicago-based managing director and co-head of global investment research at Heitman, told the forum that demographics and immigration patterns are driving a series of global megatrends that are converging to dictate demand for real estate in markets around the world.
Ageing populations and shrinking workforces, changing tenant needs, and elevated levels of migration are reshaping the investment landscape and creating new opportunities, Adachi said.
“Real estate fundamentally, is about serving the needs of people,” Adachi said.
“But what I’ve observed over the last decade or so is that real estate has really become more and more people-centric.”
Needs-based niche
This is sparking interesting new opportunities, such as student accommodation, and Adachi said property portfolios of the future might hold as much as 40 to 50 per cent in so-called “alternatives”, including sectors such as self-storage, seniors living, life sciences, single-family rentals, student accommodation, and data centres.
And portfolios of the future might hold as little as 5 per cent in office real estate, with 10 to 20 per cent in retail, 10 to 20 per cent in industrial, and 20 to 25 per cent in residential.
“So, this is where we see things shifting,” Adachi said. “And it’s not just us, because this is actually how the public markets in the US have evolved. They have gone to a point where the traditional sectors are a very, very low percentage of the overall index.”
Adachi said institutional private real estate portfolios have been slower to change, but they are changing.
“I will say this is easier to do if you are starting from scratch building a portfolio,” Adachi said. “It’s very hard to rotate a portfolio into this given current weightings.”
Future Fund director of property Belinda Chain said investors need to anticipate the market they will be selling into years down the track. That requires an understanding of how markets will change, and how to position the portfolio today.
“We think about what drives the NOI [net operating income],” Chain said.
“Is it based on a residential user? Is it based on an industrial occupier, and that would probably bolster the [residential] and the industrial allocations.
“And then to actually get to whether or not we think something’s investable, it’s not just about a categorisation. We try not to get wrapped up in allocation or portfolio construction [and] hard boundaries, because ultimately, those demographic trends that you refer to are what will drive your ability to increase your NOI.
“And then you can be a little bit less wedded to the market you’re selling into because you’ve actually bolstered the income. That’s our focus.”
Frontier Advisors head of property and principal consultant Jennifer Johnstone-Kaiser said that “for many, many years” the firm has been advising its clients to approach real estate investments from a needs-based perspective.
“Whether you call it ‘alternatives’ or niche or whatever it is, it’s the idea of the demand that’s driven by demographics and migration and so forth,” Johnstone-Kaiser said.
“So think about it [through that] lens: it’s housing, it’s storage, it’s student accommodation, it’s senior housing. It makes absolute sense. But what I would say is that it’s not easy to access those sectors outside of certain geographies. You really need to be very pragmatic about the implementation, even if you have an allocation.”
AXA Investment Managers global head of alternatives Isabelle Scemama, visiting Australia from Paris, said megatrends are pushing investors across the globe to consider non-traditional real estate sectors, including residential such as PBSA but increasingly also social and affordable housing.
Scemama said PBSA and social and affordable housing were among real estate sectors with both attractive short-term fundamentals and the ability to pass-through the effects of inflation, along with other sectors such as life sciences, data centres and logistics centres.
Traditional sectors such as retail and hotels were unattractive in the short-term and retail, in addition, had limited scope to pass through inflation effects.
“It’s a question of diversifying your portfolio,” Scemama said. “I’m not saying we will exit the office sector. It’s preserving some diversification, it’s one of the very best ways to protect your return; and also look at the fundamentals and being sure that you will be able to capture the to get the income and to capture those income.”
Scemama said AXA manages about €26 billion ($43 billion) of residential property around the globe. She said the Australian residential market has some attractive investment characteristics but it is significantly under-developed compared to other parts of the world.
Comparing Sydney with a population of about 5.2 million people to Paris with a population of about 7.1 million, she said the key factors underpinning the Sydney market were population growth (1.3 per cent a year in Sydney compared to 0.3 per cent a year in Paris) and the proportion of housing stock in each city classified as “affordable” or “social”: 24.6 per cent in Paris, and 8.1 per cent in Sydney.
“But what has emerged and what has been developed over the past years is the affordable housing segment that is now 2.5 per cent of the stock in Paris, and almost not existing really in Australia and in Sydney,” Scemama said.
Hail the hyperscalers
A key megatrend underpinning an emerging real estate sector is “explosive and exponential growth in data”, which makes data centres potentially attractive, said Brookfield Asset Management senior vice president Mary Zhu.
Data growth is being driven by three main factors, Zhu suggested: rapid uptake of generative artificial intelligence; accelerating migration of “user workloads” to the cloud; and individual users generating and demanding data on devices such as smart phones.
“Tens of billions, if not hundreds of billions of [dollars’ worth of] capital investment is required to support the additional workload,” Zhu said.
“The hyperscalers who are at the forefront of generative AI and cloud computing – the likes of Microsoft, Google, Meta, AWS – have pre committed unprecedent amount of data-centre capacity.”
Zhu said investing in data centres with the capacity to support the hyperscalers presents a number of potential barriers. How data centre operators tackle these challenges should give investors clues as to which operators are good, and which are great.
“For data-centre operators now the ability to secure scarce resources is paramount,” she said.
“I’m talking about power, land, planning. In major data centre hubs, and particularly in the context of a large data centre, availability of power is the major constraint to the data centre operator’s growth. Having a good land bank, having good relationships with utilities, will position the data centre operator very well against peers.”
Zhu said a data centre is a specialised piece of infrastructure and operators need to have “the skills and expertise to do very smart designs to build and operate with sufficient redundancy, so that you can provide your customers with uninterrupted power supply, which is a critical requirement for many hyperscalers”.
Zhu said physical and cyber security issues need to be addressed. And the four or five largest hyperscalers account for essentially the entire global demand for data centres.
“That means they are customers that are highly sophisticated, very demanding,” she said.
“And in order to service and win them, you need to have global ecosystems, you need to have multiple layers of relationships into the customers. And you need to have the track record have continued to deliver for them on time and on budget.”
Finally, Zhu said, a data centre operator “needs to firstly be able to price contracts correctly, needs to be able to build on time, build on budget, they need to be able to overcome inflation on cost and capex”.
“And needless to say, data centres are very capex intensive,” she said.
AustralianSuper senior portfolio manager, property, Nadeem Hussain, said the emergence of new sectors id causing, in some cases, asset owners to rethink internal structures to most effectively capture the opportunities they present.
“Recently, we combined our property and infrastructure teams into one team,” Hussain said.
“Part of it was what we were doing on data centres. We found that both property and infra guys were both looking at a data centres and working out where does it sit? That was one of a number of reasons to say, well, look, we don’t care what it is or where it sits; if it’s a good investment, let’s just do it.”
“On the living side…the overall sector looks really strong with some great thematics. Student accom is something that’s, I think, starting to look more and more attractive alongside traditional rental housing models. So I think there’s a couple of the alternative spaces that we’re a bit more interested in.”
Hostplus investment analyst, private markets, Balraj Sokhi said the fund has been moving away from focusing on traditional, core real estate assets to incorporating more alternative sectors.
“Now, alternatives is probably coming more into core, so at some point there’ll be some sort of synergy,” Sokhi said. He said the fund’s lower member age profile – averaging around the mid-30s – means it can take a long-term perspective, which is partly why it has a higher-than-average exposure to unlisted assets.
“We’re more willing to accept illiquidity premiums and complexity premiums,” he said.
“The way we see the world is that through the use of megatrends…and how that’s going to play across the next five, 10, 20, 50 years from now, and how does that percolate down to each individual asset class?
“How do we play that in the most efficient and scalable way possible? We are a small team we do run an outsourced manager model.
“It’s a case of how can we partner with managers who have got the best access to those relevant thematics in the key markets? And how can we partner with them to grow at scale over the long term?”
Golden age of debt
The forum heard that after a year or two of extremely tough conditions in real estate credit, the future is looking much brighter. But asset owners remain unsure in some quarters on how to treat the sector, with mixed views on whether it should be part of a property allocation.
JANA senior consultant property research Alastair McIntosh said despite the attraction of real estate credit as an asset classes, asset owners struggle to know exactly where to place it in portfolios.
“We did bucket it within property, and it was great; then the performance test has come along and been a new challenge, because … clients have generally moved it into their credit asset class,” McIntosh said.
“And so now, when they’re looking at making investment decisions it’s, fighting is too strong a word, against other credit investments in the private credit space – corporate, private credit, infra debt, things like that.”
Rest portfolio manager, property investments, Ben Shortal said an issue for asset owners is that the Your Future Your Super credit performance benchmark doesn’t include real estate credit.
“It slips through the cracks, really,” he said.
Shortal said Rest “really like[s] the risk-adjusted returns that we think will be delivered in real estate credit going forward”.
He said the fund’s credit team “didn’t necessarily want to up-weight; they had existing exposure within largely commingled funds”.
“So we got approval from our IC to then go forward and bring in new investments that are dedicated real estate credits within the property portfolio,” Shortal said.
“But what that means is, we’re benchmarked against an equity benchmark…so we need to seek strategies that will be competitive against equity-like returns.”
Invesco global head of real estate credit Charlie Rose suggested that after a particularly tough period we’re currently in “the most exciting environment for real estate credit in 15 years”.
“We’re calling it the ‘Golden Age of Debt’,” Rose said. “It’s a very unique point in time where both those elevated base rates, that we have all seen have a negative impact on property values, are combining with wider credit spreads.
“Elevated base rates plus wider credit spreads, and 26 per cent of lenders having exited the market in the United States at the very time when maturities are going to hit record levels [of] close to two $2 trillion of loans maturing in the US alone, over the next couple of years…is adding up to a really unique entry point into the commercial real estate debt markets.”
Rose said this represents a turnaround in an environment for real estate debt that recently has been extremely tough. He said central banks hiking interest rate at a record pace had sparked a roughly 20 per cent decline in property values and raised borrowing costs, putting pressure on existing borrowers.
At the same time, lenders pulled back from large segments of the commercial real estate lending market, which put borrowers under pressure to find take-out lenders as loans matured.
“This last year has been really tough for commercial real estate credit,” Rose said.
“But in the context of a real estate market that has seen property values decline by [around] 20 per cent in many major markets, I would still say that real estate credit has served its place in properly diversified portfolios, presenting much less volatility than we have seen in the equity markets.”
Rose said Invesco’s analysis suggests that banks aren’t going to return to the market for another two to three years in the US and Europe.
“Banks are still lending, but nowhere near the same scale they were in the past,” he said.
“And that is going to continue to drive this opportunity set for the next couple of years.”
