MAGAZINE: What lies ahead for Dutch real estate? - Experts discuss

What does a shock like Covid-19 do to a market whose reputation as a rock-solid investment destination seems unshakable, and to which international investors have been flocking for years for its stable fundamentals?

That was one of the key questions addressed by a group of leading market experts at PropertyEU’s Investment in the Netherlands Roundtable, which was held in Utrecht in early September.

The five-strong panel, representing property adviser Savills, law firm CMS, development company Edge, industrial giant Panattoni and alternative investment firm Angelo Gordon, gave their views on a wide range of topics, from demand and supply of real estate to occupier markets, rental prospects, financing conditions, opportunities per asset class and investment style, legal terms and negotiations taking place, and factors at play within the ESG context.

In any other year, five experts meeting in an office in Utrecht would not be unusual. But as no one needs reminding, 2020 is not a normal year. So it was with some degree of awkwardness with fist bumps and ‘elbow shakes’ plus palpable excitement that our roundtable participants agreed to meet at PropertyEU's HQ to discuss investment in the Netherlands.

New work routines
At first, the panellists sketched how Covid had led to a new ‘working life’. For instance, Angelo Gordon’s Marcel Hertig, who heads the firm’s German and Benelux investment business from Amsterdam - where the team is busy relocating to new premises - says a 50-50 office/home work policy is currently in place, with staff having to ‘subscribe’ to a workplace before they go into the office. But as a self-confessed ‘people person’, he said that after seven months of video calls he greatly missed the social interaction and inspiration that physical meetings bring.

That sentiment was unanimously shared by the rest of the panel. Edge’s chief operating officer Boudewijn Ruitenburg said his company similarly operates a subscription system for office working, with the Amsterdam HQ currently around 30% occupied. Although encouraged to work from home, employees also go into the office as it is ‘essential to meet from time to time’ and to ‘facilitate creative processes’, he said.

Savills Netherlands director and head of sales, Reinier Wegman, said that of the 150 staff at the firm’s Amsterdam base, around 30-40 work in the office on a daily basis, booking space via a subscription system.

At law firm CMS, staff is going into the office only when required, said partner Arnout Scholten, who explained that teams have been ‘cut in two’, dividing their hours between home and the office. On balance, the majority of employees work from home, he said.

Panattoni’s Dutch MD Jeroen Gerritsen, who started up the company’s operations in the Netherlands from scratch in December 2019 and has since built a team of five, said he and his colleagues still work mostly from home, occasionally going out to meet clients.

Mixed picture
What emerged from the ensuing wide-ranging discussion was a mixed picture of the Dutch real estate market, giving cause for both concern and comfort.

To be sure, international capital is still chasing - increasingly scarce - core product, as illustrated by the brisk trading activity seen in the first half of 2020 despite the onset of the pandemic. Research from adviser Savills shows over €7 bn was invested in the Dutch real estate market in H1 2020. While this failed to reach the record levels of the past three years, the volume was equal to that of 2016 and thus 11% higher than the 10-year average. The bulk of transactions – 75% -  involved core product in the residential, logistics and prime office sectors, where demand is still far ahead of supply.

But nine months into the year and six months into a crisis, activity is being hampered by uncertainty, said Savills’ Wegman. ‘Product is coming to the market, but there are a lot of question marks about the occupational side of things, about rental growth, about financing – that’s where we are right now and nobody really has the answers.’

Assets coming to market are mainly core and core-plus office properties, he noted, but in general buyers and sellers are taking a wait-and-see attitude. ‘Clearly the summer has ended and people are back at work, but everyone is waiting for things to happen and nobody really knows what’s going to happen with pricing for rents or trade. So that’s the biggest challenge for the next six months.’

Paradoxically, despite Covid, Wegman believes the ‘huge mismatch’ in supply of product and available capital will only increase during the rest of the year, leading to further yield compression as a result.  ‘The Freshfields HQ sale in Q2 2020 is a good example of that with a strong GIY of 3.75% in a highly uncertain market. We see prime yields in general being stable, bearing in mind that rental growth has been put on pause for now,’ he said. At the same time, deal certainty is seen as more important in the current trading climate than price, he noted. ‘Track record and local presence are the most important things for buyers right now. Because deal certainty in today’s market is more crucial than the highest price.’

Hotels are struggling
On the occupational side, with the notable exception of logistics, pressure is mounting in most sectors as the pandemic persists and economic recovery takes longer to kick in, the panel heard. Combined with lower government support for businesses which is due to be phased out by mid-2021, this will lead to corporate distress and insolvencies further down the road, according to the experts.

Hotels in particular are suffering from the impact of Covid-19, with many seeking rent reductions from landlords to ride out the crisis. CMS’s Scholten, who co-heads the global real estate & construction practice area group, said his firm is involved in ‘a lot of litigation regarding rent reductions’, especially relating to hotels in the Amsterdam area.

Covid will, for example, spawn a debate about liability and definitions, he believes. ‘A lot of people are talking about “sharing the pain” between landlords and tenants, but what is that, and what is the pain? For example, with a hotel, does the landlord also have to bear some of the pain relating to the operations? Or are you just talking about a rent reduction? And how long will that last? When is the end of the negative effects of Covid? Is that when there is a vaccine on the market or when the occupancy rates are back to normal? How do you define that? That’s all quite challenging new ground.’

The pandemic has already claimed its first casualties in the Dutch hotel sector. Tidal Operations, operator of the Holiday Inn in Amsterdam-Zuid and Crowne Plaza Schiphol in Hoofddorp near Amsterdam, is among those that have been declared bankrupt. Both hotels have been shuttered.

Said Scholten: ‘We’re seeing the first few insolvencies among hotels but also the first discussions with developers about whether you can redevelop a hotel into something else.’

The CMS lawyer said he was ‘quite optimistic’ that Covid’s impact on the real estate market will lead to ‘interesting new discussions and interesting new legal thinking about buildings’.

Office refurbs
Ruitenburg of innovative office developer Edge, which has been involved in several landmark (re)developments in the Netherlands, believes occupier demands for healthier buildings as a result of Covid will lead to ‘big refurbishments in the office sector’.

‘We’re seeing major corporate clients starting to make plans about how to go back to work and how to restructure their office portfolios,’ he said. With greater numbers of employees expected to work from home in future, this will lead to ‘completely different office fit-outs and technical installations’, he noted, and may result in reduced space requirements overall.

Before the pandemic, the modern office was defined as a ‘flexible, serviced, high-quality, environment’ where sustainability and worker health and wellbeing were already key trends, Ruitenburg explained. Covid has turned the spotlight not only on the health dimension, but also triggered a complete rethink of how corporates use their offices, he said.

‘The vast majority of the stock is not really healthy inside; we have been measuring office air in different buildings and it is really poor – even in newer buildings the ventilation capacity and air quality are not impressive. So we believe office occupiers will start demanding guarantees of better air quality from their landlords and that will lead to major refurbishments.’

New technologies already in use by Edge prior to the pandemic ensure continuous air renewal within buildings so that the residue of stale air is kept to a minimum. Said Ruitenburg: ‘We think professional corporates will demand these new technologies and realise that existing premises cannot meet these requirements. But we’re only at the beginning of that process.’

From a sales perspective, too, ventilation capacity has climbed up the list of priorities in deal processes, remarked Savills’ Wegman. ‘Ventilation capacity used to be a typical due-diligence question looked at once a deal is almost done, but nowadays it’s more a case of “What’s the lease price, and by the way, what’s the ventilation system like?”. So you need to adapt to that, it has become a sort of minimum requirement.’

With around 45% of Dutch office employees expecting to work regularly from home in future, against 14% before the crisis – which was already the highest rate in Europe – speculation is mounting about what this will mean for office space requirements. Edge’s Ruitenburg believes that the ‘clubhouse’ function of a central office is essential for a company’s DNA and for socialising and training purposes.

‘It will be a place to meet, to be inspired and to socialise and be creative. That means you will end up with more meeting space, fewer desks and that will lead to completely different fit-outs and also technical requirements because you have to redo your installations and your whole BMS [building management system].’

Where such reconfiguring does lead to downsizing of office space, Ruitenburg believes it will be ‘at the lower end’ of the market in terms of stock quality, and which may end up being vacated over time. ‘It’s difficult to say how big such a decrease would  be as occupiers are often bound to long leases so it would take some time – it’s not that easy to reduce, say, 20% of your space.’

Value-add opportunities
For a value-add investor such as Angelo Gordon, buying buildings with vacancy or other risk and selling them on after refurbishment and repositioning is the mainstay of its business. The US private equity firm, which operates in the Dutch market with a number of local JV partners, has completed several deals across different sectors.  

‘We buy existing buildings which have good bones but have another problem that we can fix – that might be high vacancy because the current owner is not well capitalized, tenants about to go insolvent or other complexity around the capital and ownership structure- and we always want to add value by fixing that problem,’ said Hertig.

The firm is targeting more Dutch business after raising $1.5 bn (€1.3 bn) of equity over the summer for its third European fund – the highest amount it has ever raised for a closed-ended Europe-dedicated real estate investment vehicle.

At present, Hertig noted, there is ‘very little value add product on the market and that is mostly driven by uncertainty’. In the current Covid market, he said, ‘it might take years until you eventually see some distress emerging because the government subsidies have definitely helped. I think now as an owner you don’t want to accept a 20% lower price because you still have yesterday’s price in your mind which was much higher’.

The panel heard how financing for deals is becoming increasingly difficult to obtain and at much higher rates. ‘There’s a clear lack of financing and it has become so much more expensive, banks have become more cautious on what they lend,’ said Hertig. ‘We used to go to Dutch or German lenders. For anything with a bit of a value add angle in B-locations, we go to debt funds. But they are about three times as expensive as Dutch banks,’ he said.

Logistics light spot
One sector proving to be not only immune to the crisis but actively benefiting from it is logistics. As elsewhere in Europe, developers of warehouse space like Panattoni are struggling to meet the huge demand for facilities triggered by the surge in e-commerce growth following the onset of Covid-19. Industrial giant Panattoni, which launched its Dutch operations less than a year ago, already has two developments under way in the Netherlands and another four unannounced speculative projects close to transfer, country head Gerritsen told the panel.

He sees no end to the growth in demand. ‘E-commerce is booming and more online means larger warehouses and more last mile,’ Gerritsen said.

Panattoni’s strategy is two-pronged: landbanking and build-to-suit (BTS) developments. ‘There’s a scarcity of land in the Netherlands, so our main business is buying brownfield plots and transforming them into new facilities; we need to create product to satisfy customers’ short-term demands,’ Gerritsen explained. ‘There’s still a lot of companies out there that put goods on a ship that all of a sudden needs a place to stay, like within six months. We need to be ahead of that, certainly when greenfields are so scarce in our sector. So to prepare that land and accommodate all those demands and facilitate that within a six-month timeframe means you have to anticipate and be ahead of the game.’

The company is also receiving a growing number of requests for BTS developments, notably from supermarkets. ‘All the major chains are looking at locations up and down the country to set up a last-mile hub,’ said Gerritsen. ‘Every major grocery retailer in the Netherlands is busy reconfiguring its network to be able to accommodate the growing demand for online food.’

‘For us as a developer to be able to be part of  that, we need locations, hence the landbanking and knowing where land is set to become available and being able to respond quickly to that and quickly transform those locations.’

In a densely populated country like the Netherlands where land is scarce, ‘creating product’ can sometimes mean ‘tying plots together’ to get the requisite scale, Gerritsen said, adding: ‘That really takes a lot of work and wheeling and dealing with all the different owners.’

Sustainability still hot
The panel agreed that ESG issues – particularly sustainability – remain top of mind for investors and occupiers, despite Covid. ‘I think sustainability is a very big topic and one really good thing to come out of Covid,’ said Angelo Gordon’s Hertig. ‘People really think about how much C02 emissions a building produces these days. We’ve been looking at alternatives for materials like concrete – especially wooden prefab structures - since wood is far better than concrete from a C02 and circular economy point of view.’

‘We see the push for sustainability coming from investors,’ Hertig continued. ‘We recently raised a $1.5 bn fund for Europe and our investors are asking more and more about ESG. The Netherlands is one of the leaders when it comes to sustainability –  it’s at least two steps ahead of bigger countries like Germany.’

Ruitenburg of Edge, which has a number of award-winning green office developments under its belt, agrees that sustainability is a way of future-proofing buildings against obsolescence.  ‘What you will see is that the sustainable offices let to strong covenants will trade. We have a sales process running right now for one of our properties and we don’t see signs that prices are going down. Because the location is super, the covenant is super, the building is sustainable so it ticks all the boxes. In the short term, I don’t see any negative impact from Covid for properties that tick all the boxes.’

Conversion to other uses
An uncertain fate awaits properties that do not tick the boxes. Further down the road, as businesses fail and vacancy rates rise, conversion of buildings to other uses may become the only an option. Said Savills’ Wegman: ‘If you look back at the last crisis and its aftermath, we found a solution for all the excess supply of product that came to market because we were creative and looked at things differently. Offices were converted into student housing and residential or hotels and other types of real estate, so I think we need to be more creative and we’ve shown we can already do that.’

Hotel properties may be among the first ‘convertible’ assets, given insolvencies have already hit the sector. Said CMS’s Scholten:  ‘Hotels are obviously in distress, but it depends on which area, which city and which segment you are operating in. Luxury hotels are far more affected than others and size also matters - the bigger you are, the more affected you will be.’

He warned it would ‘not be easy’ for other operators to take over hotels that come to market. ‘It’s an asset class that’s not easy to recover with other operators stepping in and that necessarily means you have to think about the future of those buildings.’

‘Obviously it’s all still very new but we see developers looking at some hotels with operators in distress to see whether they can have a new purpose like mixed use. A lot depends on the location of the hotels and things like zoning restrictions. Changing the zoning will take time but there will be a lot of buildings where change is the only option to allow them to survive.’

The panel agreed that, given the scarcity of product in nearly all sectors in the Netherlands, a building can always be repurposed, no matter how long that takes. ‘Values can vary over time but in the end, anyone who has invested in bricks and mortar or land comes out pretty okay in the end,’ remarked Panattoni’s Gerritsen. ‘In the logistics sector, even old stock gets taken up by occupiers who are looking for lower rents or who don’t need a 20.20-metre height warehouse.’

‘Because of its restrictive spatial policies, there’s always scarcity in the Dutch real estate market,’ said Ruitenburg. ‘And for every sector, whether hotel, office or retail, there’s always a fallback as long as the location is urban, and that’s residential. Because for decades, almost since World War II, we haven’t been able to meet the demand for housing. So that is something you really need to keep in mind with everything you do.’

Concluded Gerritsen: ‘The GFC crisis of  2008 was very different to this one because it was a structural crisis and it took a long time for values to drop before everyone bit the bullet. Here there’s no bullet to bite, just a matter of survival for 12-18 months and if we do that things can come back very quickly.’