Geopolitics and inflation are the two key risks on minds of real estate investors today – as highlighted by IPE Real Assets’ survey earlier this month. But anyone hoping they will be short-term phenomena are likely to be disappointed. This was one of the early takeaways from this year’s IPE Real Estate Global Conference & Awards in Amsterdam on Thursday.
On the day that UK inflation was revealed to be at its highest level in 40 years, real estate investors were told they needed to expect today’s heightened geopolitical tensions to continue for a long time amid global competition over who gets to “set the rules”.
Bruno Maçães, former secretary of state for European affairs of Portugal and author of books including Dawn of Eurasia, said the conflict of Ukraine should be viewed in a wider global geopolitical context where the traditional “rules of the game” have been shown to be malleable and that there was a “great battle going on to shape the future”.
He said: “This sense that the rules are up for grabs and whoever is more active and smarter about it will be able to shape the world of tomorrow is in my opinion what truly defines the current geopolitical [situation]. That is why it is so intense and so existential. We are no longer fighting for a piece of territory… we are no longer fighting about some particular economic question. We are setting about setting the rules of the whole game.”
For real estate investors, this means they should accept that the world is in a period of heightened geopolitical risk that is unlikely to end any time soon. Maçães said: “This moment of intense geopolitical competition will continue because it is directly connected to the current technology development.”
Maçães was referring to efforts to create a virtual world – most notably Mark Zuckerberg’s Metaverse. “The race to decide who will control this virtual world will be more and more intense,” he said. “This is geopolitics on the grandest scale… so [I have] no illusions of going back to a world of geopolitical stability.”
The conference was bookended by two keynote speakers whose expertise exist outside the real estate industry, but whose work and thinking have important implications: Maçães at the start and Daniel Levine, director of the Avant-Guide Institute, at the end. Levine defines himself not as a ‘futurologist’, but an expert on emerging global trends that can be measured today and can be predicted with a fairly high degree of confidence to accelerate in the next three to five years.
And it is important to distinguish between real trends and “fads”. Working from home and “work-life integration” – which goes beyond the concept of simply “work-life balance” – for instance, are two trends that are here to stay, he said.
Technology is enabling people to do things like work and shop remotely. Asked by conference chair Piet Eichholtz, professor of real estate finance at Maastricht University, whether “technology is killing distance”, Levine said it was enabling choice. “In some ways what it does it allows us to choose when we want to be distant and when we don’t want to be distant,” he said. “And the wonderful thing about this event is that we’ve all chosen not to be distant for a very real reason that is very important to all of us and that’s not going away. We are human beings and we love being around other human beings.”
How do investors respond in the short term?
The conference, which returned to its usual mid-May fixture for the first time since outbreak of the pandemic, saw about 400 delegates – mostly institutional real estate investors and investment managers – converge on Amsterdam to share ideas and perspectives in one place. Front and centre for everyone was the ongoing conflict in Ukraine and inflation that is clearly now set to be higher and more persistent than most predictions a few months – if not weeks – ago.
“Russia’s attack on Ukraine has pushed up the prices for natural resources and food, and these price increases have acted to prolong and exacerbate the levels of inflation,” said Jon Zehner, head of global partner solutions at LaSalle Investment Management, who presented and moderated the opening panel session.
“Russia’s war in Ukraine has also prompted changes in how we think about many issues including energy transitions, migration, supply chains and travel. It has also forced us to reconsider how we look at Central Europe, Finland, Sweden and China amongst many other countries.”
The war seems to have revived the concept of country risk premium, something that had faded during the years of rapid globalisation. It was something “that we forgot”, remarked Nathalie Palladitcheff, president and CEO of Ivanhoé Cambridge. “I’m old enough in the early 90s, or late 80s, [to remember] everybody was really concerned with country risk premiums in their underwritings and then for a while everywhere had more or less the same price.”
Zehner wondered whether “the glut of capital” allocating to global real estate markets would “overwhelm any efforts to better incorporate country risk premiums into pricing”.
While most institutional real estate investors do not have exposure to Russia, some of the biggest players have been making inroads in to China in recent years. “The longstanding passion for real estate investments in China seems to have cooled,” he said.
And different countries are being affected to different degrees by inflation. “America is furthest ahead in terms of tightening, but this reflects both strong economic growth and inflation,” said Zehner. “The [European Central Bank] is behind in terms of current progress [and] Japan seems to have persistently lower interest rates.” He said: “Is the US the winner when looked at through the lens of real estate risk and returns? So long as the Federal Reserve can find the right balance of increasing interest rates while reducing quantitative easing, the answer is yes.”
Brazil, meanwhile, which has suffered from a lack of growth in recent years, is benefitting from increases in commodity prices, prompted by the Ukraine conflict. “There is obviously a lot of hopes for a turnaround right now for a sad reason: the crisis in Ukraine/Russia has led to commodity prices increase again and that benefits Brazil in a major way,” said Dietrich Heidtmann, managing director and head of international capital markets at GTIS Partners. “It is often in emerging markets that economic trends locally are somewhat decoupled from what’s going on globally, and we’ve seen that in Brazil.”
However, Megan Walters, global head of research at Allianz Real Estate, made the case for continuing to back European office markets, citing research looking at global office markets versus bonds. The spread of property yields over the risk-free rate has recently averaged around 520bps, well above the long-term average of 300bps. Recently that spread has reduced in markets like New York and Sydney, but in some major European markets it has actually increased.
“You’ve still got a bit yield compression going on in places like Paris and Frankfurt and the risk-free rate continues to decline because inflation is so high and central banks might have difficulty lifting the bond yields enough,” Walters said. “So, I’d actually go as far to say generally across Europe you will continue to do well by putting your money into office as a diversification against bond yields, because you’ve got this spread.”
Dutch pension asset manager APG will also continue with its “build to core” European real estate strategy, despite rising construction costs that have “eaten into our development margins”, according to head of European property investments Robert-Jan Foortse. “We are fortunate that we will deliver these developments and will have great portfolios,” he said, adding that rising development costs could also generate opportunities. “There are developers who are facing construction risk,” he said. “It is a great opportunity for us to take over these projects.”
Tony Brown, head of global real estate at M&G Investments, said for-rent residential markets were looking strong. “During COVID, we saw migration away from big cities, so occupancy rates fell and rental levels fell accordingly,” he said. ”We’ve now seen in the last two or three months in particular really strong bounce-backs in both rental levels and occupancy rates.”
M&G’s UK build-to-rent fund now had the highest occupancy level since its inception in 2013. “Residential rental is quite a good hedge against wage inflation. There is strong wage inflation in the US and the UK right now,” he said. “Japan generally looks quite good. There is a much more benign interest-rate environment there than in most parts of the world.”