Inflation, Interest rates and REITS; the resilience of the listed sector

It’s clear that the sustained economic headwinds have sent shockwaves through the listed real estate sector – but the performance of asset classes such as data centres and co-living facilities for the elderly are demonstrating a strong emerging opportunity – and nimble shareholders will be well poised to reap the rewards.

Datacentres as 2023’s hottest asset class
The datacentre investment market emerged at the beginning of the 21st century together with the IT bubble. As with many new asset classes, the sector has offered great opportunities – with research conducted by Savills suggesting that yields range from 3-5%1 depending on the quality of the asset, thus offering investors the potential for significant growth.

Data centres also compare favourably with other real estate sectors in terms of tenant risk. Users of data centres tend to be large corporate clients with strong credit ratings willing to sign long-term leases – 10 years or more on average – thus offering investors long-term income stream and security.

At our recent 2023 EPRA Conference, the consensus amongst our panellists in our Investor session – which included analysts from Green Street, Fidelity, and Pimco – was that data centres are a largely untapped asset class across the continent. Europe has lagged behind the US but this is slowly beginning to change as developers look to diversify their portfolios. There are two main pioneers in the listed space of this asset class in Europe – Segro and Merlin Properties – both of whom are proud of their early adoption. But it’s still nascent and many of us in the listed sector are excited about the opportunities for growth.

However, any industrial sector growing as fast as the data-centre segment inevitability brings new challenges and risks for property developers and investors, particularly when it is as distinctive as IT infrastructure. Investors need to take sector-specific factors into account, among them climate risks and the related issues of environmental impact and energy costs, especially given energy prices are yet to stabilise across the continent. To increase the likelihood of stronger yields, investors should ensure they are investing in the most sustainable companies' shares.

Europe’s evolving population, and its effects on listed real estate
Another area where listed real estate fundamentals are strong is the residential sector driven by the evolving demographic trends across Europe. These are shaking up the set of demands being placed on real estate.

By the year 2050, a substantial 30% of Europe's population is projected to surpass the age of 65. As a result, numerous companies are proactively aligning their investment strategies with this demographic shift, directing capital into assets that meet this evolving need. This shift is giving rise to a more diverse real estate landscape, including co-living spaces, retirement housing, assisted living facilities, and care homes, all designed to provide better support and care for the elderly.

When considering both healthcare specialized landlords and diversified real estate corporations investing in healthcare properties, this collective sector now commands a notable presence, constituting 5.5% of the FTSE EPRA Nareit Developed Europe Index in July 2023. Collectively, they wield a substantial free-float market capitalization amounting to €8,575.9 mln (July 2023).

Investor sentiment is clearly positive too – as recent data collected by Savills reported that over the next three years, 51% of investors intend to target co-living initiatives, while 43% aim to focus on senior living projects. These data points suggest that co-living and retirement housing assets are set to experience a boom in the years ahead, but Europe’s demographic shifts, and the opportunities for nimble investors, don’t stop there.

Throughout Europe, there's a projected to be a 6% increase in the population of young people aged 15 to 19 by 2027. This demographic shift coming alongside the ongoing attractiveness of European institutions to international students, is significantly impacting the student housing market and creating a growing demand for better-quality accommodations that are institutionally managed.

While countries like France, Germany, Italy, Spain, Portugal, and the UK host some of the world's most renowned universities, many of these institutions struggle to provide sufficient beds to meet the rising enrolment numbers. This creates a notable supply and demand gap, especially for purpose-built accommodations (PBSA) that meet contemporary occupancy standards. With high occupancy levels alongside an influx of domestic and international students, PBSA is well positioned as a resilient asset class with an upward rent growth trajectory.

Going further: keep ESG at the fore to encourage greater returns
Europe’s current infrastructure, spanning from the data centres to PBSA, can and will serve as the foundation for net-zero carbon emissions. Reports have indicated that 80% of 2050’s projected global building stock already exists, highlighting the importance of embedding sustainable features into design and operation. However, it will be a steep uphill climb, especially in mature European markets with aging buildings.

Approximately 80% of offices in the UK fall short of an Energy Performance Certificate (EPC) rating of B which will be the minimum as of 2030. In the residential sector, about six in 10 homes score an EPC rating of D, far below the government’s 2025 target of C for new private rentals. The urgent need to improve the sustainability credentials of assets like these is clear – not just from a regulatory perspective, but also to capitalise on the “green premium” that greener assets fetch. Green premiums can result in valuations and rents being up to 28% higher than less climate-friendly counterparts. Additionally, as highlighted in CBRE's latest Sustainability and ESG Adoption research, energy-efficient assets are more resilient to the impacts of energy rate increases8. Combined, these findings present a strong case for the need to prioritise eco-conscious developments, and demonstrate that despite the ongoing economic uncertainty, nimble and environmentally conscious investors can thrive.

Some final thoughts
All in all, in this dynamic landscape, astute investors who recognise these emerging trends and adapt their strategies accordingly stand to reap substantial rewards. By embracing the opportunities within the data centre sector, responding to evolving demographic trends, and prioritising sustainability, investors can navigate the challenges and position themselves for success in the ever-evolving world of listed real estate. The current state of interest rates and inflation are undoubtedly causing some challenges but by keeping focused and responsive there’s plenty of scope to be positioned for future success.