A message from our Global Head of Real Estate & Construction
Entrepreneurs react and respond to the economic effects of Covid19 with the aim of transforming their business operations and adopting business models built on resilience that are fit for the future. It is important to recognise and understand some key underlying trends as we see them happening among our client base.
Actual market movements
The Covid19 pandemic is leaving its mark on the real estate and construction markets, as shown clearly in the Global Property Research 250 Index, a benchmark of returns of the 250 most liquid property securities listed worldwide, as such being a sustainable representation of the global property market. Their December 2020 market update shows a major impact to the hotel, travel & leisure industry following the implementation of worldwide travel bans. Retail, especially shopping malls and main street shops, have suffered greatly from the lockdowns and offices continue to remain largely vacant due to the shift to homeworking. Residential also saw a decline, which is unsurprising given that many expat workers have returned home.
Overall, the markets saw an approx. 15% decline in return, but this effect is not equal across the globe. Asian markets declined in January, while European and American markets continued with increasing returns for a while before following suit with a steep dive in February/March 2020. Once knee jerk reactions faded and entrepreneurs started to adapt to the changed circumstances, markets started to recover slightly. Based on the global index, one may say we are now back to the level of December 2018 and that in 2020 we lost the entire market increase of 2019. But it is more relevant to consider that the pandemic did not so much bring us new impacts in real estate and construction, but rather accelerated existing trends.
Some key underlying trends
Covid19 directly highlighted the vulnerability of global production locations and supply lines. For years the western world outsourced as much as possible to lower wage countries, employing business models that came under increasing pressure. Multinationals need to rethink their global footprints as consumers became more aware of and increased demand for ESG. Political pressure increased against rising dependency on and - as a result - the growing power of China. Covid19 accelerated the move from “Just in Time” deliveries to “Just in Case” deliveries. Production is being reshored from China to other countries to become less dependent on one source. Other southeast Asia countries may likely benefit from this shift. We also see more nearshoring of production, moving back the facilities to the consumer home countries and increasing stocks locally. The number of distribution centres is also rising; Logistics is an investment category in real estate significantly benefiting from the trends. This comes with huge investment in tech such as RPA (Robotic Process Automation) and in IT, in order to allow for these higher cost locations and to manage complex but resilient supplier relationships. E-commerce pushes logistics in ‘Last Mile’ issues.
Most office workers nowadays work from home and in certain areas the same happened to teachers and students. This shift towards homeworking has had a profound impact on our work-life balance. Do we still need offices? Do we still need schools? Do we now need bigger houses to provide a newly required and suitable working or study place? Whilst realising that many of our staff and certainly the younger generations live in city centres, where spacious living places are not readily available or affordable. Moreover the attractiveness of the city centres has collapsed as cultural and social life has ground to a halt due to lockdowns. Nowadays even young workers are moving away from expensive cities in search of more affordable and spacious housing, greater value for money and a better quality of life in the countryside. We will likely see less demand in central business districts and city centre offices. We need to adapt and diversify work methods as it seems working from home is here to stay, in combination with work from dispersed multiple smaller office locations. The function of the office will change to meeting places and co-working places. Even more so than now, real estate will be dominated by flex-use supported by apps. Property investment portfolios need to diversify as offices should become multiple tenant and buildings should become multi use.
The pandemic has intensified existing trends in the retail and logistics sector. E-commerce was already expanding and exploded during 2020. Companies that had already invested in tech & IT systems for e-commerce benefited greatly. In the beginning this overwhelmed local physical shops which later gave rise to a movement to preserve local shops and help local entrepreneurs. We could not visit shops but in general collecting pre-ordered goods has remained possible. New businesses formats like the ‘dark kitchen’ are arising and local shops have begun partnerships with local delivery specialists.
As we are forced to spend more and more time closer to home, Covid19 could be viewed as a stimulating factor for local neighbourhoods shopping centres and workspace over central business district and central shopping centres and out of town business parks. We need to reinvent city areas and the use of many office and retail properties in order to preserve or regain value. Our recent A-REIT survey 2020 provides some recent market insights. This year as much as the last, tenants and landlords will be discussing who will bear the economic effects and argue pro and con rent reductions. You can find more details in the BDO Legal guide to the impact of Covid19 on commercial leases in Europe and our international financial reporting bulletins 11 and 12.
Although all focus is now on fighting the pandemic and handling its immediate effects to business and private life, we should nevertheless also continue to focus on long-term trends; global climate change could pose a next crisis for example. Many governments provide stimulus programs aimed at short-term solutions such as preserving jobs and businesses. In the longer term significant investments in infrastructure and sustainable businesses are necessary. Banks can help with their low interest bearing loans, but set clear conditions to ESG investments, as discussed in the ‘Sustainable Finance’ brochure of our Financial Services industry group. More and more countries and tightening legislation to curtail CO2 emissions and demand a decrease in the energy use of buildings, requiring sustainable investments to improve properties. Any entrepreneur should have a clear narrative on ESG nowadays.
In the past financial crisis we saw the hunt for low priced properties and businesses, which may come by again. Due to the huge government spending on supporting employees and entrepreneurs, we see an all-time low in insolvencies. That may not last. When the crisis fades away over time, government spending may be winded down, while customer demand may not increase and replace the government shield equally. As a result, many businesses may not live to see the light at the end of the tunnel and decreasing values will result. This will provide opportunities for PE firms and other investors. We may also expect increasing numbers and amounts in M&A transactions this year. Real estate involves high values which may pose a risk with regard to the integrity of parties involved. Businesses are vulnerable to events that damage their reputation and business leaders are increasingly aware of the need to show integrity. Business leaders also recognise that they need to be more proactive in managing these risks. These are the findings of the ‘Global Risk Landscape 2020’ report.
Demography in general and its impact on healthcare especially are other relevant trends to keep an eye on in determining business risks and opportunities in real estate and construction. The new generations youngsters have other demands towards housing, the work place and retail experience, whereas the more elderly set other demands aimed more towards housing and care.
As you will have noticed from above mentioned trends, it’s all about risk management. Economic slowdown, computer crime and business interruption have emerged as key business risks in general. The growing amount, values and impact of use of data in daily business are reflected in the growing number and size of data centres filling the landscape and arising as a new separate asset class in real estate. The real estate and construction industries are becoming more aware of the relevance of data for themselves too. Social distancing and lockdowns lead to different working methods, the construction industry becoming one of the biggest adaptors of drones for site inspections and shifting fast to digital modelling, offsite production involving 3d printing and robotics. Housing landlords often have more privacy sensitive data about their tenants then they are aware of. That applies increasingly for office and retail operators as flex and sustainable use of property goes together with user monitoring. GDPR, data integrity and protection and reputation risks should be high on the list of the real estate and construction industry too.
In the former Financial crisis, present Covid crisis, next Climate crisis and next crises to follow BDO will help its clients to react, become resilient, and realise new business models.
BDO Global Head of Real Estate and Construction