What will drive Post-COVID Investment in Real Estate?

New trends have risen to the fore at breakneck speed throughout 2020 and 2021. In real estate, COVID-19 has changed the investment landscape in ways that will dictate developments for years to come. Some of the effects, such as increased work from home (WFH), are well-known. However, WFH being far from the death of the office may come as a surprise.

The supporting arguments for why the office and office space investment could see a comeback sooner than some may suspect arose during the Post-Pandemic Trends in Real Estate webinar hosted by BDO’s private equity and real estate teams. The webinar featured industry experts alongside BDO’s Arjan Endhoven, Partner with BDO Netherlands and Global Head of Real Estate & Construction, and Scott Hendon, Partner with BDO USA, International Liaison Partner, National Leader of Private Equity, and Global Leader of Private Equity.

The expert panellists were:

Dr. Mark G. Dotzour, Chief Economist and Director of Research for the Real Estate Centre at Texas A&M University. He has given more than 1,600 presentations to more than 295,000 people and has written over 90 articles for magazines and journals. His research findings have appeared in the Wall Street Journal, USA Today, Money Magazine and Business Week.

Jan Boers, Partner, Real Estate, at Van Gool Elburg, one of the most esteemed real estate advisors in the Netherlands. Jan Boers holds a bachelor's degree in Business Administration and a master’s degree in finance & Investments from Erasmus University in Rotterdam. He has worked with NEW NRG Real Estate in Rotterdam, VolkerWessels in Canada has been at Van Gool Elburg since March 2015.

Mollie Fadule, Founder and Partner at Pallet, an SPC providing high quality, cost-effective, and portable shelter systems. She is a senior board member of several companies and founder and partner in Cephas Partner, a private equity firm specialising in alternative investments with a primary focus on real estate-related opportunities. Furthermore, Mollie Fadule is a board member of CREW (Commercial Real Estate Women), which seeks to transform the commercial real estate industry by advancing women globally.

Below are some of the areas and topics discussed during the webinar.

The Changing Investment Landscape

An overarching investment trend during COVID-19 has been investors prioritising supporting portfolio companies and targeting technology investment alongside hard assets. As detailed in the latest edition of the BDO Private Capital Pulse Survey, private equity investors are increasingly focused on new deals and deployed some of the record-level dry powder they have in store.

Data, Graph: BDO Private Capital Pulse Survey

Other investor groups are likely to focus on new deals too, and real estate is a prime target, offering a wide array of options for investors.

Addressing the current investment landscape, Dr. Mark Dotzour said:

Industrial real estate is popular among investors here in the US, which is my focus market. The reasons include the dramatic shifts in global trade, including lower focus on outsourcing to, for example, China and growing nearshoring and onshoring industry and production operations.

Furthermore, companies are reacting to the pandemic by prioritising diversification of manufacturing and supply chains. This increases the risk of overheating, but I would not say that we are anywhere near overbuilding yet.

Another hot sector is the multi-family construction space. Cap rates are still compressing, and demand remains high.

Uncertainty still surrounds tax reform, interest rates and inflation in the US, making investors increasingly focused on Europe right now.

Jan Boers said:

Due to COVID-19 most investors were only focused on core product vis-à-vis core locations. Prices for assets on core locations did generally not change as a result of COVID-19. Investment activity on secondary locations has been low during the COVID-19 period and therefore it is uncertain what the price effect will be for these locations.

Similarly to the US, we see a huge demand for industrial and logistic real estate due to the rapid uptake in e-commerce activity. In Rotterdam harbour, which is one of the gateways to Europe, we have seen increased market activity. I am not sure what the situation is elsewhere, but I would speculate that similar trends are in play.

Mollie Fadule said:

We are also seeing increase in logistics demand here in the US. Furthermore, storage is a related space with high activity levels. This is tied to e-commerce and likely also changes to manufacturing processes and just-in-time supply chain strategies which were challenged during COVID-19.

Retail remains somewhat challenged, in part due to the uncertainties surrounding the future of shopping, but we see opportunities in technology-driven experiential retail and pockets where retail real estate is performing quite strongly.

Office Real Estate Ready for Resurgence?

While office space investments may have seen a drop-off during COVID-19, there are signs of a resurgence. It would seem, to borrow a quote often attributed to Mark Twain, that the reports on the office’s death are greatly exaggerated. Instead, we are looking at a more general transformation of where and how we work, including within office spaces.

On the changing work dynamics and their influence on real estate and real estate investment, Jan Boers said:

In the Netherlands, we saw an early shift towards working from home due to the mandatory lockdown measures. During the first lockdown in April and May 2020 employees were delighted with the new opportunities that created. However, during the second lockdown end of 2020 and start of 2021 sentiment has changed. Most employees are now looking forward to getting back in the office. It has proven difficult to perform specific job aspects and maintain strong collaboration during 100% WFH. We are likely to see employees split their time between WFH and the office. It is still too early to say for sure, but I hear from many office space tenants that they expect employees to work 40% to 50% from home and the rest of the time from the office.

The office space itself will likely need to change. While demand for square metres will probably show some fallback, I do not think the drop will be as steep as many initially predicted. Demand for meeting rooms and collaboration spaces, which take up more space, will increase. Creating and updating such spaces is going to be a priority for both real estate companies and tenants – and could be an area that will see many investment opportunities arise in the coming years.

Mollie Fadule said:

I agree that we are going to see the office space and its prime functions change somewhat in the post-pandemic era. This is one of the reasons why there is increased focus on digital innovation related to interactions with physical building spaces and smart city environments.

Dr. Mark Dotzour said:

In the US, we are going to see some strong indications of whether WFH is here to say – and I think it is – in the coming months. For land development, the changes to working locations holds huge significance.

As a rule of thumb, US land development has traditionally happened with a 45-minute car drive of the city’s business hub. You can draw a circle around most cities that matches this. If you are only going to the office three times a week, that circle gets a radius of 60 minutes. Thereby, vast areas of land could be prime for new developments. I am not only talking about single-family houses and retail areas but also suburban offices and office condos for remote working.

Innovation and Technology Plays Pivotal Role

Real estate has, rightly or wrongly, often been pointed to as one of the slowest industries to innovate and integrate new technologies. Some of the reticence is justified when considering the scale of construction projects and compliance demands placed on real estate companies. However, the global pandemic has heightened the need for rapid change. Furthermore, customer and tenant demands are changing the outlook for construction and real estate, related technology companies – and investment. The latter remains strong, especially in the VC space. However, real estate often works at capex levels beyond where VCs are traditionally looking to invest, opening the door for the likes of PE investors.

On the role of technology and innovation in real estate, Mollie Fadule said:

Construction and real estate are two overlapping areas with huge runway for innovation. You could say that they are second to last to agriculture when considering being disrupted by tech. This opens a massive opportunity across financing and investing that we have seen manifest in the market.

In 2019, we saw US$5 billion invested in construction and real estate technology. In 2020, the number was US$24 billion. Considering that real estate equals 16 to 17 per cent of GDP for most western countries, there are massive opportunities for companies able to lower costs through innovation and technology.

3D printing buildings and off-site construction are seeing a lot of interest and activity. Concrete production and construction are among the world’s largest carbon emitters and companies are also looking to disrupt that.

From an investment standpoint, prop-tech is still somewhat in a nascent, albeit high-growth, phase. Throughout the space, we are seeing that real estate investing and VC investing are two very different things. What is required is bringing those two together, which is challenged by the digital innovation and Capex requirements. The concern as an investor in that space is that ensure that companies have the runway to disrupt because real estate is a very intensive business.

There is an increasing focus on ESG across the industry. The maxim of doing good and doing well has created a range of changes. For example, mass timber building and multistorey timber construction is very hot right now. There is an upstream issue with logging and lumber prices, but if they normalise, we can expect to see tall timber buildings go up rapidly in many cities across the US.