Risk-Return profile headed for profound change – Barings Institute

Flexibility is the key now for real estate investors, as the corona crisis is likely to have long-term effects on real estate markets, is the clear message from a recent study by the Barings Investment Institute.

The global pandemic is affecting not just stock and financial markets worldwide, but the latest Baring study tries to pinpoint where commercial and investment property markets will be exposed to both short-term and permanent change.

According to Philip Conner, US Head of Real Estate Research and Strategy at Barings, "The pandemic will have an enormous impact on the way we live and work," he said, with significant changes in the real estate sector ahead. “The unique nature of the pandemic and the containment measures employed to mitigate its impact have placed commercial real estate at the epicenter of the crisis.” While he believes that medical science will find a solution for COVID-19, the awareness that a new pandemic could break out at any time will ‘almost certainly’ affect long-term behaviour.

“If there is one takeaway for the real estate industry from the past few months, it is that connectivity and the virtual world enabled by technology increasingly can act as a substitute host for many of the activities that previously could only take place in physical space”, says Conner in his report.

The Barings researchers identify four key trends, broadly grouped under the categories Work-from-Home, Health and Hygiene, Tech Adoption, and Vulnerability and Resilience.

Although the researchers conclude that people will be much less concerned about health and hygiene in two years time, until a vaccine is found people will remain cautious and economies will be operating at reduced capacity. "Buildings with a more advanced healthcare infrastructure are likely to be more in demand in the future - this will attract both tenants and capital.” Not good news, in other words, for retail and hotels, whose cash flows will remain depressed for the near term.

Secondly, "Private tenants will be looking for larger apartments to work from home," Connor is convinced. However his researchers were still unclear as to whether this would specifically lead to a lower aggregate demand for office space, with the corporate office still being viewed as having a critical role to play in nurturing corporate culture, training and mentoring new employees, recruiting talent, team building and a long list of other intangibles that would be difficult to replicate on a sustained basis in a virtual world

Thirdly, and perhaps the most impactful according to the researchers, is the adoption of technology. if e-commerce continues to grow at such a rapid pace, this could herald the end of physical retail. Even online grocery sales have surged during the pandemic, and many of these gains arising from changed behaviour will stick even when retail is fully operational again. There are also clear implications for education and real estate demand, including for student housing.

And fourthly, storage capacities would have to be yet further enlarged for fear of bottlenecks, with companies carrying higher levels of inventory. Re-shoring and Near-shoring of production, even on a small scale could have a multiplier effect in terms of industrial demand. Together, this will mean more demand for ‘Big-Box’ warehouses and ‘Last-Mile’ distributution facilities near to large urban supermarkets and retail outlets.

This is all likely to lead to a change in human behaviour, and with it the behaviour of the real estate markets. In a way, all bets are off. Any earlier forecasts by experts must now be called into question, and markets will just have to be judged differently after Corona than before, warns Connor. Investors who currently want to fill their portfolios should therefore remain flexible, until it becomes a lot clearer which regions or markets will be turn out to be post-crisis winners.