Natalie Breen, Global Head of Strategic Growth and Business Development at Sanne Group gives GRI Club her perspective on current trends in the European real estate market. What is the impact on investor appetite, current economic conditions, ESG outcomes, and digital transformation in the funds sector?
As the global economy started to emerge from the pandemic, we saw fund managers pivot toward more resilient or defensive asset classes, like logistics, residential (whether student housing, private rent sector, affordable/social housing), healthcare and life sciences.
There are clouds forming on the horizon in terms of rising inflation, interest rates, the general global economic uncertainty, and its impact on the European real estate market. The war in Ukraine, global supply chain issues, labour shortages, increases in commodity pricing, and the tightening of the US monetary policy have all created global economic uncertainty and European real estate will not be immune from this impact. In the UK, we’ve seen the Bank of England raise the base rate a number of times already in 2022 trying to curb the rise in inflation. This created opportunities for private real estate debt funds as a result of the current uncertainty. Traditional banks reduced their lending capacity and pull back from some of the more complex development deals to focus on key core sectors. Those non-bank lenders can fill the gaps in the lending market. Typically the private debt lenders are not as constrained as banks for their lending terms and can look at a larger range of opportunities.
With the current economic conditions, private real estate funds, investors, and investment committees have all become more cautious around downside risks. There is also a flight to familiarity with investors gravitating to fund managers with whom they are familiar and have a proven track record.
ESG (Environmental, Social, and Governance) is not a new phenomenon, however, the pandemic has certainly focused fund managers and investors and accelerated the push towards more sustainable investments.
Global corporates have adopted net zero carbon targets and integrated ESG factors into their decision-making, both in respect of their investments and global operating strategies. In the real estate sector, the commitment to ESG practices extends to owners of buildings, asset managers, facility managers, occupiers, residents and employees that use buildings, thus increasing their focus in the sector on ESG factors.
Europe is leading in relation to implementation and regulation around ESG. The introduction of the Sustainable Finance Disclosure Regulation (SFDR) should improve transparency in the market for sustainable investment products and increase transparency around sustainability claims made by financial market participants. In recent years, “green-washing” has become a bit of an issue so the transparency and objectivity of the SFDR regulation should assist in mitigating this.
The SFDR regulations provide for different classifications of fund products. Managers to whom the regulations apply will have to classify their fund products as either an Article 6, Article 8, or Article 9 fund. Article 8 and Article 9 funds are more ESG focused (being the ‘light green’ and ‘dark green’ products). Whilst it might not always seem to be the case, standardisation around ESG terminology and reporting is moving in the right direction. Global investors are very keen to see globally consistent ESG metrics and measures evolve from the current alphabet soup.
A noteworthy investor group collaborating in ESG is the UN-convened Net-Zero Asset Owner Alliance. This is a group of 73 institutional investors and they have US$ 10.6 trillion in assets under management. They include several global real estate investors and sovereign wealth funds, which have made bold commitments to transition their portfolios to net-zero GHG by 2050. ESG has to be embedded in investment decision-making and reporting. New investment opportunities need to be able to fit within ESG ambitions and net-zero commitments. Whilst regulation may not have caught up globally, global investors are driving managers to deliver ESG outcomes and consistent reporting regardless of jurisdiction.
With the focus more on sustainable assets, there is potentially a real threat of value erosion for assets that are more carbon intensive. The gap between sustainable assets and less sustainable assets looks set to widen. In the office sector, workplace practices (at least in London) are now starting to broadly settle to three days in the office and two days working from home. Employers are keen to attract their workforce back to the office, and to do this occupiers are choosing buildings which have the best amenities for staff, which include an in-house cafe, a place to park your bike and shower facilities. These premises tend to be the premium/grade A type buildings, which also tend to be the more sustainable and environmentally friendly. Strong environmental metrics marries well with the net zero targets which many investors, asset managers and tenants have now adopted.
In many cities, a two-tier office market is developing between assets that offer strong ESG credentials and those that do not. For the latter, there are opportunities for investors to reposition and renovate assets to make them more sustainable and attractive to tenants. For some assets there is a risk of becoming stranded when viewed through the ESG lens.
In the funds industry, we have experienced increased demands from fund managers for access to real time data to improve the quality and timeliness of decision-making and to also meet the demands of their investors who are also wanting more regular performance updates.”
There is no doubt the pandemic accelerated and potentially effected long-term structural change in our work practices and how we use digital innovation. The overnight imposition of “work from home” across the globe, meant employers had to quickly pivot to ensure they had the relevant technology platforms to maintain business operations and sustain their employee’s new way of working. Those businesses that had previously invested in these types of platforms and already had systems up and running had a clear advantage and could quite smoothly transition to the work-from-home model. Those businesses that had not, probably have now invested in these types of platforms as a response to the crisis. There is no doubt that the pandemic has accelerated digital transformation in the workplace. Many employers recognise that flexible working is here to stay and that if utilised effectively has benefits to staff mental health, retention, productivity, and motivation.
The impact of the pandemic on digital transformation goes well beyond the workplace. As a result of the growing importance of ESG outcomes and the impact of regulation, building owners are also requiring real time data around building performance and energy efficiency to meet reporting requirements. This is driving investment and development of smart building technologies/prop tech solutions that can track and report these measures.
In the funds industry, we have experienced increased demands from fund managers for access to real time data to improve the quality and timeliness of decision-making and to also meet the demands of their investors who are also wanting more regular performance updates.
There is also a move to aggregation of data into data lakes responding to fund manager’s desire to centralise their data as much as possible. This allows fund managers to drill-down on data and be able to do that from their own secure portal. Historically the fund administration industry has adopted quite a manual approach to reporting, using excel spreadsheets as a way of analysing data. For the reasons above, regulatory and ESG reporting, alongside solutions which can securely house and aggregate portfolio and fund data are in high demand.
There is no doubt that we are in interesting and potentially unprecedented times, the current social and economic outlook, global supply chain issues, labour shortages, increases in commodity pricing, tightening of monetary policy is creating uncertainty. How the Bank of England and the ECB approach their monetary policy in response will also determine the length and depth of any downturn.
Investment in real estate has traditionally been viewed as a defensive strategy in uncertain times and there is no reason to think it will not play a similar role now. Investors and investment committees will no doubt be more cautious and careful when due diligence and scenario planning. In the private debt space there may be more opportunities to invest and grow portfolios, filling the gaps in the market left by the traditional banks. Moreover, the real estate industry has proved itself to be resilient and innovative in its response to changing market conditions. The investment made into ESG, prop-tech, and innovative technologies has proved to be a sound asset with an abundance of talent in the sector.