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Schroders Capital: Secular trends driving four conviction themes in real estate investment

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This is a sponsored article from Schroders.

Kieran Farrelly
Head of Global Solutions, Real Estate

In the midst of a period of repricing across real estate markets, investors continue to balance a range of economic and geopolitical issues in the second half of 2023. While downside risks remain, the outlook is starting to improve and become more certain.

Inflation has continued on a downward path in recent months and interest rates are likely to have reached or are close to peak. The highly restrictive monetary policy environment is weighing heavily on economic growth. Even so, a full-blown recession in major developed economies will likely be avoided. While growth is likely to be below trend in the coming months, economic momentum is expected to pick up again in late 2024.

Meanwhile, occupational markets continue to show resilience and demand has softened. Even so, tight supply conditions continue to support income, given elevated constriction and debt finance costs. We expect the scarcity of high-quality ESG-compliant space to fuel renewed rental growth in 2024.

Given the extent of the observed repricing and its uneven pattern thus far, we view the asset class as in the early phase of a broader cyclical buying opportunity. This dynamic sits alongside existing and newly emerging opportunities from structural change.

Patient approach with “sequential playbook” warranted

We recommend investors adopt a patient approach with what we call a “sequential playbook”. This refers to our ordering of opportunities across capital structures, sectors, and geographies. Six months ago, we favoured a balanced approach to portfolio risk. We now believe that investors could start to consider growth strategies to a greater extent.

From an equity perspective, our proprietary market valuation model indicates a materially higher number of markets offering fair or better value, having previously been much more selective. There is a natural geographic ordering to this, with clear signals for those markets that have repriced the most, such as the UK.

Sector-wise, logistics assets have repriced significantly and remain supported by solid, structurally driven fundamentals. More generally, those property types providing contractual or indirect inflation protection and where operational skills can drive sustainable medium-to-long-term income and value, continue to be of most interest.

We remain of the view that private real estate debt offers immediate and attractive risk-adjusted value, particularly for high-yield loans. We are seeing an increased appetite for sustainability and impact-focused debt solutions. Closely related is a developing need for equity recapitalisation to reinforce balance sheets and provide a base for future growth.

Key sustainability and impact considerations should be prioritised, meaning capital expenditure must also increase to meet evolving regulatory and shifting tenant requirements.

Four conviction themes creating investment opportunities

Our preferred strategies continue to be led by four conviction themes that are driven by secular trends as follows:

  1. Technology & the knowledge economy
    The interface for work has shifted, consolidating value in those buildings which address specific needs and evolving tenant preferences, as the industry sectors continue to evolve.

  2. Individualism
    Individual preferences with regards to “work, live and play” continue to shift, deepening disparities in demand between – and within – related sectors.

  3. Ageing populations & demographic shifts
    Rapidly changing demographics further altering the relative demand for various types of (affordable) living formats.

  4. People, places & planet
    Increased regulatory and industry standards demand a holistic approach to the creation of value for all stakeholders, including investors and communities.

Strategies that we have conviction over include:
Repriced warehousing & logistics

Capitalising upon significant sector repricing through acquisitions, refurbishments and/or development on rebased land values. Demand tailwinds remain strong, driven by a combination of further growth in e-commerce, diversification and reorganisation in supply chains to increase resilience, and growth opportunities across Asia and developing markets. Urban logistics facilities in high-barrier-to-entry markets are favoured.

Private real estate debt with impact
We favour newly originated senior whole loans and development loans, structured to incentivise ambitious, predetermined sustainability performance objectives. This is a new private capital angle to drive positive social and environmental outcomes, leaning into a supply-constrained market. The loan covenants and interest rate ratchets are also aligned to sustainability objectives as well as more common financial considerations.

Operational property-types
We have a continued focus on living and other more operational segments, able to provide long-term resilient cashflow with outsized income growth potential, aligned with the success of tenants. This requires specialist operating expertise to deliver. For example, having the expertise to position hotels for their target markets can drive significant value growth.

“London living & hospitality” illustration – from prime housing to budget hospitality. Significant demand for both

Source: Knight Frank, Schroders Capital, September 2023. The forecast should be regarded as illustrative of trends.
Actual figures will differ from forecasts. Prospective returns are hypothetical and are not guaranteed to be achieved.

Find out more about Schroders Capital’s insights on private assets here.

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This material has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.

Schroder Investment Management (Hong Kong) Limited
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This is a sponsored article from Schroders.

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