The past few years have turned the world on its head.
The pandemic caused the European economy to shrink, leaving many countries across the region in precarious positions.
Now, volatile markets caused by the war in Ukraine and soaring inflation levels have only added to the struggles.
However, the managing director of the International Monetary Fund’s recent statement that the “horizon has darkened” is not necessarily the whole truth for every industry.
Real estate’s potential as a proven hedge against inflation and instability has meant activity is still high, with London sitting at the top of the charts, contributing €16bn (£13.5bn) during 2021.
But other factors at play mean that we are seeing a sizeable shift in where the investment opportunities lie for fund managers and how the market is performing.
The pandemic, alongside the rapid rise of ESG, has led to increased demand for alternative assets, a new way of office working, and new requirements for buildings.
If fund managers do not adjust to the complexities of the rapidly changing market, returns will begin to fall, and investors will ebb away.
Alternative real estate assets hold the key
With investors facing macroeconomic difficulties on multiple fronts – such as slowing post-pandemic recovery, high inflation, rising energy prices and the current geopolitical crisis – fund managers are looking to different asset classes in the hunt for returns.
The two largest traditional real estate classes – office and retail – are going through a period of transition.
The rise of ESG principles has exposed the majority of traditional real estate assets as lacking on this front. This is driving down prices, and encouraging fund managers to look for alternative property assets.
Ten years ago, logistics was the hottest real estate asset class, but now sectors such as student housing and senior accommodation are being viewed as underrated and underappreciated.
Record levels of students were accepted into university or college last year, up 7 per cent from 2020 according to UCAS, and the age profile across the general European population is rising; by 2058 more than 30 per cent of the EU population will be over the age of 65, increasing the demand for elderly homes.
This presents a huge investment opportunity – building new social hubs that both students and the elderly can appreciate will help bring investors and higher rent.
To return or not to return to the office? That is the question
The Covid-19 pandemic entirely upended office life. Post-pandemic, hybrid working is here to stay, and we are unlikely to ever see a return to the office five days a week.
However, this does not mean city centres and central business districts will become ghost towns, and we are beginning to see a situation in London where pre-pandemic numbers are starting to return to the City on Tuesdays, Wednesdays and Thursdays, a trend reflected across Europe, including in cities such as Paris and Luxembourg.
While companies have a responsibility to encourage employees to come into the office for training and company cultural purposes, it is not about forcing employees back; companies must in fact incentivise them to return.
This requires finding a way to overcome many of the constraints of traditionally smaller office centres, with measures such as hotdesking, increasing the number of break-out rooms, freeing up office areas and optimising working spaces for employees becoming even more important.
The ability to work from home has led to an exodus of people from tier-one cities such as Paris, London, and Berlin due to the higher cost of living.
The rise of satellite offices in tier-two cities, where a company sets up a smaller branch separate from their main headquarters in major cities such as London or Paris, has been a direct consequence of this.
People enjoy being in an office with their colleagues, but they want to avoid longer commutes.
Cities such as Reading, Bristol or Toulouse have therefore begun to increase in popularity as secondary working hubs for businesses, as it is easier to find plots and interesting buildings that are cheaper and have less competition.
This in turn is attracting real estate fund managers, who are constantly looking for new opportunities and higher returns.
If you cannot buy it, build it
The EU’s Sustainable Finance Disclosure Regulation was introduced in March 2021, and more rules are being introduced on January 1 2023, putting a new standard on environmental, social and governance reporting.
Fund managers, therefore, are becoming increasingly conscious of how ESG fits into their portfolio, with Article 9-labelled funds on the rise.
However, there are not clear differences between SFDR’s Article 8 and Article 9 labels, opening up concerns over greenwashing.
The regulator needs to clarify these classifications better, to ensure general partners are setting up Article 9 funds that are truly ESG compliant and not just ticking the right boxes to raise easier capital.
Although the demand for office space is falling across the industry, the demand for commercial property that is ESG compliant is on the rise.
To meet this demand, fund managers are both incorporating ESG-compliant buildings into their portfolios and retrofitting dated buildings to meet these new standards.
However, keeping CO2 emissions down in the construction phase is not an easy task. Currently, the CO2 emissions are so high in this process that it seems incorrect to call the building ESG compliant.
Developers are taking various approaches to combat emissions, such as reusing materials during construction.
From investors and fund managers to companies looking for ESG-compliant buildings, the real estate industry needs to take note of the shift in focus to ESG and ensure commercial property, both new and old, fits these standards.
The European real estate market is undergoing a significant change, as the traditionally strong asset classes begin to wane due to low yields, and new, stronger, and more attractive classes take the reins.
As the return to the office plays out, one thing is clear: the buildings that companies are returning to must be enticing on an environmental and social level, or companies will risk losing their talent, and fund managers will see their powder pool dry up.
Tamas Mark is head of real estate at IQ-EQ
