As one investor told Aviva in its Real Asset Study:
“A lot of the business that we write is annuity or long-dated, so we are looking to assets in the UK and Europe where the profile is also annuity or long-dated. We have been heavily involved in commercial real estate lending for a number of years, but the current appetite for risk capital is changing, which is requiring us to think about alternative asset classes and parts of the world outside our traditional focus as well.
“We currently favour commercial mortgage loans, infrastructure debt and equity-release debt, but that will change as the real assets sector evolves and new opportunities arise.”
Pricing is at historically high levels but some global cities, such as Paris, are seeing prime yields of around three per cent. Investors are comfortable with this return in a low-bond-yield environment as long as a property is well-let. In fact, vacancy rates in Paris hover between one and two per cent, demonstrating the strength of demand for space.
Manchester is another success story, with a good demographic profile and high levels of education, as well as a large pool of graduates who are increasingly inclined to stay in the city when they finish university, adding to its appeal.
Political risk, however, is considered a threat to the resilience of some parts of the real assets universe. Brexit is viewed as a threat by all investors, but there are also concerns in the UK around the intentions of the opposition Labour Party to re-nationalise parts of the country’s infrastructure.
Another area under threat is retail real estate. In the UK and the United States, values fell by more than ten per cent between mid-2018 and mid-2019, and e-commerce now accounts for up to 20 per cent of total retail sales. This has created an over-supply of secondary retail space with little prospect yet of being re-purposed. In particular, debt is being withdrawn from the retail real estate market, and loans to finance the sector are becoming more expensive.
Offices will also have to adapt as the rise of flexible working takes hold; flexible office groups now account for over 15 per cent of annual office demand in core cities.
While structural changes are having a bigger impact than ever before, in particular on real estate, the biggest talking point continues to be where the sector is in its traditional cycle.
In a May 2019 research paper, ‘Mastering the real estate cycle’, Aviva Investors’ Director of Research, Real Assets, Chris Urwin argued that real estate is more cyclical than other investment classes, firstly due to the nature of development, with long lags between conception and completion of new buildings. The second factor is the widespread use of leverage, adding to the volatility of returns.
Aviva created a toolkit of 15-17 different metrics to assess the main factors driving the real estate cycle, and found that, among Europe’s key capitals, risk is higher in Berlin than Paris and London. Compared with previous late-cycle markets, however, lending remains relatively restrained – making the real estate component of the real assets world more resilient than at many points in the past.