BNP Paribas: life science research boom bodes well for real estate demand

The boom in life science research activities – genetics, biotechnology and medical and pharmaceutical innovation – means there is serious growth potential in the related real estate markets over the coming decade, predicts BNP Paribas Asset Management.

Shaun Stevens, strategist in the real estate securities team, at BNP Paribas Asset Management, suggest three drivers are supporting optimistic outlook:

  • Demand for lab space is rising inexorably;
  • Global health spending and venture capital funding is mushrooming; and
  • Real estate companies that can offer specialist properties should prosper.

Stevens explains:

“Life sciences have taken off since Crick and Watson unravelled the double helix structure of DNA and cleared the way for genetic research, opening up the field to tackling an ever wider range of medical issues, attracting a broad spectrum of scientists and turning lab, manufacturing, testing and research-and-development space into a multi-billion real estate market for developers and investors.

“The field of life sciences has now broadened out to biotechnology, pharmaceuticals and medical devices. The top clusters are typically in the US and characteristically involve concentrations of life sciences researchers, adding in specialists in related fields, all using a stock of suitable lab space, and importantly – with access to venture capital funding.

“With impressive amounts currently being spent on life sciences, the prospects for the real estate end of the industry look favourable, including from an investor perspective. As global health spending grows inexorably, demand for lab space should continue to benefit. (As an offshoot, the broader local real estate market stands to prosper too, for example, as highly paid scientists look for homes, retail and leisure.)

“And while a limited set of public real estate companies are exposed to this segment, a significant number of US real estate investment trusts (REITs) are trying to increase their presence in lab space or office segments linked to lab space.”

The combination of population aging driving healthcare spending and more pharmaceutical research provides a solid platform for the continued growth in demand for life science and lab office space over coming decade, argues BNP Paribas. Global pharmaceutical spending should outpace overall healthcare spending, according to the Deloitte 2019 outlook.

More than $66 billion in venture capital was invested in bioscience companies between 2014 and 2017, benefiting commercial real estate demand.

Stevens added:

“Life science start-ups and established companies prefer to cluster in specialist office campuses so they can access talent and share ideas. This favours real estate companies that can offer specialist property in the main life science markets.

“Clearly, this is a niche space to invest in with only a handful of companies providing meaningful exposure. But it is an example of an opportunity that the smarter real estate managers in the REIT segment identified correctly. They spotted an innovation at an early stage and took significant steps to exploit it.

“It also reminds us that technological advances may harm businesses. Just think of the effect of e-commerce on physical shopping centres. However, progress need not always have a negative impact on property. E-commerce boosted warehousing and datacentres. Similarly, rapid advances in science can open up meaningful investment opportunities. That includes the listed real estate sector.”

Small to mid-sized lending market dominated by operating asset financing as borrowers shift to defensive sectors, JCRA debt analysis shows

Operating assets financing was the dominant asset class for UK financing requests over the 12 months to end of June, indicative of borrowers shift towards more defensive assets and reflecting 57% of total financing transaction activity, according to data compiled by JCRA, the independent hedging and debt advisory firm.

After re-sampling, which excludes the impact of the five largest financing transactions closed by JCRA in the period, the proportion of operating assets financing deals – including hotels, marinas, leisure, healthcare and student accommodation – slipped to 44%, with an increase of 22% on the previous period.

JCRA has identified a number of key trends in the UK debt markets in the 12 months to end of Q2, based on analysis of its own advised transactions which comprised 74 deals worth a combined £6.3 billion and an average ticket size of £53 million (excluding the impact of the five largest transactions).

The advisory analysis provides a window into the trends within financing markets, which are opaque relative to investment markets.

Financings of operating assets, industrial and REIT corporate facilities were the only segments to see a rise in loan volume over the previous year, says JCRA. Around 70% of the loans provided by non-traditional lenders, including international and challenger banks as well as alternative lenders, reflecting the greater credit flexibility offered by non-traditional lenders, all of which have increased their activity over the previous period.

All other asset classes saw a drop in both transaction activity and loan volume, with retail and consumer unsurprisingly seeing an 85% reduction in volume compared to the previous year, JCRA reported.

Elsewhere, JCRA reported a pick-up in acquisition and development financing picked up on the previous year, while refinancing was the primary source of transaction activity, albeit dropping to 57% of loan volume compared to the previous year, or 31% after the data was re-sampled. With 5-year swap rates sitting at their lowest level in the past three years, borrowers are finding value by locking in rates for longer terms.

Simon Marshall, Director, JCRA, says:

“We saw an overall increase in appetite for higher LTV loans over the past year, with the re-sampled data suggesting the largest increase occurred in the 70 – 75% range, when compared to the previous year. High street bank lending decreased considerably, most likely a result of a tightening credit policy, however they have remained sector agnostic. On the other hand, the re-sampled data suggests that international and challenger banks have become more competitive in the higher LTV space, and have increased their lending compared to other lenders as a result.”

Other trends included:

  • a significant increase in international bank (non-UK and non-German) lending, up 148% from the previous year, with loan volumes reaching close to 60% of total advisory mandates;
  • Challenger bank lending increased 61% in loan volume over the two periods. While the number of transactions was stable, at 14 up from 13 in the previous period, the average deal size increased from £33.8m to £50.6m;
  • German bank activity and loan volumes remained steady over the period compared to the previous period. This is most likely due to continued uncertainty over Brexit and Pfandbrief funding eligibility, JCRA says; and
  • High street bank activity dropped by 45% of total activity, with loan volumes dropping to 20% of the previous period total. Both average loan size and number of loans decreased over the period. “Although this may indicate a tightening of credit policy, high street banks remain sector agnostic, lending across all sectors covered in the sample,” explained JCRA.

Nuveen: nimble and informed equity can capitalise on structural-driven sectors in the late cycle

Given broad acceptance of the late market cycle, Nuveen says it is no surprise that structural-driven sectors are firmly favoured by investors.

Exposure to the European housing sector, including student accommodation, hotels and healthcare, are sought by investors who are keen to access the previously resilient and perceived future robustness of performance.

Stefan Wundrak, Head of Research, Europe, at Nuveen Real Estate, explains:

“Pan-European residential opportunities are limited, given the nascent market dynamics outside of the established German and Dutch markets, whilst an expanse of Purpose-Built Student Accommodation (PBSA) beyond the UK, which lacks adequate provision, can offer compelling returns versus the more established sectors.

“An understanding of socio-cultural and economic differences across Europe is strategically pivotal, whilst a collective under-supply of residential offerings and a growing demand for healthcare from an aging population complements investor preferences for these markets.”

As the office sector has been disrupted by flexible office providers with its increasing focus on the end-user experience, the residential sector will similarly have to provide a solution to the challenges of affordability, desire for community and convenience of tomorrow’s workforce, argues Nuveen.

“This is where opportunity exists for nimble and informed equity, by partnering with best-in-class operators and developers will add value to any proposition and help to future proof valuations,” says Wundrak.

Any notable yield spread for European residential sub-sectors has largely been eroded for standing assets. There is a pricing variance between Northern and Southern Europe. For example, 100bps for PBSA largely reflects the varied maturity of the asset class, investor base, and associated borrowing costs.

The sectors’ liquidity and sophistication should improve over the long term with residential forming a much greater proportion of a multi-sector portfolio. Our residential strategy aims to offer diversification and value-add returns. This can be through forward-funding, forward commitments or a build-to-core philosophy in the right location.

Wundrak continued:

“In all its guises, the housing sector appeals to investors who are attracted by past performance and projected resilience. Challenges include achieving scale and operator efficiencies.

“Pricing reflects that European markets are at different levels of sophistication and maturity. There is an undersupply of purpose-built build-to-rent, student housing and healthcare assets across Europe. Pricing is keen but value-add returns are achievable through forward-funding and build-to-core strategies.”

Multi-asset class investors must be vigilant of the probable degree of correlation with equities during late-cycle, warns bfinance

Multi-asset class investors diversifying into real estate as a portfolio diversification strategy need to be vigilant of the probable degree of correlation with equities, says bfinance.

This is particularly significant during the later stages of market cycles when returns compress and market participants come under pressure to maintain performance, says bfinance.

In its white paper, Five Levers for Reducing Equity Risk, bfinance argues that there is no ‘silver bullet’ for improving portfolio diversification or resilience to crashes. Instead, investors should consider an approach which is:

(a) multi-faceted; and

(b) sensitive to current market conditions or implementation practicalities.

The paper goes on to outline several currently popular methods, including two real estate-related strategies: increasing illiquid and liquid alternatives.

Bfinance says investors and stakeholders should distinguish between the two key objectives of diversification: improving long-term risk adjusted returns and achieving resilience during market downturns. These two objectives are not synchronous and can conflict with each other.

In order to enable a better understanding of diversification, many sophisticated pension funds and other asset owners now seek to view their portfolios through a risk factor lens rather than relying on more conventional asset allocation strategies. This task is not straightforward: risk factor models vary greatly in their complexity and scope. They also differ in their applicability, with private market risk exposures proving particularly problematic.

Lever 1: illiquid alternatives

Private market investments such as infrastructure, private debt and real estate have perhaps, been the most popular diversifying “lever” of the past decade. In part, this trend has been anchored in the promise of diversification. Yet market dynamics have encouraged a drift towards equity risk, both through visible strategic shifts and less visible style drift within similarly-labelled strategies.

The attractiveness of this lever is, however, enhanced by the growing breadth of opportunities and strategies available: there are now more managers, sub-sectors, geographies and implementation approaches available to investors than ever before.

Lever 2: liquid alternatives

Although private markets have been the chief beneficiary of the trend away from ‘traditional’ asset classes, alternative strategies in liquid markets provide different and more explicit forms of diversification.

Liquid alternatives encompass an exceptionally broad range of strategies, asset classes and instruments, varying not only greatly in terms of the liquidity of the vehicles in which they are packaged, but also in terms of the correlation with equites.

Investor appetite is particularly strong in two major areas: hedge funds with very explicit convex returns profile (e.g. CTAs, Global Macro), and lower cost strategies (e.g. Alternative Risk Premia).

Toby Goodworth, Managing Director, Head of Risk and Diversifying Strategies, explains:

“Appropriate diversification for a particular institutional investor depends on so many things – the current exposures, the ability tolerate downturns, the factor-sensitivity of their liabilities, the real (as opposed to risk-adjusted) return requirements, to name just a few. It is important to understand that diversification is often expected to accomplish different – and potentially competing – objectives, and that a portfolio may be ‘well-diversified”’ from one perspective but not from other perspectives: you cannot eat good Sharpe ratios, as the maxim goes. This is really an issue of good governance as well as robust portfolio construction.”

Cushman: new wave of foreign investors flock to UK investment market

A new wave foreign investors’ have flocked to the UK real estate investment market in 2019, led by French, South Korea and Israel, which have displaced traditional European sources of capital, such as the Netherlands.

The main sources of foreign capital are changing, according to Cushman & Wakefield. Top investors from the United States, China and Hong Kong have either been net sellers or absent from the market in 2019.

In their absence, other investors have stepped up. Persistent buying by French investors (£4 billion) over the last 12 months has launched the country back into the top 10 rankings for net investment into the UK since 2006. Investors from South Korea (£0.9 billion) and Israel (£1 billion) have also been buying in large volumes, Cushman says.

Both countries are now top 20 net investors into the UK, displacing traditional European sources like the Netherlands.

Greg Mansell, Head of UK Research & Insight at Cushman & Wakefield, explains:

“Average net initial yields were 5.6% for transactions this quarter, up 15bps on Q2 2018. Most deals had yields between 4.5% and 7.5%. But more deals completed below this range compared to earlier quarters, as appetite for long-income assets continued to drive their yields down. With further declines in government and corporate bond yields expected this quarter, Cushman & Wakefield anticipates the demand for long-income portfolios to continue. Furthermore, the growth in ground rents and income strip deals is also set to persist.

“In contrast, there were fewer high yielding deals. Opportunistic investors are keen to buy higher-yielding assets, but these deals need extra work to assess the risks and financing them is increasingly difficult.

“Lower economic growth and higher credit risk are applying upward pressure to real estate yields. However, government and corporate bonds fell this quarter, allowing spreads to increase without making a material impact to real estate yield levels. Overall, real estate pricing is proving steady with lower prices becoming common in the challenged parts of the retail sector.”

Source: RCA, Cushman & Wakefield

According to Cushman, the top three UK deals in Q2 2018 include:

  • Vinci acquiring a major stake in Gatwick Airport in May 2019 for £2.9 billion;
  • A £1 billion+ acquisition of a London office building by an owner-occupier; and
  • The sale of 12 supermarkets to Realty Income Corporation at 5% initial yield.

Nuveen: UK retail asset demand has almost completely disappeared

Demand for UK retail assets has almost completely disappeared and secondary yields are turning upwards in most markets, says Nuveen Real Estate, with e-commerce trends exacerbated by rising costs and falling store sales compounding the strain in non-food retail.

The increasing erosion of in-store sales from the growth of e-commerce has further to run in the UK with the pain likely to increase, says Nuveen, while other markets still have 4-8 years to run until online sales reach a high enough level to tip the occupier market into decline.

Stefan Wundrak, Head of Research, Europe, at Nuveen Real Estate, explains:

“The downturn will be greatest in markets where broadband availability is high and consumers are happy to use a card instead of cash. Food sales are, however, proving highly resistant and retail formats with strong food grocery anchors and innovative F&B offers continue to outperform.

“Shopping centre prime yields are also rising in France, Spain, Italy and Germany, but retail warehouse yields are firmer and have sharpened further in Germany as convenience retail continues to attract support.

“Prime high street assets are generally holding firm, except for Brussels, the Netherlands and regional cities in the UK and Spain. Europe’s strongest high streets were the best performers of the post GFC retail bull market, and the easing back in monetary tightening in the UK and eurozone will underpin support for these assets from non-institutional investors.

“With the market outside the UK only just entering a correction phase, the window has not yet closed to dispose of non-core assets before pricing deteriorates even further. But with potential sellers unwilling to crystallise losses and finance still available on retail assets, it is still too early for bargain hunters to enter the market. However, we believe finance will become more difficult to secure.”

Retail rental values are expected to fall further amid an oversupply of property, according to Andrew Burrell, Chief Property Economist, at Capital Economics. “However, once this oversupply is reduced, solid rates of consumer spending growth should spark a recovery.”

Burrell continued:

“Regardless of the Brexit outcome, we expect all-property returns to be squeezed as a result of weakness in the retail sector. However, as Brexit could dramatically alter the near-term outlook for the economy and UK commercial property, we are publishing three sets of all-property forecasts based on different Brexit outcomes. Under a no deal, returns could contract in the near-term, as property yields jump and rental values are hit.

“But, cuts to interest rates would prevent further rises. If a deal is secured, we expect higher interest rates to put upward pressure on yields and cause sharper falls in capital values from next year. If Brexit is repeatedly delayed, yields could increase a bit more in the near term but we would expect interest rates to rise by less. Nevertheless, under any Brexit scenario, the economy could be growing around 2% y/y by 2021, which would support a recovery in all-property rental values.”

Capital Economics note can be read here.

Cushman: UK alternatives sector growth defies Brexit gloom

The UK’s alternative real estate investment sector is defying the Brexit trepidation which has dampened overall investment volumes in UK commercial real estate (CRE), according to Cushman & Wakefield new quarterly research.

However, the growth in the alternatives sector seemingly continues unabated. Alternatives now account for 37% of year-to-date investment volumes into UK CRE, making it the most active sector in the market. All other property types have seen their share of investment decrease in 2019 – offices’ share is down to 33%, for example.

Greg Mansell, Head of UK Research & Insight at Cushman & Wakefield, explains:

“This collection of specialist real estate, infrastructure and long-income deals has steadily grown its share of the investment market since the global financial crisis. In the last few years, we have seen this trend accelerate as retail and office performance has weakened and we expect the appeal of alternatives to continue.”

Jason Winfield, Head of UK & Ireland Capital Markets at Cushman & Wakefield, said:

“Investors like alternatives for different reasons. For some, the abundance of long leases is the appeal. For others, the high returns associated with operational responsibility is the draw. Tellingly, investors are willing to invest at scale when they find the right opportunity irrespective of the property type.”

While the alternatives sector is upbeat, total UK commercial real estate volumes amounted to £12 billion in Q2 2019, down 23% year-on-year. Cushman & Wakefield forecast £45 billion total investment volumes by year end.

Winfield added:

“The decline in overall investment volumes is in part due to institutions decreasing their activity. A slowing UK economy and a fast-approaching Brexit deadline has made those already heavily invested in the UK more cautious. That said, private equity investors have been increasingly active as both buyers and sellers. As buyers, they had a 28% share of all investment in the second quarter – their largest share since 2008.”

The three largest deals this quarter accounted for a third of all investment, the highest share since 2013, demonstrating the enduring appetite for big deals.

Cushman’s analysis concludes tomorrow.

Nuveen: labour market resilience buoys European city leasing outlook

Resilience in the domestic economies of Europe, most notably in the labour markets, continues to propel buoyant leasing prospects in most cities, says Nuveen Real Estate.

It remains to be seen whether the negative external environment will eventually “spoil the party,” says Nuveen, but for now the underlying trend in take-up is well above its 10-year average by a factor of +20% in most office markets, rising to +45% and +60% above average in Milan and Rome, respectively.

Technology and creative sectors are driving the demand for space, along with serviced office operators, according to Nuveen. Some markets experienced a relatively quiet start to the year, including the Tier 1 cities of Frankfurt, Munich, Paris CBD and London West End & Midtown.

This can in part be explained by a lack of suitable product, particularly in Paris CBD where the vacancy rate has subsided to 1.8%. In Tier 2 cities, Benelux cities generally had a quiet start to the year. Even Amsterdam’s exceptionally strong performance in Q4 2018 gave way to a below-par start to 2019. Again, part of the reason is lack of product in those sub-markets in which tenants desire. The benchmark prime rent increased by 6% over the first three months of 2019, Nuveen reports.

Stefan Wundrak, Head of Research, Europe, at Nuveen Real Estate, explains:

“We are very positive about growth over the short term. Even in London, the balance between availability and take up is tight across most sub-markets. Looking ahead, we must acknowledge that nominal rents are relatively high in many cities, notably Stockholm, Berlin and Amsterdam – the stars of the current cycle – but also in other German cities.

“By contrast, the Iberian markets look set for further catch up growth. With supply relatively disciplined across the continent, the business cycle is likely to be the key disruptor to an otherwise rosy outlook. Even here, inflation is unlikely to underpin rising interest rates any time soon. It therefore leaves an unpredictable sector specific or more generalised financial market shock to provide the harbinger of the next downcycle. Until that situation occurs, the good times can roll.”

Nuveen: investors refocus on fundamental differences between sectors

With the all-encompassing cyclical drivers of rental growth and yield compression running out of road, the fundamental differences between sectors are back on the minds of investors, says Nuveen Real Estate.

Headline investment activity remains historically strong, but volumes are retreating slightly, according to Stefan Wundrak, Head of Research, Europe, at Nuveen Real Estate. In a Q3 outlook of the European market, Wundrak continues:

Offices continue to benefit from rental growth, but the medium-term outlook is more muted. Rising sector allocations drive investment volumes and pricing for logistics. Strong construction activity supplies product.

“Retail valuation in Continental Europe has fallen for two consecutive quarters. France, Germany and Central and Eastern Europe defy the downward trend much better than other markets. Niche living markets are developing fast, but secular opportunities seem largely priced in.”

The logistics sector still benefits from underweighted investors who are increasing allocations substantially, says Nuveen, adding the sector remains priced for growth.

Wundrak continues:

“While we also expect logistics rental growth significantly above previous cycles, recent deals seem to imply aggressive growth expectations that the market is unlikely to deliver on. Double-digit rental growth across many office markets have vindicated low yields in the office sector over recent years. Yields haven’t compressed further over the last 18 months, implying that the rental growth cycle is expected to slow down from 2020 onwards.

“2019 is poised to deliver another year of good rental growth based on solid demand and a relative disciplined supply response so far. However, despite interest rate rises pushed beyond 2020 it is hard to see what could drive a further sharpening of cap rates.”

Elsewhere, Nuveen says the residential sector is “internationalizing” largely along niche sectors, such as micro-apartments, co-living, senior living and student housing.

Wundrak continues:

“Similar to the logistics sector, living investments have secular winds in their sails; most investors are under-allocated and the sector is bolstered by demographic changes driving a shift in demand. Investors face a similar dilemma as with logistics. Do secular trends like rising tourism and growing international student numbers justify the high valuations?

“Retail, on the other hand, is becoming increasingly unloved as the challenge of e-commerce is filtering through the system. On a pan-European basis, valuations have been drifting downwards over the last six months. Losses have so far been confined to more secondary assets, where yields have decompressed, leaving only Germany and France largely untouched.

“The former remains relatively insulated due to high investment pressure and consumers being supported by the strong economy. We expect values to continue to soften this year with no market escaping value adjustments.”

Alternatives now the largest sector in UK commercial real estate investment market as investor activity evolves

rolling annual total to £58bn, according to Cushman & Wakefield data, which if the momentum trajectory continues would lead to an estimated £45 billion for 2019.

Institutions have decreased their investment activity. A slowing UK economy and a fast-approaching Brexit deadline has made those already heavily invested in the UK more

Cautious, explains Cushman. Meanwhile, private equity investors have been increasingly active as buyers and sellers. As buyers, they had a 28% share of all investment in the second quarter – their largest share since 2008.

According to Cushman, the main sources of foreign capital are changing. Greg Mansell, Head of UK Research & Insight at Cushman & Wakefield, explains:

“Top investors from the United States, China and Hong Kong have either been net sellers or absent from the market. In their absence, other investors have stepped up. Persistent buying by French investors over the last 12 months has launched the country back into the top 10 rankings for net investment into the UK since 2006.

“Investors from South Korea and Israel have also been buying in large volumes. Both countries are now top 20 net investors into the UK, displacing traditional European sources like the Netherlands.”

The top three deals this quarter were a third of all investment – the highest share

since 2013. Vinci, an infrastructure operator based in France, bought a major stake in Gatwick Airport, classified as an Alternative asset, for £2.9bn. They announced the deal in 2018 and completed it in May 2019, making it the largest deal in the quarter.

The second-largest deal was over £1bn for a London office bought by an owner-occupier.

This deal highlights the trend of large corporates preferring ownership to leasing large amounts of space on long leases. For many companies, buying may be a cheaper option over the long term since the IFRS 16 Leases accountancy standard became effective at the start of 2019. Lessees must now recognise leases as assets and liabilities on their balance sheet.

The third-largest deal was the sale of 12 supermarkets to Realty Income Corporation at a 5% net initial yield. The sale was part of British Land’s drive to have a “a smaller, refocused retail business”. Mansell added: “Long-income portfolios, such as this one, attract buyers looking for low-risk, long-term income. With further declines in government and corporate bond yields this quarter, demand for these portfolios should continue. The appetite for long income has also driven growth in ground rent and income strip deals. The largest of these deals last quarter was £206m of ground rents secured on over £1bn of London Hotels bought by Alpha Real Capital.”

Cushman’s analysis continues tomorrow.