Alis Pay
Clifford Chance

‘Beds and sheds’ are in the sights of real estate investors, says Alis Pay of Clifford Chance

Despite the political and monetary uncertainty that has persisted throughout 2016, real estate investors seem unconcerned. Is this what you’re seeing?

There is a degree of caution in the market. Transaction volumes are down, with some saying by as much as 40 percent this year. Deals are taking longer to do, particularly because there is a disconnect between buyers and sellers on pricing. There are also examples of properties being taken off the market because of this. There is also some caution about taking up space, which obviously ultimately underpins investment.

Tenants want more flexibility, so lease lengths are coming in, incentives are moving out, and transactions are taking longer. I would say that rents are generally holding up.

But what is keeping the market moving is that, on a relative basis, commercial real estate investment is seen as attractive, given the low interest rate environment we are in and the low yields on government bonds. That is resulting in capital being deployed on the right transactions, which is essentially keeping pressure on pricing and compressing yields.

The logistics sector in particular is seeing that. The foreign exchange rate dynamic is also present and that exchange rate differential is helping to drive deals.

Political and monetary uncertainties tend to draw a correlation, but that doesn’t always align with what investors are thinking. Even before the UK referendum on its EU membership, the market was slowing. Pricing was getting frothy and nearing the top end.

Clients were telling me back in late 2015 that they had the capital to spend, but they couldn’t find assets at a price that made sense for them. So even then, there was the beginning of a slowdown.

I think the combination of high prices and political uncertainty has exacerbated the caution we are seeing. However, long term, the UK will still be considered a major location that will attract investors who will continue to invest in the stabilised institutional high-quality assets.

Many commentators are talking about high levels of debt. Is this a common feature of the real estate transactions you work on, or are investors capital rich?

We are seeing capital rich investors, particularly sovereign wealth funds. There have been some very large portfolio transactions that have been snapped up by these funds. Real estate funds have plenty to spend, too.

Following the UK’s vote to leave the EU in June, many real estate funds suspended redemptions and liquidated parts of their portfolios in response to an initial flurry of requests. But that didn’t last long and a lot of those redemption requests were withdrawn, so we even saw some funds take properties off the market that had been put up for sale to meet redemption requests. Now we’re seeing inflows to those funds, so they have money to spend.

We are also seeing debt, because for investors who are looking for cash-on-cash returns, debt will always improve that return. But that debt is still at conservative levels. The loan-to-value ratios are still quite conservative. Senior debt is between 50 and 60 percent. Mezzanine debt rarely gets above 80 percent. Lenders aren’t lending on speculative developments, either.

The other dynamic is that, before the financial crisis in 2008, commercial real estate debt was concentrated in the banks.

The great deal of regulatory change that followed made the market more diversified. Banks’ participation is highly dependant on regulatory capital frameworks, while the insurers coming in tend to be a bit more conservative.

Europe in particular appears to be doing well, with a healthy pipeline of transactions. Are any sectors standing out for you?

As one client described it to me, “beds and sheds” are the standouts. The logistics sector has been quite active. The P3 Logistics Parks portfolio was sold for more than €2 billion to a sovereign wealth fund in November, while Blackstone’s Logicor portfolio is coming to market. These are huge pan-European portfolios, so I would say the logistics sector is hot right now.

The private rented sector (PRS) is really taking off. The millennials cannot afford to buy residential properties in the UK, which is very much in the grip of a housing crisis at the moment. PRS is seen as a part of the solution to that. There a lot of examples of developments in London alone.

Stabilised institutional high-quality assets in the office sector are still strong. Foreign investors are still buying and we’re seeing a lot more forward funding as competition for better property and tenants intensifies.

What do you see as the trends to watch out for in 2017?

I think the ‘beds and sheds’ trend will continue.

Serviced offices, which make up about 3 percent of the market,will increase in popularity. What we’re seeing more and more is that need for flexibility for occupiers, which goes back to the caution that investors and occupiers are showing. However, businesses cannot wait too long to make occupation-type decisions in their strategies, and I think we’re going to see more of these serviced offices and shared workspaces being a part of that solution.

Landlords are actively courting these occupation solutions within their multi-let buildings. They want to be able to give their tenants the option of more space to give them that flexibility to scale up and down as needed.

Another trend we’re seeing and will continue to see is the destination shopping centre. These destination shopping centres consist of cinemas, restaurants and other non-shopping related experiences. This is because retailers are conscious that ‘time is precious’ and when people decide to go to a place, it isn’t just to shop, it’s to experience lots of different things. It’s likely that we’re going to see more of these. Developers are going to be creating places where people want to spend time. It’s the same with PRS. If you ask PRS developers what they’re looking for, they say it is for the millennials to keep renewing their leases, so that there is a steady flow of income and minimal voids. Part of that is providing a destination that is more than just their apartment.

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