Real Estate Reinvents Itself

Hong Kong
Highrise residential and commercial buildings are seen at Hong Kong island August 29, 2012. Bobby Yip/Reuters

CBRE sponsored report ¦ This week, 21,000 property professionals from across the world will gather at the Palais des Festivals in Cannes, on France's Cote d'Azur. At MIPIM, the world's largest property event, the message echoing through the exhibition halls will be positive: property is back.

After the global financial crisis of 2008 prompted a fall in the value of commercial real estate (CRE), and the levels of rent it could command, levels of investment are beginning to return to former heights. Research from CBRE, the world's largest commercial property advisory firm, shows that in 2014, four countries in Europe reported record levels of investment in CRE: Spain, Ireland, Sweden and the UK. The level of CRE investment in the fourth quarter of 2014 was the highest CBRE has ever recorded. The view from MIPIM looks good, and that's not just the proximity of the Mediterranean Sea.

Compared with other sectors, property has shown strong growth since the global financial crisis. As an investment it offers a higher yield than bonds. Low interest rates have also helped, and there has been a huge investment demand in property fuelled by private and institutional capital, which requires the income that bonds just don't provide now.

London and Hong Kong have experienced impressive growth due to their positions as major financial centres, aided by quantitative easing. But just because we are witnessing an upturn in property value, this does not mean a return to business as usual. New trends at the occupier level are transforming real estate.

Where, how and why companies are occupying space in cities is changing. These shifts mean that property investors and developers must now be more mindful and seek to understand the requirements and even personality of a likely tenant.

Property Stays Strong

There is an interesting story that illustrates the strength of commercial property as an investment and how it does not necessarily follow major economic trends. In London's Canary Wharf, a skyscraper at 25 Bank Street was under development in 2001, earmarked for occupation by American energy giant Enron. This plan was abandoned prior to the company's well reported collapse in December of that year. Nevertheless, Canary Wharf Group was able to secure an agreement with Lehman Brothers to rent the building on completion on a 30 year lease, and 25 Bank Street served as the European Headquarters of the financial services firm from 2004 until their own insolvency in 2008.

Canary Wharf
The Canary Wharf financial district at dusk, London, November 7, 2014. Toby Melville/Reuters

When this happened, around half the building was already let to sub-tenants who continued to occupy and paid rent; the former Lehman Brothers space was occupied by the administrators who also paid rent. The building was sold in 2010 to JP Morgan Chase for £495 million. What other financial asset – bond or equity – would continue to hold such a high proportion of its value despite such a turbulent sequence of events?

With the global economic recovery set to continue, the outlook is good for property. The US recovery is on track with growth of 2.5% in 2014 and 3.1% in 2015 likely. Growth for the same quarter in the eurozone is slower at 0.3%. However, falling oil prices, an end to fiscal contraction and QE seem likely to boost growth in 2015 and 2016.

"The real estate industry that designs, produces, manages and invests in real estate, both residential and commercial, is highly fragmented. Yet the decisions taken in this sector are highly important since they create the towns and cities in which we all live and work. The physical landscape of a city changes relatively slowly over time, so decisions made in the real estate sector, for good or ill, have great longevity."
Nick Axford, Global head of research, CBRE

'Abenomics' has been positive for growth in Japan. Reforms in the Chinese economy are set to introduce a flow of savings estimated to be £1.3 trillion into the economy over the next five years. The performance of these major economies has an impact on the finances of their citizens in the form of real estate prices.

Home owners in London experienced a 16% rise in house prices in 2014, which saw their city overtake Hong Kong as the most expensive for residential property per square foot in the world. Companies operating in Beijing, the third most expensive city for commercial real estate after Hong Kong and London, can expect prices to rise as there has been very little prime office supply added since 2009.

The real estate industry, backed in many cases by international capital, directly contributes to these property trends. As well as creating offices that allow businesses to thrive, real estate provides the modern logistics facilities that allow the city's shops, cafes and restaurants to be supplied quickly and efficiently. The industry builds homes too, providing the supply that drives prices and allows the movement of people. And you don't need to be a homeowner to be affected by real estate; if you have a pension, it is likely that around 7% of the assets your pension fund manages will be in property.

International investment is a driving force in the real estate sector, particularly in major cities. Few have been more affected than London, where more than 50% of commercial real estate is now foreign owned. It is the rental income that flows from real estate assets that is prized by investors, for its stability and its ability to keep up with inflation long term. Another major factor behind the sector's current attraction is its combination of investment characteristics, which include both the defensive features of a bond with the upside growth potential of equities.

In terms of growth, there's the ability for income to rise as rents increase, but investors are also protected from inflation. Defensively, real estate investment represents a long-term bond-like income stream and the demand for commercial office space won't disappear. Perhaps most important of all, property offers a very high level of defensive capital protection, similar to gold. Even if your tenant goes bankrupt, the building can be re-let.

Asian investment in global property is on the rise CBRE

Demand for real estate as an investment and the interest of international investors, particularly from oil rich and growing economies like Qatar and China, have pushed up prices causing some experts to call it over-valued. However, markets are unpredictable. Investors want at least part of their portfolio to be in relatively high-yielding assets like real estate.

Nestlé saw the yield on its corporate bonds turn negative recently, which mean investors are paying to hold its bonds, such is its security. In such an environment, it is difficult to put too high a price on Nestlé's own office buildings. Global prices are supported by the tide of foreign investment in real estate, which shows no signs of slowing with Asia an increasingly significant investor – the continent saw a 23% increase in outbound investment in 2014.

Several trends have emerged that are shaping real estate at a national level. As global investors dominate gateway cities like London and Paris, national investors are looking to second-tier locations. CBRE research indicates that from 2012 – 2014, major UK cities (excluding London) saw domestic buyers account for 70–85% total investment, a very different trend to that seen in the capital. A second trend is that investors have moved beyond traditional CRE sectors of offices, retail and industrial into alternatives such as hotels, hospitals, nursing homes and student accommodation.

"Intense global competition for property and the restructuring of the banks have seen the rise of non-bank or shadow lending. Insurance companies have moved quickly to fill the gap left by banks. Fund managers have set up debt funds which have proved popular. We are also seeing P2P lending by REITs. Crowd funding for development has begun to emerge. What is clear is that debt markets are changing quickly with the banks priced out by onerous capital requirements."
Richard Barkham, Global chief economist, CBRE

Changing Occupiers

Traditionally, central commercial property is occupied by the sectors of finance, insurance, law and business services. But since 2008, demand from finance has fallen away, with an influx of technology and creative industries, sectors that have fared better in the post-crisis era.

In London, creative sector take up reached a peak of 4 million square feet in 2013, over double the 1.9 million square feet annual 10-year average. Avoiding the highest-cost locations and focusing on attracting the talent of the millennial generation, the tech sector has revived central but previously unfashionable urban areas. Airbnb and Uber in SOMA, San Francisco, or Google and Facebook on London's Silicon Roundabout in Shoreditch. Across Europe, Factory Berlin is home to Twitter and Soundcloud in Germany; 22@ District in Barcelona is a successful government-backed innovation district. To understand the changing needs of occupiers, it's important to realise that the factors driving decisions about locations are changing.

Silicon roundabout
London's Silicon Roundabout in Shoreditch Getty

CBRE's annual European Occupier Survey identifies these trends.the 2015 survey results show that workforce is an important factor in office location. Approximately half of the respondents (46%) cited talent availability as a key factor, while 30% highlighted the cost of labour. Both responses were 10% higher than in 2014. Location decisions are becoming much more dependent on where labour is - or can be persuaded to move to. This trend is driven in part by the tech sector's 'war for talent', as they try to attract millennials with a marked preference for city living.

The New Office

The tech sector is leading the way in innovative use of office space: workplace strategy. This is the approach companies use to maximise the effectiveness and efficiency of workspaces, and it is viewed increasingly as a business necessity.

The most well-known examples of modern workplace strategy stem from Silicon Valley: open, colourful spaces, with hot-desking, ping pong tables and free lunches, a far cry from the impersonal and structured office designs that have dominated financial and legal offices for years. But it's a mistake to think the approaches of Google and Facebook have been implemented with leisure in mind; they are designed to maximise creativity as well as productivity.

Facebook headquarters
An employee writes a note on the message board at the new headquarters of Facebook in Menlo Park, California January 11, 2012. The 57-acre campus, which formerly housed Sun Microsystems, features open work spaces for nearly 2,000 employees on the one million square foot campus, with room for expansion. Robert Galbraith/Reuters

Open, communal areas encourage collaboration and the kind of creative accidents that lead to new product ideas or client leads. A quirky, non-corporate office attracts top graduates who prioritise job satisfaction. With the tech sector reaping the benefits of innovative workplace strategies, this trend is bound to continue, fuelling the demand for large efficient open-plan floorplates and flexible spaces. Due to the rapid growth of tech companies and the fact that their space requirements change quickly, short lease commitments with early break clauses are preferred.

Innovations in workplace strategy are taking place beyond the tech sector; many law firms are rapidly adopting alternative approaches. A CBRE survey in 2014 found that legal firms needed to reduce their office space under increased competition from new entrants and client demands for lower fees. These pressures, alongside increased mobile working, have meant that 64% of firms surveyed used alternative space strategies.

Open plan offices encourage increased collaboration and support business growth: "Once you move to open-plan, you start operating in a slightly different way. I think it will become the norm in five years' time," said Douglas Peniston, operations director, FieldFisher. But CBRE's survey noted the potential disruption a change to open-plan can bring, highlighting the importance of ensuring that any shift in strategy fits the personality and objectives of the business.

"It's about inspiring creativity, bringing people together and allowing people to feel comfortable in their workplace."
Helen Sullivan, Head of Facilities, Mother

New Needs, New Solutions

The resurgence of CRE prices and the sector's ability to adapt to changing market forces and occupier needs is the beauty of real estate investment. New companies with different needs are moving into previously unpopular office markets and, with the right support and expertise, are transforming them as well as property prices in those areas.

With intense competition for office and housing stock, investors have broadened focus to include hospitals and hotels, providing services for local communities. As bank lending decreases, other forms of financing have sprung up. It is the flexibility of real estate that makes it such a secure investment and by monitoring trends and adapting to occupier needs, investors will benefit.

The financial reasons for investing in real estate are numerous, particularly due to the stability the sector offers in today's unsettled economic climate. But commercial real estate is only a good investment if it suits the needs of its occupiers. More than ever before, the needs of occupiers are changing and investors need to recognise this dynamism, or work with advisors that are in close contact with occupiers, to ensure that they derive the benefits from real estate that they are expecting.