In the short term, there remains a lot of uncertainty as to the path developments will take. Much will depend on how the spread of the virus evolves. Will the vaccine be effective? Will enough people take the vaccine? Online polls suggest many people are sceptical to take a newly developed vaccine without data on the potential long term side effects. Will the virus keep on evolving even if the current vaccine is effective? Will the current strict lockdowns be short lived, or will we have rolling lockdowns in some form or other for years to come?

The dispersion of potential economic outcomes is very wide. The full effect of the lockdowns on the economy will only be clearly visible years from now. How many retailers and other businesses will survive? What will happen when eviction moratoriums expire? How many loan defaults will occur and how will this affect the banking system? How will governments and central banks respond further?

Let us turn now to how we use real estate and the trends in different sectors.

With most of the world being ordered to work from home (WFH), many office buildings have been empty or at a fraction of usual occupancy. The mass global WFH experiment has forced organisations to adapt and use technology to continue operating as best possible. For many organisations, the surprisingly little disruption in their ability to continue operating has led many to reconsider their need and future use of office space. A significant portion of work that is done in the office occurs on computers or are interactions between people. A large portion of this work therefore does not necessarily have to take place in the office.

The degree to which WFH policies are adopted post the pandemic period will differ between companies and sectors. It does appear that more flexibility regarding how many days spent in the office will be more common. A hybrid model where, for example, three days spent working from home and two days spent in the office for meetings and collaboration seems like a common path forward for many companies. We expect this to lead to an overall reduction in the demand for office space in the long run.

Where people work affect their choice of where they choose to live as well. When you can WFH, or can commute to the office less regularly, you might reconsider whether it still makes sense to pay premium rent for smaller living quarters closer to the urban core, where most offices are located. In the US, traditional gateway cities like New York and San Francisco have always been magnets for drawing employees to work in the big finance or technology sectors that dominate in these cities. With the ability to work from home many have opted to move to smaller cities with better weather, lower taxes, and more affordable living costs. The south east (also referred to as the sun belt) of the US has been the beneficiary of significant inward migration of people seeking out a higher quality of living standards.

Many large organisations have followed suit. Numerous technology firms have opened offices in cities like Austin, Charlotte, Atlanta, and Raleigh. Several financial companies from New York have migrated south towards Florida, with either a new primary or secondary base. These changes have resulted in huge differences in the fundamentals of the local office markets. San Francisco and New York have seen a drastic uptick in vacant space available which has impacted effective rents dramatically. In contrast, some sun belt office markets have experienced net effective rent growth or rents that are flat compared to last year.

The outlook for overall office demand in the future looks meaningfully lower, due to a combination of low office using job growth and less space required per company. We expect the bifurcation of fundamentals to play out over the medium term on two dimensions: geographic and the quality spectrum. Higher growth markets with low cost of living will continue to attract companies and employees at the expense of traditional gateway cities. Modern, amenity rich office buildings with large open floor plates and high wellbeing scores will continue to be in demand from companies that want to have an office space to attract employers.

In the residential space, the pandemic has also resulted in a marginal shift in demand on a geographic and property type level. As mentioned in the previous section, in the US there has been net outward migration from the coastal markets whilst the sunbelt markets have generally experienced population growth and strong inward migration. As a percentage of the populations, these migrations are minor, but as the adage goes “it’s the marginal buyer and seller that moves the price”. In the apartment sector this strong contrast can be seen in the different rent growth experienced in various cities. For REIT quality apartments, average asking rent growth has been negative over the past year in San Francisco (-22%), New York (-20%), San Jose (-12%) and Los Angeles (-5%). In the larger sunbelt markets of Austin, Houston, Orlando, and Dallas, all are experiencing slightly positive rent growth and Phoenix is delivering strong rental growth (5%).

As most people have been working from home, demand for single-family homes has increased. Households who can afford it have sought larger rental units with workspace separate from eating and sleeping areas. Single-family rental homes are predominantly located in the suburbs, often near outdoor recreational facilities. The outlook for the single-family REITs is favourable. Record high occupancy rates bodes well for continued rental growth. In the US, the national average rent growth over the past year was very healthy around 7%. Low supply, rising construction cost, and continued institutional investor interest in the sector are all tailwinds for the sector which we expect to continue for the time being.

Fundamentals for the manufactured housing sector continue to be strong. Low supply, affordable rent levels, and favourable demographic shifts all bode well for healthy rental growth prospects for the sector.

Student accommodation operations in the US and UK were disrupted by the lockdowns. Occupancy levels were significantly lower than historical norms as many campuses were shut for prolonged periods during the year. With most universities being forced to deliver lectures online, some student housing landlords were pressured to forgive rent. It is not yet certain what the short-term occupancy picture looks like as much will depend on the direction the spread of the virus takes. In the long term we expect on-campus education at top tier universities to remain an attractive proposition for many young students. However, headwinds from lower international enrolments and growth in online learning alternatives is expected to continue. It is uncertain what the magnitude of the impact on the long-term demand will be.

One of the top performing sectors globally was German Residential, delivering 36.24% in USD for the full year. The sector has proven to be particularly resilient with its affordable product and sturdy cash flows. Supply is still relatively limited by high replacement cost, making development of new product unattractive for developers. Political pressure in some regions have led authorities to implement freezes or caps on rent growth. Some REITs in the sector have responded by increasing their modernisation programmes to unlock earnings growth. Generally, when apartments are upgraded, landlords can capture a healthy spread between in-place rent and market rent.

Before the pandemic hit, the retail sector was already struggling from structural changes due to the rapid growth of ecommerce. The lockdowns forced most retailers to shut down. Unable to trade and generate revenue, many retailers did not have sufficient reserves and could not pay their rent. In the Mall sector, rent collection improved from ~45% in 2Q20 to ~80% at the end of the year. The Strip Centre sector, with more necessity type retail, had better rent collection, improving from ~83% in 2Q20 to 90% at the end of the year.

The US has been over retailed for a long period. Only the strongest retailers and retail properties will survive. Many shopping centres will close or be converted to other uses. The retail properties that do survive will probably have to reset rent levels lower to more sustainable levels that retailers can afford.

What has been bricks-and-mortar’s pain had been industrial’s gain. The Industrial sector has been one of the top performing sectors globally, delivering 13.6% in USD for the year. Ecommerce growth has been a secular driver of demand for modern logistic facilities for a few years already. The lockdowns have accelerated this growth dramatically, with the US Census Bureau estimating the ecommerce percentage of total sales increasing form ~12% pre-pandemic to ~17% at the end of 2020.

The pandemic has also placed more emphasis on more robust supply chains, as many retailers experienced shortages of goods in the initial phases of the lockdown. A shift towards carrying slightly more reserve inventory instead of the just-in-time delivery method translates to overall more demand for warehouse space.

Figure 1 – Ecommerce Retail Sales as a Percentage of Total Sales

Strong rental growth prospects and increasing investor demand bodes well for total return prospect from the sector. Demand is still expected to outstrip new supply in the foreseeable future. However, new capital entering the sector will undoubtedly lead to a pickup in supply over the long term. With relatively short development timelines compared to other property types, this is a metric which we monitor closely.

It is hardly a secret that we live in a world where we all continue to consume more data. Whether in our personal lives, watching streaming video services, or communicating with colleagues over video calls, the increase in the consumption of data is growing rapidly. All this data is housed somewhere on computer servers located in data centres. When we use our mobile phones outside of Wi-Fi reach the data is transmitted through cell towers. The pandemic lockdowns have not materially impacted this trend in a major way, if anything, it has slightly accelerated the growth.

Data Centre and Tower REITs own the physical infrastructure that enables the internet to function. As the demand for data has been increasing, so has the demand for the infrastructure grown with it. Data Centre and Tower REITs have been growing significantly over the recent past as they are able to develop new facilities at very profitable margins or use their premium valuations to acquire competition. Whilst the demand for data centres continues to be strong, the competition to supply data centres have also increased. Development margins have reduced as more competitors are attracted to develop new properties. We expect upcoming supply to soften the rental growth outlook for the sector in the medium term, compared to its high historical growth. Albeit the earnings growth expectations from the sector is still significantly higher than the average property sector.

The Health Care REIT sector consists of companies owning predominantly Senior Housing, Medical Office Buildings, and Life Science assets (which are specialised laboratories catered towards biotech and pharmaceutical tenants). Operating conditions in the Senior Housing segment was severely impacted by the pandemic. Excess fatality rates from the pandemic, as well as a halt in new move ins resulted in drastic reductions of occupancy for many senior homes. Added cost from increased Personal Protective Equipment, stricter health protocols, and higher staff overtime payments led to significant declines in operating income. We estimate that the average Senior Housing portfolio Net Operating Income (NOI) for 2020 is ~30% below 2019 levels. We expect the NOI from Senior Housing to recover to 2019 levels sometime between 2023 and 2024. In the long term, the growing aging population should lead to increased demand for senior care facilities.

The Medical Office Building (MOB) segment continues to live up to its steady reputation, with stable and high cash rent collections (~90%). However, the sector has not been immune to the pandemic effects. During the lockdowns, many outpatient elective procedures were banned, and medical office visits plummeted by 60%. At the end of the year, outpatient visit numbers rebounded to the same levels they were at before the pandemic started. Apart from the slight decrease in cash rent collections at the height of the pandemic, we expect NOI from the MOB segment to continue its steady pace in the medium term.

The Life Science sector continues to enjoy favourable fundamentals. Demand for specialised lab space in key clusters located near research universities, like in Cambridge outside Boston and in south San Francisco, continue to be strong. The strong demand has not gone unnoticed. As funding for biotech and pharma research has increased, new players have entered the market to develop these specialised facilities. A few traditional office landlords have recently announced plans to develop lab space, and we have seen some of the Health Care REITs increase their focus on lab space.

Lab spaces are highly specialised property types. Tenants occupying these buildings generally want to partner with a landlord that has a track record of developing and running these properties successfully. Additionally, the location of these lap spaces is critical. Proximity to medical research campuses is vital for researchers, and where majority of venture capital funding takes place. We expect the landlords with the best located portfolios and long track records to continue performing well in this sector.

The lockdowns have wreaked havoc on the economy. Central banks responded by flooding the markets with record amounts of liquidity. Trillions of dollars where injected via credit creation and directly paid to individuals and businesses. Since the trough in March, bonds and equities rallied to all-time highs, whilst most of the underlying economy has continued to perform poorly. Global listed real estate has underperformed both bonds and equities. Some real estate sectors, like Retail and Hotels, still face a very difficult and uncertain period ahead. Other real estate sectors like, Industrial, Lab Space, Manufactured Housing, and Single-Family Housing all performed well during the year and continue to have fundamental tailwinds.

Equity market valuations in most developed markets are at or near all-time highs, regardless of which measures one looks at. Fixed income, including government bonds, investment grade, and high yield, all trade at or near their lowest levels in history. Relative to fixed income and equity, the real estate sector looks very attractively priced on expected total return spreads. The estimated forward FAD (Funds Available for Distribution) yield for the sector is 4.40%. Based on our earnings estimates and market break-even inflation expectations, we expect the listed real estate sector to deliver at least 5% real return for buy and hold investors over the medium term. Within the real estate universe, more attractively priced opportunities exist in specific real estate sectors and stocks, providing opportunities for astute active managers.