How modern real estate investors are making decisions during Covid-19
The dramatic impact Covid-19 has had on global mobility is bound to shift global capital flows. In the coming year, real estate investors will be thinking twice about where they invest and what they invest in. We speak to Knight Frank’s Victoria Ormond, CFA, Partner, Capital Markets Research and Anthony Duggan, Commercial Chief Strategy Officer & Head of Global Capital Markets, about these shifts, and how investors’ decision-making processes are changing.
5 minutes to read
Q: Thinking about the way in which investors make decisions, how do you see that changing, or having changed?
Victoria Ormond: It's evolving increasingly rapidly, although the real estate sector has been slower to adopt sophisticated uses of data, compared to other more frequently traded assets. A large reason for this is because the nature of commercial real estate, including how it is valued and how it is traded, is quite different, and in many respects, less transparent, than other asset classes. This means that big data hasn’t existed in the same way for commercial real estate as it has elsewhere.
However, we're finding this is starting to change and we are seeing increased sophistication of analysis by investors, whether it’s looking at portfolio optimisation models, or thinking about the components of discount rates and other assumptions when running cash flows.
But investors are also increasingly taking advantage of data by employing, for example, machine learning, geospatial analysis and other statistical methods, to help design fund strategies and make investment decisions, with the benefit of enhanced rigour. Part of this is a recognition that it is not just about an asset and its tenants, but also about where the asset is and other attributes around it, for example.
Reflecting the increased demand for sophistication of analysis, this year’s Active Capital is more data-driven and model-led than ever before. For example, we’ve used an enhanced type of statistical analysis in the form of a gravity model, originally used to forecast international trade flows, to predict where we could see real estate capital flowing from and to in 2021. We’ve also combined hundreds of thousands of data points and used machine learning to identify which cities are drivers of innovation, which supports the wealth and population needed for well-functioning real estate markets.
Q: Focusing on the capital gravity model used in Active Capital, can you explain a little more about this analysis including some of the results and interesting takeaways?
VO: I would first of all caveat that it is difficult to forecast even in normal markets, and we are now in a pandemic – we have faced an unprecedented shock. However, what we have tried to do with this analysis is incorporate a shock factor, which in essence helps the model look back at previous (albeit different) shocks and reflect the previous, lagged effects on capital flows in the predictions for next year and beyond.
The model includes ‘traditional’ economic and financial factors, such as GDP, exchange rates, amount of foreign direct investment and share price indices, but also overlays other factors.
For example, is there a common language between countries or other ties? Is there is a shared border? How far apart are these countries? We also overlay country effects to account for the peculiarities that are within each type of country to get to our predictions for 2021.
In terms of results, we see two main themes coming out of our forecast. The first is, and probably not unexpectedly, that investors are likely to target safe-havens – those more liquid locations – over the coming year. Reflecting this, the US is number one, and the UK is number two in terms of top forecast destinations for capital, being relatively liquid, transparent, markets.
But another theme is looking at or identifying near-neighbours, i.e. capital flows intra-regionally, such as within Europe or within Asia Pacific. And there are a couple of reasons, if you think about it, why that is happening.
Near-neighbours could also be known 'old friends' perhaps, and it is investment in those locations where investors are comfortable with and can find geographic diversification, but are still closer to home, which might make travel easier. They might even have a shared border. There may also be increased likelihood of investors having local offices in these locations, making it easier to transact.
As examples of these intra-regional investment corridors, the biggest capital flow predicted for 2021 is from Canada into the US, while Singapore into Australia is another predicted top 10 capital flow.
Q: Anthony, what have you found most interesting about these forecasts? And what changes are you seeing in the ways investors are making decisions?
Anthony Duggan: What I found really interesting was that, no matter how much we tested the model, it was telling us that flows would be similar volume-wise to last year. It's really encouraging that international capital will remain an absolutely critical part of the global marketplace. It will continue to drive those key gateway global cities, and competition throughout will remain.
The continued strength of the industrial sector is an interesting one, as well. Last year, the model was telling us about this rotation into specialist assets – including industrial and logistics. We’re increasingly seeing that and, if anything, the pandemic has sped that up further and our Data Centres team – and even our Film Studios team – are seeing far more interest and really robust growth in these sectors.
As the pandemic has spread, it’s catalysed a lot in terms of adoption of what in the past have been seen as niche or alternative sectors, to the point where we’ll see a much wider of range assets being targeted by investors who have probably been quite traditionally focused on three or four sectors in the past.
The other key message from the research is that, if you’re looking to invest over the course of the next 12 to 24 months, our research has shown how innovation-led cities will be attractive and defensible – innovation will be a core driver of investment resilience.
Our research also really focuses on the ESG agenda because it is in laser focus for us globally. What Active Capital does, which is really important, is it unearths where these green-hotspots are for real estate investors, and I think people will be surprised by just how diverse the pool of assets already is. It's not just a few locations, it's already embedded a significant scale in many locations around the world, and the bifurcation will increase between those assets that display those ESG attributes and will perform better and those that don't.
These insights were first explored on September 25th, in the webinar “Commercial Conversations: Active Capital – Your guide to navigating the next investment cycle.” Watch the full discussion now.