However one cuts the data, it is clear that commercial real estate continues to enjoy a very healthy level of investor demand. In 2018 global transactions amounted to more than US$900 billion, similar to the level of activity seen over the past few years.
So what is behind the continued allure of the asset class, and why is it receiving greater attention from private capital in particular? There are two types of force – macro and micro – at work.
These general drivers apply almost regardless of timing within the market cycle. However, there are a number of specific considerations relevant to any investor thinking about commercial real estate in the immediate future.
For one, competition for certain types of commercial real estate will become more intense. This is especially true of markets for which there is a very well understood investment rationale.
Does this mean such markets will be off limits for all but the most determined investors? Not necessarily, but with this in mind, we expect that investors of all descriptions will need to think creatively about the most appropriate way to access these markets and, where possible, to avoid overpaying for assets.
It may also be the case that some investors will need to move up the risk curve in search of returns. One way of tackling the issue of competition is to consider a broader range of assets, including those which may not be defined as prime. Indeed, this could become a necessity for those with defined return targets, as strong pricing has gradually reduced returns for any given level of risk.
However, this is not without its challenges. Maximising the potential of such real estate typically means taking a more hands-on approach. This may involve re-letting, redevelopment, or some other type of active management where a level of sector expertise is helpful.
The greatest challenge, as always, is to identify those markets that allow investors to sidestep the strongest competition, but which can still offer up compelling opportunities. We believe that the best chance of doing so involves taking a global perspective.
To that end, we have selected a variety of themes and markets that we believe are worthy of consideration by any private investor targeting commercial real estate.
Australia stands out for its remarkable track record of robust growth.
Australia: Getting down to business
Two ways to gain exposure to a growth market
Among developed economies, Australia stands out for its remarkable track record of strong and sustained growth, having escaping the financial crisis largely unscathed and avoided recession for the past 27 years.
This is clearly a supportive backdrop for investment and, indeed, recent years have seen a strong run of growth in Australian commercial markets. Looking ahead, the outlook remains favourable, with strong population and employment growth continuing to create investment opportunities.
The question, then, is how best to tap into this growth potential? After all, many markets have already enjoyed a strong run of growth.
We believe that there is still substantial opportunity, although at this stage in the cycle a more selective approach is needed. In Sydney, the market is experiencing very low vacancy rates and strong rental growth which is creating opportunity in the emerging urban fringes such as Pyrmont, Surry Hills and Alexandria as tenants increasingly seek an alternative to escalating rents in the CBD. Many of these markets offer cutting edge amenities and in time will benefit from public infrastructure improvements.
At the other end of the spectrum, both geographically and in terms of recent performance, is Perth, where the market has been subdued for several years due to a prolonged downturn in mining investment.
However, recent months have seen sentiment improve, with an upturn in tenant demand and prime vacancy now dropping fast. At close to 7%, prime yields are attractive and for investors seeking value with strong upside potential, Perth is now firmly in play.
From co-working to co-living in Hong Kong
Evolving opportunities in the territory’s real-estate landscape
Co-working has taken root in Hong Kong and has already had a noticeable impact on the territory’s office sector. Private investors need to understand this new environment, says Paul Hart, Head of Commercial Property at Knight Frank Greater China.
For example, international operators such as WeWork and Regus and new players such as the Beijing-based Ucommune have all expanded. The latter took 15,000 sq ft of space near Central and 20,000 sq ft in Kowloon during 2018.
In response, a number of property developers and office landlords have converted traditional offices and, in some cases, retail areas, into co-working and co-event spaces.
The Mustard Seed, owned by the Emperor Group, is a case in point. This trend coincides with the findings in Knight Frank’s (Y)our Space report, which finds that even traditional firms are embracing co-working concepts in their real estate planning.
We have also seen Hong Kong-based hotel operator Eaton (part of the Langham Hotels group) create a co-working hybrid, combining a private member’s lounge with workspace.
Meanwhile, Kafnu, an operator newly arrived from India with an extensive South-East Asian footprint, has an enhanced offer that also seeks to incorporate a short-term stay element.
Co-living, meanwhile, is still at a nascent stage. Gaw Capital was one of the first Hong Kong players to experiment with co-living projects including Campus Hong Kong in Tsuen Wan.
Pamfleet recently launched the Nate studio apartments with value-added services in Tsim Sha Tsui. Local Hong Kong co-working operator Campfire is also emerging from the co-working and entertainment spaces with the opening of a 80-bed Campfire Home at Garden Hill in Sham Shui Po.
Co-working has taken root in Hong Kong and is having a noticeable impact.
The UK: Playing the long game
Locking in stability with long-leased assets
As investment horizons lengthen and investors seek ways to diversify their long-term income streams, some (both private and institutional) have taken defensive positions by investing in blue-chip tenanted long-leased real estate assets.
The benefits of long-leased assets are that they traditionally have index- linked, upwards-only rental reviews, often for 20 years or longer. This provides investors with sustainable and predictable income growth during a period where significant further yield compression is looking less likely.
Accessing the market is not always straightforward, however. Private investors have sometimes found it difficult to acquire such assets given the weight of capital (largely from institutions) targeting the same product.
In addition, strong pricing on long-leased core office, retail and logistics buildings has made it harder for these assets to produce the desired returns for private investors.
Nevertheless, opportunities do exist in non-core office and industrial markets, including those assets with lease covenants that are robust, albeit perhaps not quite strong enough for the stringent institutional investor.
Equally, less traditional real estate asset classes such as service stations, healthcare facilities or hotels can provide an attractive income return for private investors and a strong lease covenant that might not otherwise be attainable with an office, retail or logistics asset.
German retail – buy it and they will come
Understanding the sector’s nuances is key to finding value in the retail sector
Given the strength of demand from both domestic and cross-border investors for German core real estate assets, private investors will need to look further up the risk curve in order to gain exposure to this market.
The retail sector may not be the natural first choice, given the current challenges it faces in some countries, and it is true that investor demand has been subdued.
However, the headwinds caused by the growth of e-commerce do not apply to all retail subsectors in equal measure. Supermarkets, for example, have long provided consistent, inflation-linked income for investors with limited downside, thanks to the non-discretionary nature of food spending.
In addition, Germany’s population growth is running at above long-term average rates, and this, combined with improved economic momentum provides a good driver for growth in non-discretionary spending.
The blanket anti-retail approach adopted by some could provide private investors with a good opportunity to acquire long-leased, defensive assets with strong covenants, possibly at a significant discount to an equivalent office or industrial asset.
Mainland Europe: Going Dutch
Seeking opportunities for growth beyond the Netherlands' capital
Economic momentum in mainland Europe is the strongest it has been for a number of years and investor interest has increased as a result.
Germany is the standout performer, with strong economic fundamentals fuelling buoyant occupier markets across the country. However, given the strong pricing levels investors are having to reach to secure assets, some will need to look further afield for stock.
The Netherlands is a market currently in the crosshairs of many institutional investors due to its strong occupier market. Competition for core Amsterdam assets is increasing and investors have to price in strong future rental growth levels in order to secure assets.
Opportunities do however lie in neighbouring Dutch cities such as The Hague and Rotterdam, which are also receiving the knock-on effects of strong economic conditions but which, as yet, have not seen pricing reach the levels of Amsterdam.
This gives private investors an opportunity to secure higher yielding assets that still have the potential to see income growth during a reflationary environment.
Opportunities await in US cities such as Denver.
European logistics: delivering the goods
Tapping into demand for last-kilometre logistics
Due to a combination of investment market momentum and strong underlying fundamentals, the European logistics market has gone from strength to strength since 2010.
Mainland transaction volumes in the sector have increased by a compound annual growth rate of almost 15% since 2010, and the industrial sector now accounts for over 15% of commercial real estate transaction volumes.
Gaining exposure to the growth in e-commerce and the resultant demand for different types of logistics facilities is very much on investors’ radars.
Given the high levels of institutional interest in the sector across mainland Europe, private investors have found it difficult to attain prime assets at prices that allow them to achieve the required rate of return.
One alternative investment strategy for private investors is to target higher-yielding secondary assets in good locations (preferably urban edge) and with strong residual land values, with the long-term plan to convert them into prime ‘last-mile’ logistics facility.
This approach presents two investment opportunities: either undertake an intensive asset management strategy to maintain occupancy and generate rental growth; or manage the existing tenancies in the short to medium term with a view to redeveloping the site into a more modern facility.
The US: (still) the land of investment opportunity
Finding a way into the world’s largest commercial real estate market
Given the strength and depth of the US commercial real estate market, private investors need to be creative in order to avoid competition with the highly capitalised real estate investment trust market. One approach is to seek out investments in suburban or secondary office locations within gateway markets.
These can provide alternative investment options for investors searching for higher yielding investments that still benefit from strong underlying economic fundamentals.
However, if core office locations are a prerequisite, opportunities still lie in cities such as Denver, Phoenix and Austin where occupier markets have been slower to hit the expansion phase.
Outside the office sector, the industrial and multi-family sectors remain buoyant across the country. Competition in gateway cities for multi-family assets has pushed investors to less established markets, where there is nevertheless still some strong growth potential.
Pricing in the industrial sector remains strong as investor demand persists. Nevertheless, opportunities for private investors still lie within the smaller industrial niche sectors like data centres, which should continue to benefit from the strong underlying long-term fundamentals driving the subsector.