Why global change could yield opportunities for real estate investors

As featured in Preqin’s global real estate report, Melissa Reagen, Head of Americas Real Estate Research at Nuveen, discusses why amid uncertainty real estate will play a key role in investor portfolios as the industry adapts.

Q: After the extraordinary events of 2020, what are your views on the viability of real estate as an asset class today?

Numerous economic scenarios could arise in 2021 and the implications for real estate from each potential outcome are varied, so trying to peer into a crystal ball is ineffective. Real estate is facing a K-shaped recovery: certain property types, such as warehouses, life sciences, single-family rentals, and self-storage are facing rising values and rents, while other property types, such as malls and lodging, are facing plummeting values and rents. Still, the current spread between direct real estate cap rates and corporate bond yields is well above the historical average – signalling real estate’s strong relative value. 

The pandemic has not caused a paradigm shift for real estate, but has accelerated already-present underlying trends. For example, we expect to continue to see strong e-commerce retail sales, more of a movement to the Sunbelt cities in the southern parts of the U.S., and an increasingly digital economy. Most of us who have endured previous cycles remain optimistic and believe that new opportunities emerging from current circumstances will strengthen portfolios in the long run. Agility and insight into tomorrow’s world are the two qualities I believe are most critical for managers and investors today.

Q: What opportunities do you believe will prove the most attractive?

We believe there will be opportunities to acquire real estate assets at attractive prices as the pandemic endures. And we expect that the alternative property sectors are likely to become a mainstay in institutional investors’ portfolios during the next decade. Currently, most institutional investors, according to NFI-ODCE, have less than 15% exposure to the alternative property types. I suspect that to shift closer to a 50% allocation within the next decade. 

Property types that can generate superior net operating income (NOI) growth are going to play a significant role and will dovetail with trends being driven by the pandemic: a continued shift toward renting, a transformation of the US healthcare system, and a rise in the digital economy. Specifically, medical office, senior housing development, self-storage, data centres, life sciences, and single-family rentals are the alternative subsectors we are currently focused on because their fundamental drivers are less tied to the economic factors that are so uncertain right now.

Q: But with institutional investors already deeply embedded in primary sectors like office and retail, how should they manage the portfolios they own today?

Office and retail are certainly experiencing unprecedented challenges, yet they were under pressure to evolve pre-pandemic. I don’t doubt the viability of these sectors in the future – it just may come down to the asset level and be a survival of the fittest scenario, making property management, technology, and competitive insights more crucial than ever. For instance, our office strategy embraces the growing demand for more flexible space and the wellbeing and health of the occupants. With retail, we are repositioning assets that can remain relevant and seeking to repurpose others. 

An ideal portfolio today is a defensive portfolio, with long-term leases and high occupancy rates, along with low leverage to cushion volatility and downside risk. And yes, portfolios will need to shift over time to better balance retail and office exposure and avoid or limit exposure to hospitality, gaming, or leisure.