European alternatives: A slow burner destined for a big future
In Europe, the evolution of new property types, also called alternative sectors, have tended to lag behind the U.S., as Europe’s range of legal and tax systems, capital markets, currencies and city planning regimes make it much harder to implement strategies across borders. Consider the great variety of building designs across countries, which is in stark contrast to the relative homogeneity of shopping malls, apartment blocks or offices in the U.S.
A slow start
Globalisation is a great leveller as business models, designs and demand characteristics tend to converge over time. However, the familiar challenge of Europe’s diversity arises every time a new institutional asset class emerges. Senior living, for example, comes in many shapes and forms depending on each countries’, or even regions’, healthcare and pension systems. Single family rentals face an array of diverging factors, such as household preferences, planning constraints, demographics and, most importantly, rental market legislation in each country or even each city. It seems, at least initially, a one-size-fits-all approach in Europe is likely to fail for new property types.
The hurdles are as high as ever for some new market contenders despite the solid tailwinds of ample supply of capital, favourable demographic shifts and global technology advances. But some currently considered alternative property types will eventually develop into a widely accepted pan-European asset class.
Accelerating or decelerating?
Faster progress can be expected in the data centre sector. Building characteristics are determined by global technology standards with minimal local variety. They are, however, likely to remain a niche sector because of the large lot sizes required, technology’s daunting obsolescence risks and the limited depth of the tenant base.
Healthcare, affordable housing and senior living options face the largest hurdles for European integration despite strong support from demographic trends. Not only do consumer preferences differ widely, investors also have to navigate highly complex local webs of subsidies and regulations. In this area, European integration is likely to remain incomplete.
Technology-driven self-storage lends itself well to international business models, but consolidation will likely take time. A plethora of national and regional players are on track to gain scale in their domestic markets, which may propel them to soon vie for international pole position.
A similar path for building scale and international market share could emerge for alternative housing models (e.g. micro apartments, student homes and co-living), office off-shoots such as life science buildings, and infrastructure relatives, such as service stations or car parks. However, like hotels, these building types are closely linked to operators. Investors will have the opportunity to play an active role in the development of international operator chains. But it will take many years for these to mature, while investment markets will remain thin and noticeably local in nature.
A bigger slice of portfolios
The moderating effect of Europe’s fragmented markets should not distract from the sizeable opportunity emerging over the coming decade. Nuveen estimates that the market share of alternatives in diversified portfolios will climb to 12%-20% in a decade from now. This translates to a significant chunk of the roughly €280 billion annually invested in European real estate.
This growth expectation is less optimistic than it may seem, because many existing alternative assets are not yet classified as such in transaction data. Only once new sectors have reached critical mass, do they start to split from related property types. In the U.S., medical offices have grown into a distinct alternative and are no longer mixed in with offices. In the same vein, logistics has morphed into a well-defined sector dominating the broader industrial category. The projected growth in alternatives is therefore as much the result of differentiation of traditional real estate as it is the creation of something genuinely new.