In their recent Real Assets Viewpoint report, the APAC research team at BlackRock Real Assets laid out their thoughts on the state of the real estate market and gave an update on their APAC investment thesis.
The report identified which real estate sectors have performed best and worst and how they might perform going forward in a world reshaped forever by the traumatic events of 2020.
As APAC seems to be emerging from the crisis faster than the rest of the world, albeit with a very cautious eye on potential reinfection, the BlackRock team ask whether investors should focus on finding ‘NEMO’ (New Era Market Opportunities) or finding ‘DORY’ (Dependable Occupancy, Rents and Yields)?
COVID-19: Finding Nemo and Dory
With the pandemic starting to be contained in Asia while continuing to spread in other parts of the world, BlackRock expects economic and market recoveries to diverge significantly in the second half of 2020.
Given that the recovery in real asset prices may take time to realise, the report suggests that this could be a good time for investors to ready capital to take advantage of the next upswing.
Inspired by Pixar’s aquatic odyssey, the report asks whether investors should be finding NEMO or finding DORY.
NEMO stands for new era market opportunities, created by structural changes driven by demand for distance working, online shopping and the COVID-driven digital revolution. These include logistics, data centres, digital upgrades and facilities with lower density usage.
DORY stands for dependable occupants, rents and yields and includes sectors with cyclical resilience. Residential, for example, has held up relatively well with multifamily seen by BlackRock as a sector that has retained its defensive credentials with resilient incomes.
APAC’s growing importance in driving global growth
BlackRock notes that at a macroeconomic level, the structural growth dynamics for the APAC region, which include robust population growth, rising productivity and improving incomes, are still very much intact. The APAC region is a key global growth driver, even with the downgrades of 2020. According to figures sourced from Oxford Economics, July 2020, current APAC growth expectations are 2½ times that of the US and 4½ times that of the eurozone.
According to the report, firmer growth is historically strongly correlated to occupancy demand growth, rental income growth and total returns. Good news for APAC, it would seem.
Entry price is key
The BlackRock team stresses that whichever strategy investors pursue, price is the key. Prices have softened during the pandemic and value opportunities have emerged. However, amid a downturn, pricing is uncertain and moving every day, making it a challenge to pick the right entry price for each market or to time market entry.
In addition, the risk of further lockdowns is always present. While government authorities across the APAC region have been relatively successful at containing infections, the report admits that a circular pattern of outbreak, response and containment may be the default course for the foreseeable future, at least until a working vaccine is deployed.
To help with market timing BlackRock have performed some modelling analysis on yields across key cities in APAC, showing a near-term softening before a firming due to rebound in activity and low interest rates.
When searching for opportunities across APAC, the report stresses the importance of considering the clear divergent trends for COVID cases, economic indicators and pricing adjustments and how they will affect markets to varying degrees over both the short-term and longer-term horizons.
As to whether investors should find NEMO or find DORY, the report suggests a bit of both.
Digging deeper into the sectors the report makes the following insights…
Office has experienced a clear demand reduction in 2020, but beyond 2021 the outlook is more ambiguous. Neither employees nor employers seem to be sure as to what they will do post-COVID, with questions over productivity vs rental savings vs work-life balance untested over the long-term. If there is a move from dense, inner-city, static fitouts to sparser, multi-functional hubs in suburban locations, rental growth will likely be constrained and any moves will likely take time, considerable refurbishment expertise and value-add capital to realise.
The report sees an even more troubled outlook for retail with structural headwinds strengthening. Recessionary pull-back in spending aside, periodic returns to lockdown may tip more retail categories into a downward spiral. Revenues and profitability would be hit as foot traffic diminishes, insurers withdraw trade credit protection, inventory range narrows and social distancing requirements increase. While the report highlights some at-risk categories, such as department stores, restaurants, cinemas, gyms, salons and tourist-related entertainment, the report also sees some bright spots in the retail space. Groceries, pharmaceuticals and home office equipment have, in fact, seen a boom. The report suggests that some landlords may change to larger formats to include more space, drive-thru pick-up and last-mile delivery, all of which may be at lower-than-before rents.
While industrial has received a boost from e-commerce, traditional retailers still take up a significant share of warehouse space, although the report suggests that this may slowly be supplanted by fast-growing pureplay logistics providers. The report stresses that in the fast-growing logistics market finding the right undersupplied location remains crucial. The report also saw potential opportunities driven by bio-security, withinnovative uses of warehousing space emerging, such as hydroponic farms (full of vegetables), dark warehouses (full of robots) and dark kitchens (free of diners).
The report does not have much to say about hospitality other than that travel restrictions continue to weigh heavily on the sector, with distress mounting and no imminent turning point in sight.
The report instead favours multifamily, where the sector retains its defensive credentials with resilient incomes.
Data centres, also are seen as promising, with continuing growth in demand, driven by the increase in working, schooling and entertaining from home.
In conclusion, the report’s authors stress that given these differentiated markets, the entry price is key and that even the most challenged sector can work if the price is right. The report ends with a handy chart based on anecdotal reports from their local investment sourcing teams showing buyer expectations vs pricing adjustments.
But in the end the report leaves the investors to make their own decision about market entry. The report concludes with a series of questions that investors must ask themselves, “What is the required entry price window(expressed as a discount to 2019 asking prices)? Which sector and which region warrants a higher threshold? What is the real-time adjustment in price we should look to realise in sourcing potential pipeline assets (in impaired assets, as opposed to well-stabilised yielding assets)?”
We look forward to seeing how these predictions and ideas play out.