Beyond the property cycle, new megatrends are changing the game
Interview with Samy Bchir, Chief Investment Officer at Sienna Real Estate, to Agefi, France.
The Pandemic, then the sharp rebound in interest rates and geopolitical & economic uncertainties have reshuffled the cards on the real estate markets. How do you analyze the new emerging trends?
The pandemic has caused significant disruptions in real estate markets, but also accelerated new megatrends, which have an important influence on the markets: the acceleration of remote working and the development of e-commerce, for example. These new megatrends, combined with the risks associated with traditional commercial real estate sectors, such as office and retail, have changed the perspective of institutional investors. With a view to diversification, interest has focused primarily on logistics, which has benefited from very strong momentum since the lockdowns. Its potential remains particularly strong in southern European countries, where e-commerce has very low penetration rates compared to the United States and the United Kingdom. The pandemic has also highlighted the need to invest in the healthcare sector and increase exposure to the residential sector.
Heightened uncertainties and risks, driven by recent events and combined with a sharp increase in financing costs, made institutional investors more cautious and generated more pressure on returns, but also increased the desire for geographical diversification. Sienna Real Estate, which operates in 8 European offices, experienced in the last months a high demand in new geographies.
Sienna Real Estate is particularly present in the office segment. How is the demand evolving?
With the renewed emphasis on centrality, companies tend to favor locations in CBD locations or well-established business districts. We have been observing this trend for several months, for example in Paris, where companies are leaving sub-markets such as Issy les Moulineaux or La Défense to go to the heart of Paris, while significantly downsizing their let area.
As a result, these markets are very tight, because if the demand is strong, there are very few offers, and the vacancy rate is less than 3%. Conversely, neighbourhoods far from the center are neglected. For example, the vacancy rate exceeds 20% in the peripheral markets at La Défense. We can see the same movements in all European countries, where certain neighbourhoods are deserted in favor of other more central ones.
A second selective factor is ESG. Indeed, the tenants’ CSR policy encourages them to look for buildings with the best environmental labels. More generally, the awareness by all players of the importance of an environmental and social approach has created a duality, by removing buildings that are obsolete or not up to standard from the market. Sienna Real Estate also has a responsible investor approach, both by acting on the environmental dimension of buildings (for example, by improving the insulation of buildings and optimizing electricity consumption) and by taking account of social criteria.
Are these phenomena also observed in the United States?
The situation is quite different in the United States. Vacancy rates are very high. Office occupancy has dropped by 70% since the pre-Covid period. For example, the vacancy rate in San Francisco has exceeded 30% today, compared to a level below 5% before the pandemic. As a result, American investors are very reluctant to invest in the office market, including in Europe, because they are convinced that this phenomenon will also prevail there. This reluctance has a strong impact on the European office market, given the heavy weight of American investors, particularly in large transactions.
What lessons do you draw from these developments for your own strategy in the office market?
We remain convinced of the potential of the office market. This full-time telecommuting trend is also starting to reverse with companies like Google asking their employees to return to the office to transition to a more hybrid work arrangement. If the hybrid model, with at least one day of teleworking, is established over time, we do not anticipate that the offices will be gradually deserted – quite the contrary. Sienna Real Estate continues to focus on this market, attaching major importance to location and favoring buildings with services likely to make a company attractive to its employees. In addition, we are also in a process of diversification on asset classes that benefit from long-term market trends, for example, logistics or healthcare assets.
Are real estate markets at an inflection point and, as a result, how will valuations and yields go?
While interest rates are returning to their historical average, the pace of the rise in key rates that we have experienced over the past 12 months has been incredibly fierce (9 successive increases, equalling 375 basis points). This change disrupted the financial markets in general and the real estate markets in particular. In fact, we are witnessing a rebalancing of appraisal values due to a sharp rise in the cost of debt and changes in allocation with a greater appetite for fixed-income products.
The real estate market remains suspended on the evolution of interest rates. We see in this repricing of real estate assets, an opportunity to invest at very attractive price levels, particularly in the United Kingdom, where asset prices have fallen the most in Europe. We are not in a bottom fishing strategy, because it is quite difficult to predict the low point. Nevertheless, with investment discipline, focusing on buoyant asset classes, prudent valuation models, quality locations and giving ESG a central place, we are beginning to see very attractive opportunities in the current market.