Michael Dembinski talks to Mike Strong, Executive Chairman of CBRE for EMEA
These are challenging times for investors. Interest rates are at a historic low, stock markets are underperforming, government bond yield rates are flat and emerging-market growth is evaporating.
So are investors choosing to move into real estate as an asset class? Mike Strong, Executive Chairman of CBRE for EMEA, says that this is the case. “There has been a readjustment in the total invested universe, something like a 1% shift in weighting towards real estate – though as you can imagine, that 1% is a very large number,” he said.
“Volumes were last at this level back in 2006-2007, but then a large amount of it was funded by debt. Bank leveraging was heavy and widespread. This led to a development boom,” said Mr Strong. The results of that debt-fuelled boom could be seen in countries like Ireland and Spain – developments standing unfinished for many years. “There’s nothing like those levels of debt leverage this time. The market is better funded,” he said. “The yield gap between a 10-year treasury bond and well-positioned real estate with a solid rental income has never been as great, it’s currently around three to four percent above the risk-free rate.”
“More equity is currently aimed at real estate than has ever been seen – more than in the previous peak in 2007. It is coming from multiple sources – China, the Pacific Rim, the Middle East, Europe – although the ‘New Europe’ is not so prominent – and Norway. Most Sovereign Wealth Funds are present in real estate markets, many having entered only four-five years ago; traditionally SWFs have invested in bonds, equities and cash. We’ve also seen the Canadian pension funds very active in real estate over the past four-five years. Greater diversity of investors, with a deep pool of equity. They don’t need to leverage when buying.”
We go into greater detail. Which sector of real estate attracts the most investment? “By value the biggest component is still offices,” says Mr Strong. “There are a number of dynamics converging. Supply of new, high-quality office space is at a very low level in absolute terms. And what are the occupiers doing? They’re using floor space more efficiently and flexibly. People are still the biggest cost for business; attracting and retaining the best talent is the biggest challenge. The trend is less space per head in the best-quality buildings. And the focus is on prime property – there’s not much about, tenants are chasing it. At the same time, less-than-prime space on the peripheries of cities is being turned into residential and being adapted for other uses. Landlords in such areas need to do something or lose tenants to better quality, better located property.”
Corporates have always been big drivers of trends in commercial real estate. But there are new players entering the market – tech start-ups in cities like London and New York. “Tech start-ups have different occupational needs,” said Mr Strong. “They tend to cluster around the outer ring of the city’s Central Business District (CBD). Start-ups don’t feel comfortable with big corporate neighbours. The model we’ve seen from the 1970s and 1990s – business parks custom-built on the edge of town, the US model – is coming to an end. Google is into the heart of the city. Predictions that everyone would work from home have proved far-fetched. Young employees want to socialise and work in an interesting environment.” And not only employees. Yahoo!’s CEO, Marissa Mayer, stopped home working in February 2013, to improve collaboration, internal communication and the speed and quality of work.
In the tech world, chance meetings and conversations can spark new creative ideas. For Google, the coffee machine is a key office installation. In today’s war for talent, the quality of the working conditions determine whether an employer holds on to the best people. “New users want vibrancy of workplace. They like the new ways of working; the cellular office is outdated. Employers are seeking to provide the best environment for everyone.”
These trends affect everyone. “Investors and developers need to enhance, not restrict. This flexibility is not limited to the lease terms; everything has to be flexible – new fit-out, private rooms for quiet work, co-working environment,” said Mr Strong
Retail property trends are also changing along with our cities. The biggest game-changer has been the rapid development of e-commerce. “It’s a small- to medium-sized revolution. There are clear trends. The best malls have prospered, even though the economic environment has been rocky. In Europe, there’s been a strengthened trend for destination and experience shopping – food and entertainment along with retail. The best malls have tenants waiting – leisure, retail, food courts. They are going up-market, with fine dining and art galleries. This is good for consumers and tenants,” said Mr Strong. A similar picture has emerged with the high streets. “The very best high streets have maintained their positions or have even strengthened. As for the rest – it’s too early to say.”
We talk about the challenges that e-commerce has brought to retailing. Mr Strong points out that there have been hiccups along the way. “The issue of the last kilometre – distribution to the consumer remains a problem. The complexity of deliveries and returns of faulty goods cause massive logistics problems for online shops. It looks like there’s a second level of retailing taking shape, with the biggest players in e-commerce looking to open physical shops, so they can get closer to the consumer. But it’s too early to say if there’s a clear trend there. And pop-up stores are appearing to fill the gaps, another new trend we’ve noticed.”
Food retailing is also undergoing change. The growth in building edge-of-town hypermarkets is clearly slowing. “Retailers are coming to neighbourhood retailing – this is where we see massive expansion. And it’s affecting the shape of our cities. In London, New York, Paris or Berlin, car usage has been dropping progressively. Citizens are turning to bicycles and public transport, moving away from cars. They don’t have to worry about car parking-space angst. They want to be near cinema, sports, fitness, theatre, art galleries,” says Mr Strong.
“City centres are giving over less space for parking, broadening pavements. And public transport is being prioritised. Without good connections, even the best building with the lowest rent is not going to fly. The young want to live near their workplace. I go back to the war for talent – short commuting time is shown in survey after survey as being more important than a higher salary. There’s a cycling revolution going on. Cities are following the examples set by Holland and Denmark in providing safe, segregated cycle paths. London’s Cycle Superhighway will be an excellent facility. This is a trend that’s coming globally. The old trend to move out into the ever-more distant suburbs has been reversed, people are living closer and closer, ideally within walking distance to their place of work, which ideally is situated in the city centre,” he says.
Today’s city dwellers “don’t want to waste a single minute of their time,” says Mr Strong. This leads to an exceptionally dynamic, well-balanced mix of office, leisure facilities in a prime city location. Cities are being more lived in cities – Paris, he believes, shows the way forward, as opposed to the City of London which still has low levels of residential occupancy. Optimising cities for 27/7 living, working, shopping and relaxing will inevitably push up property values; investors are sensing this.
In manufacturing another big trend is being reversed – to move offshore, to the Far East, but now manufacturing trend is to bring it back. Smaller batches, mass customisation, and new technologies such as 3D printing will bring manufacturing back, nearer to the consumer, as well as higher social and environmental awareness. This – along with the warehousing implications of this shift – will inevitably have some impact on the real estate market.
Mr Strong also talked about CBRE as an employer in Poland. “As well as the 250 staff we have advising clients, who are working here in Rondo ONZ 1 in Warsaw, we employ a further 600 people in our GBS (Global Business Services) outsourcing hub in Służewiec. This is working exceptionally well for us.