Why multi-let assets are the future of institutional real estate investment
25 April 2019
How would most people typify the real estate assets that institutional investors are most eager to invest in? Up to now, the answer would probably have been large buildings let to a single tenant—such as a major bank—on a 30-year lease. A couple of years hence, the response might be very different.
Why? Because across the commercial real estate industry, we’re seeing a significant shift away from single-tenant to multi-tenant occupancy. In our view, it isn’t going to stop. And it’s a change whose implications investors haven’t yet fully taken on board - partly because it’s just one of a number of parallel yet interconnected shifts under way in the market.
Demand for shorter leases and greater flexibility…
Among these shifts, one of the clearest is rising demand for shorter leases: in our Emerging Trends in Real Estate: Europe 2019 study, some 57% of the 885 real asset professionals we interviewed believed that shorter leases would have the greatest impact on real estate strategy over the next three to five years. And 71% said they thought occupiers would continue to want shorter leases and greater flexibility.
Indeed, the demand for more flexible buildings is another key shift. One manifestation of this is the increasing role being played by serviced operators such as WeWork, The Office Group and IWG. Another is the growing pressure on landlords to provide additional “wellbeing” focused amenities such as gyms, cycle racks and social areas. A third is the rising demand for occupiers to have sensors and analytics embedded into buildings so they can be flexed with users’ needs.
…under the impact of multiple drivers
What’s driving these changes? In terms of the shift towards shorter leases, an immediate contributory factor is the introduction of the new lease accounting standard in IFRS16, making shorter leases more attractive to occupiers. Occupiers are considering their own vs lease strategy; resulting in building buy-backs (of some single occupancy assets) - or enhanced volumes of income strip style financing leases. But there are also much more fundamental long-term social and employment forces at play.
Perhaps the most powerful is the changing nature of work and jobs. While PwC’s Workforce of the Future study sets out several different scenarios, the clear direction of travel is towards a more contingent workforce and the continued rise of the gig economy. Of 10,000 people surveyed for the report, 60% think “few people will have stable, long-term employment in the future”.
A less obvious but more significant shift, is the transition towards more ‘agile’ working lifestyles for the workforce in full-time employment. In effect, the workforce is becoming more dispersed and less tethered to the corporate head office - whether that’s because they embrace more days working from home or indeed from any other mix of convenient locations which brings the benefits of avoiding time wasted commuting or any ‘lifestyle’ benefits.
All of the above point to a future where occupiers and property operators will need to work harder to provide better, more appealing workplaces. Occupiers will increasingly favour more amenity-rich, dynamic, flexible property solutions - including ‘core and flex’ offerings, mixed-use and multi-tenanted buildings.
Implications for investors
So we’re heading for a market characterised by shorter leases, more flexibility and more multi-let assets. What does all this mean for investors? In many ways it’s positive: an asset with diverse shorter-term tenants spread across different floors can provide a more sustainable and lower-risk income than a single-tenant building on a long lease. But to adjust to such a market, investors need to make several changes to what they do and how they do it—including updating their investment and valuation criteria and the way they design new funds.
They’ll also need to reshape their teams to enable more active management of assets—a point also highlighted in our blog on operational focus. Partly as a result, fees may also have to rise: charging 60 to 75 basis points may not be enough to fund the skills and workload involved in moving from a passive asset management stance to an active one.
However, the biggest worry for investors may be what effect all these shifts might have on yields and valuations. True, it’s hard to be certain about these. But experience in France suggest that a multi-tenant asset on a three-year lease can yield the same as a 30-year single-let one. So as the UK shifts towards a more continental European-style real estate model, the effect on yields may be negligible.
Overall, the message from occupiers is loud and clear: shorter leases, more flexibility, and a move towards multi-tenant. Investors need to listen. Because it’ll actually be in their interests to do so.