School’s out
The idea that summer is for play, not work, seems hard to shake for many Europeans. The habit is especially ingrained in old manufacturing sectors. Until the 1980’s, Volkswagen chartered trains at the start of summer break to move thousands of Italian workers from its plants in Wolfsburg, which turned into a ghost town, to their homes in Italy. One reason for doing so, was an assembly line does not function very well without a full complement of workers, so it makes sense from all to take time off together. It was also a good opportunity to perform any maintenance or upgrades on the factory floor. Yet despite, or perhaps because of, their leisure seeking ways, Europeans are the most productive workers in the world. As we approach the summer, we thought it a good occasion to take stock and consider which European city would qualify for investment come autumn.
In the short-term, investment volumes are expected to be impacted by the rise in long-term interest rates. Brookfield report that the market is set to cool in the ‘new paradigm’ of rising rates and a global economy in turmoil with stress likely as investors come to refinance their debt. The Head of logistics at BNP Paribas Christopher Raabe concurs with a correction in yields but is confident in continued occupier demand. LBBW are concerned about the economy, suggesting that Germany is "just a blink of an eye away from a recession".
However, there is plenty of capital sloshing around in the system. Manulife state that 49% of insurers and 37% of pension funds expected to increase their allocation to real asset strategies. These institutional investors have long valued real estate for its diversification characteristics but now it is also a natural fit for investors wishing to put their capital to work in the drive for net-zero.
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A survey of market sentiment by Hodes Weill & Associates into institutional investor appetite in Europe identified population trends and economic development as factors that continue to push investors towards residential and logistics. Capital is also going to be required to deal with the changes to how people live and work in cities, with CMS reporting that almost a third of real estate is earmarked for conversion – with retail and offices to housing the most popular choices. Chicago-based fund manager Harrison Street are following the sector preferences in Europe that emerged in the U.S., raising ￡675m of equity for a fund that will invest in life sciences, student housing and build-to-rent. European chief executive Paul Bashir told PERE that in each of the sectors in which Harrison Street invests in Europe, the maturity of the market is about six to eight years behind the U.S. For example, one U.S. trend is the relocation of Wall Street firms to Florida as employees gravitate toward its warm weather and lack of state income tax. Office leasing is reported to be gaining momentum as banks, private equity firms and hedge funds looking to bolster their presence in the region. The latest announcement is from Ken Griffin the billionaire founder of Citadel pledging to build a pristine office tower in Miami with developer Sterling Bay that will serve as the global headquarters of his hedge fund and market maker.
Turning to Europe: should investors follow the weather, the tax regime or the demographics? AustralianSuper, which plans to invest a further ￡23bn into UK and Europe and already holds investments like Heathrow, Peel Ports and the King's Cross redevelopment, identified “deep pools of high-quality talent, a stable and reliable legal and regulatory environment and many like-minded partners with whom to work. There is also a strong cultural fit.” Nuveen helpfully created the Scale-Adjusted Metropolitan Indicator (SAMI) to rank cities. Heretofore, the usual ways of doing so came with fundamental flaws, all too often absolute variables are used with the predictable result that the biggest cities lead the pack. “Absolute comparisons and per capita measures miss that cities’ urban socioeconomic indicators scale with population along super linear power laws with exponents of about 1.15. This means larger cities are disproportionally producing good things like innovation, wealth and art, but on the flip side also disproportionally of negative effect such as crime, health problems or pollution. There are two reasons why cities scale super linearly or have an ever-increasing edge the bigger they are: Firstly, cities enjoy economies of scale with regards to infrastructure. For example, if a city population doubles, the road network does not need to double as well but only grow by roughly 85%. More importantly, however, cities benefit from social network effects. With the number of people increasing the connections between people grow exponentially. That is the effect which leads to disproportionally more innovation and ultimately wealth the bigger a city gets. This network booster is behind the success of extraordinary tech clusters like Silicon Valley or the innovative power of mega cities like Tokyo.”
In the Nuveen SAMI rankings, London is not the top location in the UK, although Paris is in France. The presence of top UK universities in Edinburgh, Cambridge and Oxford might explain this disparity, with Paris based universities dominating French academia. This analysis might explain the increased allocation to regional cities by Grosvenor, the London centric landlord – to diversify its portfolio away from central London with two further purchases in Bristol. City selection may also have more importance in the UK than in France, with Nuveen reporting that UK cities include some notable out-performers but also a number of ‘left-behinds’. Whilst French cities achieve a greater degree of egality, with no out-performers. Whilst large cities like Munich, Düsseldorf, Paris, Lyon, Edinburgh seem to have benefitted from the super-power laws; Birmingham, Dortmund or Marseille have not. Birmingham might remain the UKs second city but CMS’s survey (Repurposing Real Estate: The future of the world’s towns and cities) continue to rank Manchester as more appealing for real estate investment purposes.
Dan Rogers of Peakon, a consultancy, thinks the dip in employee productivity over holiday periods could be a good reason to accept the European summer. Whilst the U.S. is often perceived to be ahead of the curve, there are compelling reason to be positive on Europe. Commercial real estate investment volumes reached €80bn in Q1’22, up 31% on Q1’21; European banks have limited direct exposure to events in Ukraine and Russia and the average bank's NPL ratio across the European Economic Area fell from 2.5% to 2% in 2021, according to the EBA and quoted by White & Case. Richard Haass, President on the Council of Foreign Relations in his book ‘The World’ questions whether “Europe’s best days are behind it”, perhaps Europe’s slight investment lag is actually an opportunity? This week beckons data updates on US CPI, retail sales, consumer sentiment; China IP, GDP and retail sales; as well as UK GDP. Irrespective of the results, many real estate investors are looking to reset this summer.?