Value-added real estate investment will be the engine of returns as the macro environment remains unpredictable and debt providers exert caution, according to a panel of executives at the ULI’s United Kingdom (U.K.) conference in May.
James Rosenfeld, managing director, Blackstone, who focuses on the private equity giant’s U.K. acquisitions told the audience: “Since 2016 there has been a sizeable macroeconomic challenge in the U.K., so we are used to it. You can’t control macro events but you can focus your investment activity. So we are focusing on neighborhoods we think are going to be growth areas.”
Fellow speaker Kirsty Wilman, chief operating officer, real estate, Federated Hermes, agreed, reporting that the U.S. investment manager was “trying not to panic at what feels like crisis after crisis,” adding: “We have seen a lot of inaction in the wider market, where there is fear of making a decision. But [it is important] to try not to get caught up in that, to go back to the fundamentals of property and actually add value as an investor—understand what a location needs to drive occupier demand.”
Wilman said delivering a building that “served the communities around it” was critical to generating attractive returns: “There is much more value being placed on how real estate sits within a wider community. Those that are thinking more broadly like this will emerge as the winners [in this environment]”.
She added that in order to ensure real estate appealed to institutional investors there was no point in “just delivering bland returns” because the real estate investment market was still reeling from the impact on pension funds of U.K.’s “mini-budget”, which precipitated turmoil on the financial markets.
“Money that would have been coming into real estate during the first quarter of this year didn’t, it was the lowest [level] of new investment for many years,” Wilman said. “There are other asset classes that are delivering more stable, higher returns. This means real estate needs to deliver high returns—through redevelopment opportunities, for instance.”
Michael Kovacs, partner, Castleforge, added investors able to do “hard things that other people can’t do” would be rewarded. He said: “Can you refurbish an asset? Can you create a high yielding income stream? Can you have your own integrated development asset management team? And also, can you operate the real estate … becoming real estate 3.0.”
Castleforge is applying this strategy to the U.K. regional office sector, he told the audience, as it focuses on delivering workplaces that understood how buildings should make workers “feel”, adding that occupiers were attracted to buildings that were in the right location, offered affordable lunch options and amenities.
“This is why we’ve seen double digit rental growth in some of our office properties last year and this isn’t even in central London—but in Manchester and Glasgow, for instance. So it is having the ability to see through the negativity and look for where the market could be getting in wrong,” he explained.
Rosenfeld said that the U.S. mega manager, which in April raised $30.4 billion for its largest ever real estate fund to date, agreed that operating real estate was a critical aspect of value-add investment today: “So much more real estate is becoming about operating a business. We definitely see that a lot.”
He added that the company found the U.K. to be an easier place to undertake operational real estate investment relative to other countries in Europe, due to its established student accommodation and residential sector. The U.K.’s “supportive regulatory framework” also meant it was possible for investors “to quickly navigate a changing environment.”
Driving Higher Returns
Rosenfeld, who reported that Blackstone was witnessing “exciting” levels of interest in U.K. real estate from institutional investors from Asia Pacific, said it was “really important” to demonstrate to these would-be fund investors a strategic focus on logistics, residential, life sciences, travel and leisure. The majority of Blackstone’s investment activities in the present market, he confirmed, were focused on such sectors.
He added that successful fundraising in this current environment required managers to demonstrate they were not “wedded to what was the orthodoxy in the past”. Rosenfeld said that Blackstone had quickly pivoted its portfolio away from the office sector in recent years. “Today, offices are less that two percent of our portfolio. Fifteen years ago, it was about 50 percent.”
Michael Kovacs, partner, Castleforge, said there was an increasing opportunity for private equity firms to provide debt for a market in which traditional bank lenders were shying away from the sector: “A lot of [limited partners] are wondering about real estate private credit strategies,” he said.
“There are a lot of mezzanine situations, rescue capital situations [available], to lend to somebody that has borrowed against an asset that really had no longevity of income but had worked until now because of cheap finance, and now both of those in the reverse polarity year now at, hey, you can get 15 percent [return].”
From a borrower’s perspective, however, lack of debt capital is responsible for low levels of investment transactions, said Wilman.
Global investment volumes, according to the latest data from MSCI and RCA, declined by 50 percent compared during the first quarter of the year compared with the same period in 2022.
Wilman said Federated Hermes had seen “a lot of lenders going back to core clients” and added this was creating an unreliable lending environment for borrowers, whereby it was difficult to complete deals if using debt.
“You can find yourself in a situation halfway through a transaction where the debt provider changes its mind or changes the rate,” she said.
Wilman added: “This is why there isn’t as much investment volume at the moment, and it looks like it might remain that way for a while until the banks get more confidence.”