2021 Outlook: UBS sees European retail and offices still attracting high-risk capital

Market disruption caused by the pandemic will create value-add and opportunistic investment opportunities in the two sectors, according to the Swiss investment bank.

The market correction and fall in real estate values triggered by the covid-19 outbreak, coupled with low interest rates and debt costs, will create a window of higher return investing opportunities in the coming years. That buying window will include office and retail investments, two of real estate’s most challenged sectors in the current environment, according to a white paper published by UBS Asset Management’s real estate research and private markets group.

The investment potential in the office sector, despite the structural shift towards remote working, is driven by fundamentals. As Fergus Hicks, real estate market strategist at UBS Asset Management, pointed out in the paper, the supply of grade A offices in many European markets is at extremely low levels, while development pipelines are also expected to “remain subdued for the foreseeable future.” Grade A office vacancy in the second quarter was a little over 2 percent in cities like Frankfurt, Madrid, Milan and Manchester, while Paris and London recorded less than 1 percent vacancy.

“This presents an opportunity to acquire value-add assets in strong locations at a discount, driven by weak sentiment towards assets with short-dated income,” Hicks said. “Once vacant possession has been achieved, these assets can be repurposed to create office space environments to match the changing occupier requirements we expect to see in the post-covid-19 world.”

Indeed, dealflow is picking up in the sector. The second quarter of 2020 was the weakest quarter on record for central London office transactions, with only 10 properties changing hands, according to data provider Real Capital Analytics. Since then, however, several transactions have been announced, including Hong Kong-based Lifestyle International’s £250 million ($332 million; €272 million) purchase of bp’s headquarters at 1-2 St James Square and Singapore-listed Suntec Group’s acquisition of a 50 percent stake in the Nova Victoria development project from Canada Pension Plan Investment Board for £430 million.

Meanwhile, the retail sector has seen a significant decline in transaction volumes. In the third quarter, $6.7 billion-worth of retail transactions were completed in Europe, a 40 percent year-on-year drop. For UBS Asset Management, the opportunity lies in acquiring retail assets with the intention of converting them to alternative uses. Earlier this month, M&G Real Estate reportedly sold a 230,000-square-foot Debenhams department store in the UK for £20 million to developer Native Land. The developer’s repositioning strategy for the asset includes developing homes for sale and rent, as well as mixed-use retail and commercial.

“Many of these conversion strategies are centered on the idea of densification, with retail not being removed entirely, but the space being utilized more efficiently by combining it with other uses, typically residential and leisure,” Hicks said in the paper. “This is a compelling opportunity for investors since it has the benefit of offering an initial income, and also the reconfiguration of the structure is not very expensive in terms of capex.”