Real estate faces ‘acceleration of obsolescence’

Existing assets are becoming a growing concern for private real estate’s largest investors.

“There’s a real issue about the existing stock, not only about the stock you own but the stock in the market,” said Karim Habra, head of Europe and Asia-Pacific at Ivanhoé Cambridge, the real estate subsidiary of Canadian pension plan Caisse de dépôt et placement du Québec. “Often we see players that are saying, I’m not touching that because I will not reach perfection if I buy this asset, even if I reposition it.”

Speaking at the PERE Europe 2021 conference in London this week, Habra said he is less concerned about decades-old properties, which are less complicated to retrofit because they can typically be bought at a low-enough price to make it financially feasible to put in capital expenditures to improve the quality of the asset.

Instead, “the ones I’m most worried about are the assets that have become obsolete in the last 10 years,” he explained. “One of the things that happened is the acceleration of obsolescence because of the pandemic. You have lots of assets that were built five years ago that are already obsolete. But those assets are still expensive because they look brand-new and they have a good location. You cannot afford to put in the right cap ex, otherwise your financial performance will not follow.”

For Neil Slater, global head of real estate at UK-based asset manager Aberdeen Standard Investments, environmental risk “is the biggest risk from an investment perspective.” He added that Aberdeen has been scoring each individual asset in its property portfolio on its environmental and carbon impact, and consequently needs to consider the valuation impact of ESG requirements on those assets: “If we’re sitting on assets today, we have to ask ourselves: what can we do about each of those assets? Are we going to change them, are we going to put cap ex into that, or are we going to sell them because we think it’s actually something that’s not appropriate for some of our clients with a forward-looking view?”

The UK’s Pension Protection Fund likewise has been conducting various analyses to determine when “assets are likely to be stranded as effectively, institutionally unviable” because of the net-zero targets the industry is striving to achieve, said head of real estate Lee Marshall. However, “we can’t just dilute these positions out of our portfolios. We have to be more active in terms of repositioning, reconfiguring and, if necessary, selling assets so that we can improve the overall quality of our portfolios. It is about risk mitigation and reducing that future valuation risk for us.”

Climate and ESG-related considerations will only continue to grow and have a “huge impact” on the industry, said Andrea Orlandi, head of European real estate investments at CPP Investments, the investment management arm of Canada Pension Plan. “Double check your cap ex line and all your underwriting, because it’s only going to get bigger.”

Orlandi said office properties that are obsolete but still income-generating can find buyers at the right price. He noted that such assets “will stay leased, but I suspect you’ll struggle to get rental growth out of those buildings, unless it’s at a very particular location. People will have to be careful on the cap ex that’s required.”

The institutional investor panel, “Constructing a long-term investment strategy suited for the new economy,” was moderated by Pertti Vanhanen, managing director, Europe, at Cromwell Property Group.