Paul Guest: «Some Properties Are Un-Investible»

Paul Guest: «Some Properties Are Un-Investible»

Which types of properties would keep clients up at night? Which properties could provide «safer» returns? In conjunction with the launch of their report: Top Ten Real Estate Questions for 2020, Paul Guest from UBS speaks to finews.asia in an exclusive interview.

Paul Guest, when you say that the retail sector could provide pockets of opportunities, what do you mean?

The retail sector, especially the U.K. and U.S., has been in a structural transition for a few years now. In catchments that have growing populations, growing incomes, attractive tourism inflows, there will still be well-performing shopping malls, high street (shops) and retail locations. Right now, all of them are getting marked down partly because of investor pessimism, and partly because the physical retailers have had the upper hand in rent negotiations, even in good quality locations. These are marking down asset values. 

Attractive assets in attractive locations can be picked up at a discount, compared to what they would have been available for most of the last two cycles, definitely the last 15 to 20 years when retail has been one of the most expensive asset classes.  That's why we find it interesting. It's really isn't a sector play...as there's still an awful lot of assets that are going to continue suffering.  The downtrend is furthest ahead in the U.K., and the U.S. although there is more pain to come (whereas) in Canada and Australia, it's still coming through. 

Japan had severe repricing in retail due to demographics rather than commerce. In Singapore, it had a repricing of retail because of supply dynamics almost a decade ago and has restructured to focus on food and beverage....it's not totally immune but it's better-positioned than U.S and U.K because they have re-tooled the structure of shopping malls.  In China, they are also different dynamics - there is an oversupply of retail properties in tier 2 cities.

Has the failed listing of WeWork impacted office properties?

The challenges of one particular operator do not mean that flexible working as an idea is a bust. WeWork has its challenges because of the nature of its corporate structure. But flexible working as a concept is a manifestation of the desire for flexibility on the part of office tenants, just as e-commerce was a reflection of the desire for flexibility on the part of consumers.

And it's changing how office landlords behave. Now, they have to be more involved with their office tenants, they have to be more operational. You still have the major office tenancies, like major office towers with financial occupiers who will take a twenty-year lease with inflation-indexation. So, you still have that kind of «lazy landlords» approach to office buildings, but you can have more active asset management by office landlords who then share more of the upside. It's a good opportunity for professional asset managers.

Do you see logistics properties picking up in the near-term?

There are two groups of logistics properties, the ones focused on consumers and the ones focused on trade. The distribution warehouses focused on trade have suffered this year because of the slowdown in manufacturing and slowdown in trade and that's not going to go away. It would be a brave call to decide that the trade war between the U.S. and China is over or not; it's certainly not going to roll back in the near future. 

The logistics that is focused on consumer demand will continue to perform well. Obviously, as economic growth slows, as job creation slows, you have less consumer spending, so we will have slower growth whether that is e-commerce or general consumer spending. The dynamic will continue to (drive) it to do well next year, although we think that peak returns have passed. At the global level, we are forecasting logistics real estate to deliver a total return of about 8 percent on an un-levered basis, down from about 11 percent in 2019. This compares with an all-asset return of 5 percent.

You emphasized using ESG criteria as a way for investors to de-risk their real estate portfolio. Why is this so important?

Environmental, Social, Governance (ESG) metrics are no longer «nice to have» criteria. Investors are starting to demand their investments are ESG compliant. ESG has to be a primary investment component, not just a PR exercise. If you are in an office in a flood location with a government that has no intention of improving coastal defenses, your insurance costs are going to triple, quadruple, or go up five hundred times. Then, your terminal value becomes zero. Insurance costs are rising so quickly (for these properties), that just means they become uninsurable and therefore un-investible. 

If you have pension funds from Canada, Australia, and the Netherlands telling you that if you don't have the appropriate environmental credentials and insurance, they just would not give you capital. So it's on both sides - the value of the asset, and the incoming capital, that are pushing this ESG adoption.

The report by Paul Guest and his team at UBS Real Estate & Private Markets, can be found here.