For the real estate sector, 2021 was something of a spectacular year. As the global economy bounced back from the COVID-19 recession of 2020, confidence returned even to the more troubled sub-sectors of the property market. In-vogue activities such as warehousing raced ahead. In the UK, Schroders estimated total real estate returns would reach 13-15% for 2021 as a whole, with returns likely to average 6-7% annually until 2024. And listed real estate businesses have benefited accordingly. Global real estate indices were up by around 30% over the year to the end of December.
Such returns have naturally captured the attention of dealmakers. Data published by Refinitiv reveals that there were $547bn worth of M&A transactions in the global real estate sector during 2021, up from $278bn in the whole of 2020. These were the second highest real estate deal values on record, only surpassed by the total of £518bn for 2017.
Interest returns
Activity in the UK has been a little more muted. While the $43bn of real estate M&A in 2021 was up on 2020’s total of $22bn, transaction values fell well short of the levels seen in the boom of 2017, when there was $53bn of UK real estate M&A. Nevertheless, UK deal advisers have had a busy year.
One point worth making, according to Abhishek Jaiswal, head of real estate M&A at Deloitte, is that deal volumes have yet to race ahead in the same way as values. A significant number of larger transactions – the $18.4bn takeover of Deutsche Wohnen by Vonovia in Germany in August 2021, for example – underpin those figures on deal values. The 2021 deal volume is likely to be just down on the 2020 level.
“However, I expect transaction volumes to catch up over the next year or so,” says Jaiswal, forecasting plenty more deal activity to come in the sector. “We’re at a transformational moment for the real estate sector, with a confluence of several powerful themes.”
Brett M Johnson, a principal in EY’s transactions and corporate finance group in Chicago, agrees with that prediction. “I’ve been in this industry for more than 20 years, but I’ve never seen the M&A market move at such a breakneck pace. There’s just no sign of a slowdown and I expect this to continue well into 2022.” He sees the same drivers in the US as in the UK.
Reasons to be cheerful
There are three big themes behind the trends in real estate M&A. The first is the macro context. In a low-interest- rate environment, real estate has been a very alluring asset class for many investors. It has provided unlevered annual returns of approximately 6% and Baa bonds more like 3.5%. Johnson says: “If you have low interest rates and anxiety about inflation, there’s going to be real appetite for increased exposure to real estate.”
The dynamics are similar in Europe, where bond yields are in negative territory. And assuming policymakers are right in their current view that the inflationary pressures will prove transitory, there is little prospect of significant tightening in monetary policy, given the need to support the post-pandemic recovery.
Even if inflation proves more stubborn than expected, there is plenty of room for manoeuvre, he argues: “Given the spread between real estate and fixed income, investors can cope with a certain amount of yield compression.”
The second big driver for real estate deal-making, suggests Jaiswal, is “structural change in the way we work, live and play”. The pandemic has accelerated trends such as the rise of e-commerce, increased consumption of digital entertainment and moves to new ways of working, including more people at home.
Against that backdrop, traditional sub-sectors of real estate begin to look less attractive. Most obviously, retail premises – from large shopping centres to individual outlets on high streets – are already suffering at the hands of online rivals. By contrast, surging e-commerce sales means there is huge demand for warehousing and logistics space – every £1bn of additional e-commerce is estimated to require an extra 1.36 million square feet of warehousing space.
Similarly, will the offices sector suffer from over-capacity as some large white-collar employers reduce their workspace requirements because staff are working from home more of the time? Or will demand for real estate assets such as data centres accelerate? These assets are crucial to power both homeworking and digital home entertainment.
Theme three, suggests Jaiswal, is the rise of the environmental, social and governance (ESG) agenda: “Buildings have a large carbon footprint, so as net-zero targets become more demanding, there will be a bifurcation. We’ll see ‘good buildings’ that are energy efficient and adaptive, and ‘bad buildings’ that don’t tick the box.”
On social factors, Jaiswal points to the debate about housing inequality going on across much of Europe, with pressure on the sector to provide more affordable rents.
“All of this is going to lead to a polarisation of views about the relative value of different real estate assets. We’re going to see the creation of new platforms and the repositioning of existing platforms that refocus and adapt.”
Under new management
In such a marketplace, M&A will be driven by the strategic rationale of market participants, as well as for investment reasons, argues Jackie Bowie, European head of real estate at Chatham Financial. “We’ll see some of the bigger players buying whole platforms in order to secure exposure to sub-sectors such as warehousing, logistics, data centres, and science and technology. This is about bringing management and operational expertise as well as growing assets under management.”
The £714m acquisition of Arlington, the UK science, innovation and technology real estate platform, by Canadian alternatives giant Brookfield Asset Management in June 2021 was just one example of such a deal. Indeed, Bowie points to the growing importance of these very large real estate investors – including the likes of Blackstone (see box, ‘Logistical vision’, opposite page) and other private equity players – in driving M&A.
“There’s so much capital available for real estate transactions. We’re seeing corporate acquisitions and investors competing for the best assets. The higher capital availability is also driven by increased allocations from institutions and pension funds to real estate as an asset class that offers a decent yield.”
No let-up
That suggests current elevated levels of M&A activity can be sustained, argues Fraser Greenshields, managing partner for corporate finance at EY. In the UK, he points to the residential sector as one likely area of interest: “I think we’ll see specialist areas such as student accommodation and retirement living come into focus,” he says. “I also think we’ll see more consolidation of the smaller listed real estate companies. They are too small and the cost of being on the public market is too high if they don’t have the benefit of being able to raise more capital, which currently they don’t.”
There is, in other words, little prospect of a respite in the pace of deal making. For much of 2021, only the technology sector has kept pace with real estate M&A; in 2022, that looks set to continue.
Crucial infillingEven in the most competitive real estate market, inefficiencies persist, requiring intervention from different types of investor. One such investor is the Development Bank of Wales, a member of the Corporate Finance Faculty and owned by the Welsh government. Its brief is to support economic development in the country and it has been making short-term loans that support the development of new residential and commercial real estate assets in Wales for almost a decade now. Cenydd Rowlands, property director at the bank, explains: “We launched our first small-scale pilot in 2013 because, in the wake of the global financial crisis, traditional lenders to small and medium-sized developers and builders were very reluctant to continue lending. That first £10m facility was recycled three-and-a-half times over, supporting £35m of real estate lending with not a single default.” Since then, the bank’s property lending book has expanded rapidly and now totals around £200m, spread across several funds. The loans are in the £150,000 to £5m range. “Flexible and adaptable” is how Rowlands describes the approach. The bank will lend to new companies, including special-purpose vehicles, where other lenders are more cautious. Looking forward, Rowlands says interest in environmental, social and governance is likely to increase. “We already reflect social themes, such as supporting communities, job creation and the building of new homes, but there is an opportunity to focus on environmental drivers and we’re considering the levers that might be available through new or existing products,” he says. “But there is a balance to strike between supporting good practice and not creating unnecessary barriers for developers.” |