Take a moment to reflect on the past month. I bet it was like none other experienced in your career. In the span of a few weeks, the global landscape changed in a profound way, and we are now adapting to a reality that seemingly only science fiction could have foretold. National borders have been closed, the skies are devoid of airplanes and wildlife is returning to our cities. Of course, our asset class has been impacted significantly as mobility restrictions warp the role of real estate. What is the value of a commercial asset when it is unable to operate commercially? Why pay a contracted rent if exempted by exceptional circumstances? How do you commence investment due diligence when unable to visit an asset?
For our Strategy and Research team, the unprecedented series of events has coincided with our bi-annual House Views process. We have taken an agile approach to assessing our assumptions, reading market evidence and updating our property forecasts. And while devising point-level return forecasts may be fraught with folly, the evolution of structural trends gives way to high conviction investment themes that are highly relevant in the current environment. Underlying all of these is an unwavering focus on the sustainability of cash flows.
At an overarching portfolio level this has several implications. The immediate focus must be on income durability, that which is in-place but also on space that is re-let should circumstances dictate. Attention to credit strength and the robustness of tenant business models is paramount. But so too is having the flexibility and foresight to work with valued tenants who may temporarily be facing hardship. Where possible, the bias should be towards agreeing longer leases which may provide reversionary potential even if market rents begin to fall. Core locations in Winning Cities provide the best chances of achieving these income-oriented recommendations.
When looking at the different property sectors, current restrictions on mobility accelerate the move toward e-commerce and away from physical retail. This suggests that logistics assets leased to online fulfilment and cold storage operators should prove resilient in the near term. Conversely, the precarious occupational environment for most retail means NOI assumptions are being slashed and yields are under pressure. Because of this, our current European model portfolio suggests further upweighting logistics holdings and down weighting non-essential retail. Offices should fare comparatively well due to underlying low vacancy rates. However, an accelerated move to agile working and distressed flexible office providers warrants vigilance. And with so many now living, learning, working and playing from home, investing in residential can accomplish multiple objectives. Furthermore, tenant-friendly government intervention helps sustain residential occupancy rates and ultimately cash flows. And that’s what it’s all about right now.