Real estate is a growing part of institutional portfolios and may need to be considered in a broader context, whether in relation to the total portfolio or within society. The drivers of real estate risk and returns have been more diverse and complicated than “location, location, location.” Beyond geography and sectors, drivers such as cash flows and amenities have historically affected risk, return and value.
In its 2020 Emerging Real Estate Trends report, MSCI, the leading provider of real estate investment tools, explores trends that have impacted real estate in the near term, ranging from climate risk to improved data availability, which suggests that 2020 may be a watershed year for the way investors think of real estate as an asset class.
The emerging real estate trends MSCI has identified can be summarised into:
1. Climate risk: Getting to the bottom line
- Climate risk is a risk that we now see materializing over the typical holding periods of real estate investments. As a result, mitigating and managing these risks are likely to be today’s problems, not tomorrow’s.
- While real estate investors need to be aware of more tangible physical risks, increasingly, transition risk will be an important consideration when making investment decisions
- Historically, better financial metrics have often provided for best risk management. We suspect this will also be the case for assessing climate risks for real estate investors.
2. Places are for people
- The need and desire for people to do things in a particular space drive its attractiveness to customers and occupants and, by extension, its value for owners
- Each investment is inextricably linked to the built environment, community and society that surround it. Improving the characteristics of a local area or city may have longer-term benefits for the asset.
- Environmental, social and governance (ESG) concerns are becoming systematically integrated into investors’ investment processes across asset classes, and clients tell us more attention is being paid to these social and societal impacts — the “S” in ESG. Whether or not motivated by social-impact concerns, real estate investors in general might wish to consider how ESG issues may impact the risk-return characteristics of their investments and portfolios.
3. The many dimensions of real estate risk
- Real estate is a complex asset class with many dimensions of risk that combine in a myriad of different ways and reflect its high degree of heterogeneity.
- Top-down macro risk analysis and bottom-up specific risk analysis at the asset level have generally been separate exercises, performed by separate teams. But investors increasingly realize they are inextricably linked.
- As allocations to real estate continue to increase, investors are aiming to model specific risks in a consistent, quantitative and integrated way. Addressing these analytical challenges will become a greater focus.
4. Beyond ‘location, location, location’
- Real estate investors recognise that the drivers of value have almost been more diverse and complicated than the notion of “location,location, location”, yet a huge amount of strategic analysis is still constrained to sector and geography.
- Increasingly investors seem more aware that risk, return and value are driven by a broader range of factors.
- Thanks to continual improvements in technology, more data can be generated, collected and processed more efficiently to help understand these drivers. In the same way that factor analysis has gradually chipped away at specific risk in the equities market, a similar analysis might now be made of real estate assets.
5. Everything is relative, and only that is absolute
- Relative market comparisons can help place performance in context and provide insight into drivers of return, for fixed and absolute-return portfolios.
- Asset allocators have increasingly expressed interest in the risk-return and correlation characteristics of the investments they make and what they may bring to the broader portfolio, and real estate is increasingly thought of as part of a real- or private-asset allocation.
- Managers may wish to demonstrate what investments will and do contribute in terms of the return and risks specific to an investor’s portfolio and that effort may require a new level of data and analytics.
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