In our Future of Property research, we identified important post-pandemic shifts in most real estate sectors. How these trends interact will be key to the outlook for the urban locations where most real estate is clustered. We think it is premature to declare the death of cities, but the built environment is likely to change significantly over the coming decades.
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- In our Future of Property research, we identified important post-pandemic shifts in most real estate sectors. How these trends interact will be key to the outlook for the urban locations where most real estate is clustered. We think it is premature to declare the death of cities, but the built environment is likely to change significantly over the coming decades.
- The message of our recent Global Update was that we should not write off city economies once the virus passes. Their clusters of high productivity industries and their strong amenity will continue to draw workers, residents and tourists. This attraction has historically underpinned a resilience to even the most extreme shocks and COVID-19 isn’t expected to be any different.
- But there will be changes in our cities and real estate is expected to be at the forefront of these, as we have highlighted in our Future of Property work. These shifts will affect how cities adapt to the post-pandemic world and will have consequences for investors. So, it is worth re-examining our findings and outlining the implications for urban performance.
- For us, the most important catalyst of change post-COVID-19 will be more home working. (See here.) For offices, which are the most directly affected, this will be a major hit, reducing demand, curbing development and squeezing investor incomes over the longer term. There will be some offsets, as office employment will continue to grow and a need for more flexibility should revive the co-working sector. But in net we would expect demand to shrink by an estimated 5%-10% by 2030 across global markets, with city centre offices bearing the brunt of this.
- Home working will also influence residential markets. (See here.) As cities re-emerge post-virus, we think the exodus of urban residents will slow. A supply of obsolete retail and office space will create opportunities for new urban apartments, though a desire for bigger units and constraints on rental growth may combine to restrict investment performance.
- For retail and industrial, COVID-19 provides a nudge to pre-existing trends, but this too will impact city dynamics. (See here and here.) We think in-town retail will continue to be hit hard by internet competition. Within this, we expect shopping centres, high streets that rely heavily on daytime worker populations and transport hubs to be most exposed. Industrial property is less city orientated, but urban logistics is expected to see upside from increased online penetration.
- The most important implication of all this is that there will be less traditional commercial real estate demand in cities and a contraction in office and retail space. This is not a trivial change. Office and retail have become less important, with their investment share shrinking steadily from around 80% at the turn of the century. But they still accounted for about a half of all transactions in 2019. (See Chart 1.) While investor demand for shops and offices will not disappear overnight, the sort of structural shift we expect over the next decade suggests the decline could accelerate. But what other property types can fill this gap?
- Assuming that the urban exodus is temporary as we expect, “living” uses probably provide the best alternative for any excess space. This will primarily be apartments but may also involve other types of accommodation such as student housing and care homes. Initial downward pressure on prices and solid demographic drivers will be important for sustaining demand here, though, as noted, the desire for larger apartments to accommodate more home working may limit returns.
- Another urban growth area is likely to be logistics, specifically last-mile assets for online delivery to densely packed city populations. This is unlikely to entirely fill the gap, however, as requirements here will often be in suburban areas rather than city centres, where retail and offices are traditionally located. In addition, environmental concerns may eventually bring a backlash against the costs of this convenience. Nonetheless, these urban sheds are likely to become more common in future.
- We also think that the hospitality sector will play a role in any urban renewal. These industries are currently in a deep slump and there will inevitably be some restructuring post-pandemic. But we expect that vaccines should allow tourism and leisure spending to bounce back quickly and then be sustained by healthy consumer demand over the medium term.
- Leisure will be especially vital in filling the gaps left by exiting retailers on high streets and in shopping centres. In addition, there may also be opportunities for converting excess office space into hotels. And a strong hospitality offer will also contribute beyond this, by bolstering a city’s attraction to more-mobile worker-residents and to business and tourist travellers going forward.
- While these structural shifts are relatively clear, it is much less easy to identify winners and losers. Here the interaction of local economic and social factors with property market dynamics is more complex. But a few tentative implications emerge from our analysis.
- For one, we think that size will remain important. So-called gateway centres, larger cities with internationally facing financial and business service clusters, have tended to do significantly better than their smaller neighbours over the last decade or more. (See Chart 2.) We think this is likely to continue, with centres like London, New York and Paris better placed to absorb structural change.
- Indeed, we remain convinced of the economic resilience of larger cities. Admittedly, they are the most expensive and congested, and likely to have more office and retail space. But they also have a significant advantage in areas like amenity and cultural attractions, which are needed to sustain inflows of people to offset a declining daytime worker population. This will support healthy leisure and retail demand and in turn help retain residents.
- Elsewhere, there are likely to be greater challenges, but also some opportunities. New roles could emerge for medium sized cities. For instance, the creation of more “liveable” towns based less on shops and offices and with more leisure and living could make more economic sense in future. The aim here would be to draw mobile workers from the bigger cities to a better environment.
- This idea may be close to the smart cities that urban analysts have long talked about, highly connected centres that rely heavily on IT and green technologies, as well as enlightened governance. Whatever, this implies a shift from the traditional role of cities and remains highly speculative with few real-life parallels as yet, though it would be a logical development from the structural changes that we expect.
- For other locations, there are more concerns. Given the size of the changes in real estate and potential overhang of space, many centres may require regeneration, with the conversion of commercial space to community and social use to halt urban decay. Of course, many of these centres were struggling even before COVID-19, but this may hasten their long-term decline.
- Cities will emerge from COVID-19 needing fewer shops and offices. But they will still have a key role in fostering clusters of high productivity industries and in bringing together workers, residents, shoppers and tourists. As such investors will still find returns from property assets, though they will have to look beyond the strategies of the recent past to do this.
Chart 2: Capital Value Growth (% Cumulative, 2010-19)
Sources: MSCI, Capital Economics
Andrew Burrell, Chief Property Economist, firstname.lastname@example.org