NREI asked Will Robson, executive director and global head of real estate solutions research with MSCI, to discuss the report’s findings in-depths. Here are the takeaways from the discussion.
1. Climate risks
Robson says climate change awareness is increasing across all markets globally, though some markets are more advanced than others. For many years and to many investment professionals, climate risk seemed like an abstract problem for the future. Over the last couple of years, Robson argues society has become more aware of the urgency of the problem.
The obvious climate risks for commercial real estate investors include damage to property, but the report also mentions “slow burn risks.” These include, for example, potential changes in warming cycles and the gradual impact on the costs associated with keeping buildings cool. Balancing the costs of retrofitting cooling systems against potential impacts on building values will likely become a concern for investors over the coming years.
“Beyond physical risks, you also have transitional risks,” says Robson. “So, the transitional risks include the need for de-carbonization. Obviously, achieving that decarbonization comes with a cost. So, trying to understand what the costs are of de-carbonizing, either through choosing to reduce carbon emissions or through regulations where they force you to reduce carbon emissions.”
2. The human capital angle
Improving the characteristics of a local area or city may bring longer-term benefits for a commercial assets. Factors such as housing affordability, diversity, quality of human capital and employment opportunities are increasingly being addressed in the assessment of attractive cities for investment. Environmental, social and governance (ESG) concerns are becoming systematically integrated into investors’ strategies across asset classes. Today’s real estate investors need to consider how ESG issues may impact the risk-return characteristics of their portfolios.
3. The many dimensions of real estate risk
Top-down macro risk analysis and bottom-up specific risk analysis at the asset level have generally been separate functions, performed by separate teams. But investors are increasingly realizing the link between the two. As allocations to commercial real estate have increased, investors are aiming to model specific risks in a consistent, quantitative and integrated way, Robson notes. Addressing these analytical challenges has become a greater focus.
“There’s a systematic element to it. I think there’s a lot of dimensions of risk, whether it’s lease length, tenant strength, vacancy, micro-location, walk score, these kinds of things are all asset- specific things,” says Robson. “But there’s likely a systematic element to it. There’s a lot more potential to applying data and quantitative analysis to explain that performance in greater detail.”
4. Looking beyond ‘location, location, location’
A huge amount of strategic analysis is still focused on property sector and geography, but real estate investors are beginning to be more aware that risk, return and value are driven by a broader range of factors. Continual improvements in technology mean more data can be generated, collected and processed more efficiently to help understand these drivers.
“Typically, in the past, data has been an issue for real estate investment. That has improved over time,” says Robson. “But in a world of AI, people are getting used to having more and more data in their decision making.”
In the past, many of these non-market drivers of value were hard to quantify in any systematic way. However, many of these drivers could well have systematic elements to them that affect value across a broad range of assets and throughout the real estate cycle. In the same way that factor analysis has gradually chipped away at specific risk in the equities market, a similar analysis might be possible for real estate assets.
5. CRE’s role within broader investment portfolios
Broad economic forces have been shown to impact individual property investments, but asset-specific characteristics may lead to widely different results for assets within the same property sector and geographic market. Opportunistic developments, for example, can carry extremely high levels of project-specific risk, whether it’s the level of market rents at the time of completion or the pricing environment when an investor seeks to sell a property.
Asset allocators have increasingly expressed interest in the risk-return correlation characteristics of the investments they make and what they may bring to the broader portfolio. Investment managers may wish to demonstrate what specific assets will contribute in terms of the return and risks specific to an investor’s portfolio. That effort may require a new level of data and analytics.
By: Sebastian Obando (NREI)
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