WHAT keeps fund managers awake at night? Managers seek a cocktail combination of portfolio diversification, value investments and returns above inflation with the least volatility in order to outperform markets.
These objectives are even more prevalent against the backdrop of higher interest rates and uncertain macro trends, where passive strategies face systemic risks due to large deviations from the core fundamental values.
As financial market practitioners for nearly 20 years, our empirical observation is that three factors are key to achieving the desired cocktail.
- Identifying and allocating capital to the least correlated asset instruments.
- Buying assets at significant discounts or selling them at rich premiums.
- Generating healthy and stable yields above inflation with least impact from market volatility.
Currently, with interest rates well above 3 per cent and disinflationary trends, markets are edging towards a great rebalancing act, driven by the need to refinance assets and projects at the new higher interest rates in the short to medium term, as well as to meet the obligations due to creditors and investors.
We believe such conditions have given rise to one of the best opportunities in commercial real estate, particularly in the retail warehousing space (for food and necessities), logistics and light industrial parks, and data centres in continental Europe and some emerging markets.
We will elaborate specifically on the first item – retail warehousing space in continental Europe, a segment that we believe is overlooked or under-appreciated by investors and fund managers in Asia, where the narrative on Asia-located real estate investments is louder.
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The retail warehousing sector is proving to be resilient in both environments of higher inflation and a potential recession. Demand for necessities such as food, basic pharmaceutical products and other basic products stays strong regardless of the environment. The Covid pandemic served up great evidence for this.
Globally, we see similar trends across developed markets: Pressure from higher prices, working from home, and digitalisation created distress for office buildings and premium shopping malls in the city centres. At the same time, it led to growth opportunities in the fields of discount shopping, logistics, data centres and housing outside of the large cities.
Retail warehousing serves both as a logistics play for more efficient distribution as well as an attraction for the discount shopper who is scaling back from premium shopping and restaurants, and is increasingly shopping for food and basic necessities in suburbs and peripheral areas.
According to Savills, retail warehousing is expected to be the best-performing real estate sector in the UK, and the group expects the same trend for continental Europe and even the US markets. Likewise, Knight Frank zeroed in on food warehousing and discount shopping as key areas for property sales and development globally.
The appeal of discount food shopping has been rising steadily since the Covid pandemic as pressure on employment and high inflation favoured retailers who had their own discount products such as Aldi, Lidl, Tesco and Costco. In Europe, sales for Aldi and Lidl grew by more than 23 per cent year on year in the 12 weeks to May 14, 2023, as indicated by marketing data and analytics company Kantar.
In fact, German retailer Aldi became the second-largest food retailer in the US last year, attracting 9.4 million new customers when it opened 139 new stores, which raked in double-digit sales growth year on year. This growth trend is becoming increasingly prevalent worldwide.
Outside the big towns and industrial regions in continental Europe, there is also a big shift among consumers back to the localised discount shopping for day-to-day necessities. This is due to high inflation and also the fact that the online shopping for fresh produce was not economically and logistically possible.
In continental Europe, where there is a lower concentration of retail warehousing outlets, and hence lesser competition, an investor in retail warehousing assets can expect stable growth with returns of above 8 to 9 per cent per annum. This is supported by long-term inflation-linked tenancy agreements, usually for a term of more than 10 years. The agreements allow positive rental reversion each year alongside inflationary trends, serving as a good inflation hedge.
In addition, as tenants usually comprise discount grocers and stores selling daily necessities, household goods and other consumer staples, such retail warehousing developments are resilient and recession-proof with very little volatility, and supported by strong demand from shoppers seeking cheaper consumer staples.
For fund managers who have kept their leverage ratios well under control, and therefore do not face any refinancing pressure, there are emerging opportunities to acquire discounted properties in the next year or two. We think the winners in such a trend should be able to generate of more than 11 per cent per annum within next three to five years.
Such assets in continental Europe can serve as a portfolio diversifier for increasingly astute Asian investors. The assets offer discounted values; they are resilient in cyclical downturns; and they offer returns at a reasonable level of risk.
Over the past two decades, Asia has experienced unprecedented growth, and investors have benefited greatly from a relatively higher portfolio allocation to the region, especially China. With the evident slowdown in growth, this is an optimal time to refocus on portfolio resilience and diversification, while achieving the long-term target of superior investment returns above inflation.
The stability and resilience of retail warehousing assets in continental Europe are a pertinent investment option in any core portfolio mix.
Karol Piovarcsy is CEO and co-founder and Joseph Ong is executive director and co-founder, Euro Asia Asset Management
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