Kieran Farrelly, Chief Investment Officer & Head of Global Solutions, Real Estate at Schroders Capital believes positive market movements point to real estate recovery progressing.

There is increasing evidence of positive market movements in relation to both activity and, crucially, transaction pricing – and our proprietary valuation framework continues to point to immediate opportunities across multiple sectors and geographies. While there is recognition of a challenged economic outlook and recently elevated geopolitical uncertainties, we see the early stages of a steady recovery in real estate progressing.

Performance is expected to be sequential across geographies and markets, but not to the extent that it has been in recent years. Importantly, we the see the profile of asset types within markets having a greater bearing on operational and financial performance as considerations such as sustainability profile become more influential. We remain firmly of the view that 2025 and 2026 will be strong vintages for deployment, with the potential for capital invested to deliver outsized prospective returns over the medium- to long-term.

Shift to neutral stance across sectors globally reflects ‘rental floors’ in retail and office, and elevated yields for ‘future-proofed’ assets

Operating conditions are being well supported by continued tight supply and an increasing scarcity of modern, ESG-compliant space emerging. Elevated construction costs have been a key reason for muted supply pipelines and this dynamic may be further exacerbated, with potential for large-scale rebuilding programmes assuming a cessation to major conflicts across the world. Further increases in construction costs therefore have the potential to create a meaningful ‘cost-push’ effect on rents.

Investment market activity remains subdued compared to historic levels, but improving investor sentiment, as highlighted by a range of indicators, coupled with a more supportive rates environment, should catalyse higher volumes this year. Indeed, investment volumes have already showed signs of a nascent recovery, with MSCI data pointing to 4% and 9% annual increases in European and US investment volumes respectively during 2024. The lowering of interest rates in recent months has aided the return of positive levered income yield spreads on a case-by-case basis, which will help to draw capital back to the asset class.

Owing to the extent of the repricing observed since the first half of 2022, our proprietary market valuation framework is signalling that immediate opportunities can be found across multiple geographies and sectors. Several markets, notably the UK and industrial and logistics segments more broadly, have rebased to attractive price points.

Regarding current asset views, our preferred portfolio positioning is evolving and shifting to a more neutral stance across sectors. This is owing to greater visibility on ‘rental floors’ for retail and office sectors, as well as the elevated yields available for future-proofed assets. More broadly, we expect asset and location considerations, for example sustainability profiles, to have a greater influence on performance going forward relative to recent years, which saw sector performance divergence at record levels.

We believe all real estate is operational and, armed with a hospitality approach, one can drive additional income from services by contributing to the success of tenants’ businesses in property assets, with sustainability and impact considerations a high priority. Indeed, the prevailing environment further reinforces our focus on operational excellence in active management as we drive long- term income and outperformance for our investments.

Schroders Capital’s conviction themes guiding preferred strategies:

Our preferred strategies continue to be led by our conviction themes for real estate that broadly align with key global structural trends:

Technology & the knowledge economy

The interface for “work” has shifted, consolidating value in those buildings that address specific needs and evolving tenant requirements, as industry sectors continue to evolve.

Deglobalisation

Deglobalisation has continued to impact supply chains that have been recalibrating, therefore increasing demand for local production and distribution facilities.

Demographic shifts

Rapidly changing demographics is further altering relative demand for various types of (affordable) living and healthcare formats.

People, places & planet

Further increasing regulatory and industry standards demand a holistic approach to the creation of value for all stakeholders, including investors, occupiers and communities.

Preferred strategies

Strategies that we have conviction in include:

Repriced industrial property

We believe that light industrial and last-mile facilities offer attractive relative value, given the extent of repricing, providing for accretive levered cash-on-cash yield. Robust rental growth seen in the sector creates an opportunity to capture mispriced reversionary potential, as existing leases expire and roll to higher revised rental levels. Finally, there are meaningful ‘climate transition’ opportunities in this sector that can be implemented through upgrading and expanding existing stock, as well as other activities such as the provision of electric vehicle charging facilities powered from renewable energy sources.

Operational property-types

As real estate portfolio allocations evolve from the ‘traditional sectors’, we continue to favour more operationally intensive real estate segments such as hotels and self-storage that are able to provide at a minimum inflation-linked cashflows, both directly and indirectly, with outsized income growth potential aligned with the success of the tenant. We continue to see notable opportunities to create these formats by converting and repurposing existing assets into higher-value alternative uses.

Affordable rental housing

There is a severe shortage of affordable residential space across major economies and, combined with demographic and urbanisation structural trends, this is creating opportunities to provide a range of much needed housing across various segments. These can provide long-term resilient cashflows and, alongside attractive financial returns, there are strategies that can also provide positive impact. We have a focus on undersupplied rental housing segments, including ‘workforce’ and social housing formats, as well as those catering to both students and older citizens. In many instances, careful consideration needs to be given to local regulations that are shifting to further protect tenants from rent increases.

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