As the world plunged into chaos in the spring of 2020, investors rushed to identify the asset classes that would offer the most safety in uncertain times.
With the onset of the pandemic rendering the retail market moribund and much of the world’s office space redundant, the keepers of institutional purse strings were forced to look beyond their traditional comfort zones of shopping centres and trophy office buildings. And so dawned the era of what has since been dubbed ‘beds, meds and sheds’.
Sectors such as build-to-rent, life sciences and logistics have emerged as the stand-out beneficiaries of the uncertainty created by the ongoing Covid-related disruption. In response, investors have deployed defensive strategies and turned their attentions towards assets offering stable long-term income streams. The sheer weight of capital targeting these alternative sectors has generated huge capital growth over the past two years and pushed values beyond the realms of what many would have thought achievable.
Although few have questioned the wisdom of this strategy in recent times, we are beginning to hear clients of Forbury and the wider investment community start to voice their concerns over just how sustainable current values are.
It seems we may have hit the ceiling in terms of what investors are prepared to pay
Assumptions that have been made to support this defensive approach – such as the longevity of inflation-busting long-income streams – are now being challenged by the rapid, and seemingly inexorable, rise in inflation. Not only does this raise questions over the security of certain income streams given the inflationary pressures faced by consumers and the wider supply chain, but also crucially around the sustainability of borrowing costs.
Rising asset values that may have been seen as sustainable – and provided some margin for error – when borrowing costs were historically low are now coming under far more scrutiny. These assumptions are now being quickly undermined as the very real prospect of borrowing costs exceeding projected income returns comes into play. Inevitably we are seeing growing anecdotal evidence that some investors are getting cold feet.
This is already having an impact on investment volumes as capital inflows slow down – more worrying for those with deals still in progress, as it seems inevitable that some element of renegotiation will come into play. Property values agreed on the basis of cheap debt, which is evaporating quickly, will likely be reviewed as buyers become increasingly price sensitive.
As Ronald Dickerman, president of private equity group Madison International, recently told the FT: “Anyone underwriting a building is having to reappraise… I cannot over-emphasise the amount of repricing going on in real estate at the moment.”
As rising borrowing costs have created doubt in even the most robust of markets, we are already beginning to see the corresponding impact on property values. While there will always be buyers for secure income streams in challenging times, for now at least it seems we may have hit the ceiling in terms of what investors are prepared to pay and that some level of adjustment is likely to follow.
Pete Rose is head of UK at Forbury Valuation Software