Are globalised cities changing the way property investment is allocated?

3.1 EXPERT DEBATE Are globalised cities changing the way property investment is allocated? Moderator Panelists Ben McNamara, Content Producer, Clear Path Analysis Jeroen Reijnoudt, Senior Portfolio Manager International Real Estate, MN Alice Breheny, Global Head of Research, TH Real Estate POINTS OF DISCUSSION Demographic megatrends are determining how investors will interact with real estate and what occupants need The real estate community has a huge task to react to urbanisation and be aware of the affordability of housing for different demographics Investors need to be very clear that investing only in global gateway cities is not going to achieve the true benefits of geographical diversification The boundaries between infrastructure and real estate are blurred and both need to be thought about as a broader built environment working together Ben McNamara: How are demographic megatrends impacting real estate strategies? Jeroen Reijnoudt: Real estate is a result from social behaviour, so demographics are of great importance for these strategies. To understand the long-term value of real estate, you need to have an understanding of what s driving the user of real estate, now and in the future. In this era of the digital revolution especially, retail is becoming an increasingly complicated area. People spend more time on the web nowadays than outside, they spend more time on websites than in shops. The budget of time and space for people available every day looks completely different than it did 5 years ago. This trend has a large-scale behavioural effect and leads to the necessity for people to move around as efficiently as possible. Cities do allow for this with accessibility and the available combination of functions, amenities etc. This adds to the overall global trend of urbanisation. Cities simply have a better fit with human behaviour than rural areas. Alice Breheny: Global megatrends are re-shaping the world economic order. Mass urbanisation, to the rise of the global middle classes, ageing populations, technological trends, and the shift of economic power from the West to the emerging world; all these pose major implications for the built environment and the long run demand for real estate. Real estate is ultimately about the interaction between people and the built environment. So, you have to start by understanding the behaviour and needs of people. These demographic megatrends are all determining, over the long-term, how we will interact with real estate and what the needs from real estate are for people. If you are devising a strategy for investing in real estate, then you want to look beyond the next market cycle, and that is why some of these structural trends are really important when designing strategies. Investing in Property, Europe 2017 17

A CITIES APPROACH IS REALLY IMPORTANT IN ACHIEVING DIVERSIFICATION, BUT PEOPLE NEED TO BE VERY CLEAR THAT JUST INVESTING IN THE GLOBAL GATEWAY CITIES IS NOT GOING TO ACHIEVE YOU THE TRUE BENEFITS OF GEOGRAPHICAL DIVERSIFICATION Jeroen: There is a difference between the short-term investment strategy and what you need to do over the longer-term. We are part of a fast-moving landscape and we need to adapt to it. This might mean that you have to be able to take a rare opportunity that suddenly pops up. Mandates therefore do need a certain flexibility. This is something that we also appreciate in TH Real Estate. Their European Cities fund has a great top-down strategy focused on winning cities, but also offers the flexibility needed, proven by some amazing deals like Xanadu in Madrid, Omni Center in Edinburgh and Kampii Center in Helsinki. Alice: When we are thinking about core strategies our starting point is always the demographic megatrends. Ben: You mention that a big challenge has been the technological advances that have changed the nature of real estate investment. You also talked about looking beyond the next market cycle, when planning for future investment. Is there anything on the horizon that you consider to be a major game changer in the way that strategies and investments may be made? Jeroen: Just by looking at the changing demographics you can see what kind of sectors within real estate are of growing importance. As more people move to the city there will be higher pressure on the city as a system. This means that there will be a need for houses, amenities and better social and economic infrastructure. Immediately after this we need to mention the ageing population. So, areas like senior living will become an increasingly important sector in the future. Urbanisation also means that there will be more students in these cities, which also means that housing for them needs to be provided. There is a huge task for us as a real estate community to build on this and be aware of the affordability of housing for students (as it isn t only about providing access to universities, but to urban life also). Last but not least, tourism. We have a growing middle class worldwide and these people go to the places they know from the movies, like New York, London, Paris and of course, Amsterdam. Alice: Technology is the biggest concern that we have, as there are a lot of people who are trying to disrupt our relationship with real estate and disintermediate us as landlords. Technology means that, in theory, we don t have to go out to do our shopping or to an office building to go to work. However, the reality is that people still want to do that. So, as owners of real estate, we need to make sure that the locations and assets we are investing in are resilient in light of technology and other megatrends. We also need to think about whether a piece of real estate is going to be relevant in tomorrow s world. Investing in Property, Europe 2017 18

Ben: What drives a Cities success? Alice: A Cities success is dependent on a number of factors and combinations, as what determines success for one city could be very different to another. Crudely speaking, it is about location and ability to attract global talent. If you look at the global talent base, it is increasingly mobile and discerning, so people are focusing on a smaller number of locations in terms of where they might want to live. What might attract people to a certain location can differ. In some cases, it is for its unique culture and heritage (like London or Paris), and in other places it is about quality of life (so areas like the Nordic countries). Also, cities which are progressive in their thinking (e.g. towards infrastructure and sustainability) are of interest, as they can successfully absorb all of the people who want to live and work there. Every city has very unique DNA and it is important to not just compare one city to another (in terms of how successful they are or might be in the future). By understanding that city s DNA and both the type of success and potential for future success, it informs your ground up strategy for investing (i.e. appropriate sectors or locations). Jeroen: A city s success is primarily related to the situation of that city and its scale. In today s world, where everything needs to be increasingly efficient, the main features are its economic situation, accessibility via land and air, as well as virtual, fiscal attraction, amenities etc. Ben: How has Brexit signified a rise in populism and a push against globalisation? Do you feel that this will affect the way in which property will be invested, and how cities facilitate migration? Jeroen: Brexit brings with it an uncertainty, and what we see in all of the investment strategies from investors throughout Europe is a search for real estate to provide stable income. This means that you also have to look at factors like political and economic risks, so (from the uncertainty caused by Brexit) we will hold back investing in the UK until it is more clear what is happening there. In my opinion, it is a shame, because the UK is a very much appreciated part of Europe (and also a dominant country within Europe), but, then again, we weren t part of the Brexit decision and we have to respect that. Alice: I really hope that over the longer-term it doesn t affect globalisation and progress, as it would be terribly sad. There is a lot of negative press around migration, but migration in most instances drives economic growth, creates demand for real estate, and more interesting cities. There is a short-term impact, although we have seen that in the UK it perhaps has not been as marked as it could be. London recognises that it needs to compete in order to maintain its position as the premier city in Europe, but it does have a positive attitude to accomplishing this. In terms of attracting people, London is never going to lose the charm it has, and that makes it a truly global city. Ben: Why does a Cities approach bring more diversification than a Country approach? Alice: A Cities approach is really important in achieving diversification, but people need to be very clear that just investing in the global gateway cities is not going to achieve you the true benefits of geographical diversification. London, New York, Paris, and Hong Kong are driven by financial services and tend to perform well and badly at the same time, but it is about getting an appropriate mix of different cities that helps you achieve diversification. Interestingly, those cities that score very well among softer factors (like quality of life, sustainability, infrastructure, and connectivity) are the ones that are going to gain regional dominance over coming decades. These cities tend not to be driven by financial services but other industries, and, therefore, have greater benefits within a portfolio in achieving diversification. Jeroen: One way to look at this is through the effects of correlation and diversification. If you focus at countries only, the correlation between cities within the country is quite high. Correlations become lower when you compare cities internationally on a European or global scale. This is because cities have different roles and ways of functioning, but also because cities can be in different places of the economic cycle. We do feel that there is a definite benefit in looking at this internationally rather than by region or country. However, as a company, we decided that the cost of diversification can be higher than the benefits it brings. By this we mean that if you invest further away (say in the U.S.), it is for us as a European investor more difficult to have control. Also monitoring your investments will bring higher costs, you will experience currency risks and there might be unrecognised economic and political risks. Due to these factors, we decided to invest our non-listed real estate portfolio mainly in the Netherlands and in Europe. Alice: There are many different ways of looking at diversification; the more globally an investor is able to look then the greater the chance of achieving diversification. I often say that the perfect portfolio is something that is globally diverse yet still focused on those cities that are relevant in tomorrow s world. Investing in Property, Europe 2017 19

Ben: Why is a Cities strategy more resilient than a Country approach? Jeroen: It is important that, if you invest in real estate, it is of good quality and will still be attractive in tomorrow s market. We feel that (with all of the trends leading to urbanisation) investing in cities makes a lot of sense. If we look at our new recently built portfolio in Europe, which is quite sizeable (it will be 3.5 billion in 5 years time), this is mainly focused on cities and logistical nods. We feel that this focus will lead to further stability of investments, which is what we need because our clients decided that real estate should be in the most secure bucket of the return portfolio of our pension fund. Alice: Improving resilience through a city strategy could be better achieved if you do invest in the right city. It enables you to invest in locations within economies that might get written-off, because of a higher perceived level of macro risk or demographic challenges. Germany, for instance, is a market that investors like and it is liquid, mature, and transparent, but it has some real demographic challenges with its ageing population. So, we have identified a small number of cities in Germany (five of them), which have young populations that are growing and outperforming the national average significantly. If you look at a market like China (which many investors don t want to touch, because it is not mature, liquid or transparent) we actually looked at the top four cities and treated them as part of a developed Asia, rather than developing. This allows us to access locations in economies that don t look attractive at the macro or national level. Jeroen: I agree that China will be increasingly important, but I do feel that there are still a lot of opportunities here in Europe. If I look at the quality of investment structures that we see throughout Europe, it is increasingly becoming better. However, if we compare the core real estate fund world in the U.S. with that of Europe we come to the conclusion that Europe only has 1/10th of the size of the U.S., so there is still a lot of hard work needed to make this market more accessible for institutional investors like ourselves. Ben: Do certain sectors thrive more than other sectors in terms of opportunities? Jeroen: We are focused on Europe, and see a lack of opportunities to invest through non-listed funds in the residential market. To my knowledge there is only one pan-european residential core fund. A huge opportunity exists in this sector because people like (and have) to rent their dwelling more and more. The private rental sector will become of increasing importance. IF WE COMPARE THE CORE REAL ESTATE FUND WORLD IN THE U.S. WITH THAT OF EUROPE WE COME TO THE CONCLUSION THAT EUROPE ONLY HAS 1/10TH OF THE SIZE OF THE U.S., SO THERE IS STILL A LOT OF HARD WORK NEEDED TO MAKE THIS MARKET MORE ACCESSIBLE FOR INSTITUTIONAL INVESTORS LIKE OURSELVES Investing in Property, Europe 2017 20

Section 3 - Roundtable Debate We also see an opportunity to invest in the logistical sector. This sector is replacing parts of the retail market and will continue to grow for the next few years, as long as e-commerce penetration keeps on expanding. However also in this market I only see a couple of nonlisted pan-european real estate fund possibilities; some good funds, however with high asset management fees connected. As an investor we would like to work on the initiation of new fund possibilities in this area, with modern fee and governance structures. Alice: We do a lot of work identifying cities that we feel are growing, but it doesn t mean that we ve invested indiscriminately in those cities, as some sectors wouldn t be appropriate at all. What we tend to see is that we have a much shorter target list of cities for offices, whatever region we are looking at globally, because we tend to find that financial and business services (or office employment) is fairly concentrated in a small number of locations. The drivers of the retail sector are much less concentrated, as you tend to find that there are cities that have very affluent populations with very high spending power (but wouldn t have an office market). We have a longer list of target locations for retail, and it is about understanding what makes a city successful that should determine how you deploy capital in that city. By focusing on a smaller number of cities and getting to know these cities quite well, it helps us to understand how it is appropriate to invest. Some places will have high levels of tourist spend, and so hotels might be a more appropriate area for investment. For core strategies, we tend to avoid cities with ageing populations. If you look at Tokyo, which is a leading global city, it does have a significantly older population than other global cities, so senior housing might be appropriate. For cities that have very strong universities, then student housing is a very interesting sector. Ben: Some investors are saying that a growing portion of their investment is going into an other or alternative category of real estate, which includes student housing, hospitals, property for military personnel or the police etc. How do you feel that this other segment is growing as an option for investors? Alice: It is definitely growing and, if you look at transaction volume this year (compared to last year), there is a clear trend. It is partly people recognising these demographic megatrends and their importance. A lot of these sectors are underpinned by ageing populations, or healthcare, student housing etc., and there will come a day when people stop calling these other and they will form part of a core strategy. The challenge is that they have always been grouped as niche sectors. Associating with the word niche is also risky, and the risk is that you tend to need an operating partner to successfully execute it. But many investors who have traditionally stayed in the core space are working out ways of accessing these sectors, whilst mitigating the operational risk. Jeroen: One of the biggest challenges is on the definition side. If we take hospitals, for instance, are they considered real estate or infrastructure? Because of the challenge (in understanding where items belong in your portfolio) it is more complicated to invest in these sectors. I do feel that the real estate industry organisations like the European Association for Investors in Non-Listed Real Estate Vehicles (INREV) can play a good role in defining what is real estate or infrastructure. This will allow for easier investment in these alternative sectors, as sometimes an area is too much on the edge of two different asset classes. Alice: The relationship between infrastructure and real estate is very important. Some of the best pieces of real estate are sitting on top of railway stations, for example, and improving locations in cities are often determined by improved infrastructure. The boundaries between the two areas are blurred, and we do need to stop thinking about real estate as just a single building and, rather, as a broader built environment and how it all works together. The relationship is very important, and where you draw the line is a challenge, but the successful interaction of the two is critical. Ben: In conclusion, are globalised cities changing the way property investment is allocated? Jeroen: This does and has already affected the way that we invest, because we use more investment products that are focused on growing cities. The choice for instance to invest 300 million in TH Real Estate s European Cities Fund was a direct consequence of this. We as a company appreciate these strategies. However, since we are still working with country weights in our portfolio strategy, it seems quite a switch to change to city weights. Alice: It is changing, and will do so more significantly in the future. We were one of the first to formally have a strategy that was based around cities rather than countries, and now everyone is talking about it. There are a lot of copycat strategies out there right now, so it has resonated with our competitors and investors. It is very important for core strategies, as picking winning cities is important when you are thinking about the traditional asset type (offices, retail, industrial etc.). We touched on alternatives (or others ) earlier, and you might have a different strategy or a different set of allocations, so that if you were targeting that ageing population (i.e. senior housing was your game), then perhaps the city based strategy wouldn t be quite right and you would look at scoring locations on a different set of measures. Ben: Thank you for sharing your thoughts on this topic. Investing in Property, Europe 2017 21