What can real estate expect in 2021?

After rain there is sunshine, as a Dutch saying goes. And if you have as much rain as we do, you know what you are talking about. So, can we expect sunshine to return in 2021, after this very ‘rainy’ 2020?

Fortunately, sunrays broke through in the US. The economy turned out to be the most important factor (38%) for voters, not covid (18%), which almost cost Joe his election. The statistical pollster models were wrong again, suffering from cognitive bias, while as more data are published, mortality comes in below projections and economic damage beats expectations. Furthermore, vaccine tests look promising. Optically there is a trend emerging and we can have hope for 2021.

Before we can answer how this will affect real estate markets, we should delve into the past to understand the current situation. Post-WWII we had the welfare state-led rebuilding era ending with 1970s stagflation, then the markets-driven globalisation era terminated by the global financial crisis. Today our new era is experiencing its first major downturn.

The early 1980s real estate crisis was severe, the ‘patient’ critically ill. The rebuilding era was based on real wage growth, welfare safety nets and interventionist government policies. All this overheated in the dark 1970s and caused stagflation, i.e. high inflation with no economic growth. This is probably the most adversary environment for real estate (imagine 15% interest rates, 10% inflation and 7% prime yields). This was an external disease, and it wasn’t until Dr Reagan and Dr Thatcher performed the critical surgery that our patient was able to recover to full health.

The liberalisation of capital markets was positive for real estate, and the changing attitudes to risk linking it with return created a development boom to support the growing economy financed by a deregulated banking system. The 1990s real estate crisis was hence a typical pig cycle one: excessive development of capital-intensive product based on too optimistic forecasts funded with debt.

The fallout was substantial, with many operators shutting up shop. However, the solution found revolutionised the real estate industry: equity markets. REITs were around before, but the crisis changed them forever with governments offloading NPL portfolios as IPOs and troubled operators refinancing in surging equity markets. Germans, not fond of equities, used a private market route: open-ended funds. The patient had a big post-op hangover but recovered with this new drug.

One of the reasons for the surge in equity markets was baby-boomers reaching mid-life, meaning they had savings and long enough distance to their retirement to invest in risky assets, and as the new generation they invested in the technology of their time: the internet. This led to the tech bubble crisis of 2000; an external disease, but it did not infect our patient. In fact, it soon realised this drug had just been enhanced multifold with this new ingredient: derivatives.

Just as the first baby-boomers reached pre-pension stage, i.e. pension plans replacing equity with debt, and risk became established as a return play protected by the ‘Greenspan put’ (bailing out losses), new derivative-based debt products attracted a growing audience willing to take on more and more risk…

We all know what happened next. The party ended with the GFC, which signalled the end of markets-driven globalisation. Through bailouts, debt burdens moved from private to public sectors and because financial oversight and public debt risk management require jurisdictions, globalisation has gradually retreated since.

Our patient was critically ill again, needing four years to recover, and woke up in a world where the attitude to risk had dramatically changed. Monetary easing created a near zero interest rate environment and austerity low economic growth. It was almost the mirror image of the 1970s, but whereas stagflation was detrimental for real estate, the current environment made it relatively attractive as an asset class. The result was an unprecedented surge in asset allocations. While the real economy was retreating from globalisation, real estate was indulging in it.

And now the patient has covid. Fortunately, it was in good health without co-morbidities: contrary to 2008, debt levels are moderate, mostly locked in and long-dated, while risk avoidance and government intervention had restricted new supply unlike the 1990s. However, blood pressure is elevated with rents and prices at historically high levels, its foreign medicine in the form of international capital no longer as easily available, and it also must adapt to a new lifestyle as technology is changing the way the world lives.

To make matters worse for our patient, its doctors are divided on treatment. Some want to use the 1950-1980s medicine, some the 1980-2008 one and some advert North-Korean-style self-isolation. The reality is that the patient needs oxygen to recover; the longer it is deprived of it by wearing masks, the deeper and longer the downturn will be.

It is within these conditions that the real estate industry must deal with the biggest drop in demand it has experienced. The other crises revolved around investment criteria, oversupply and over-leverage, and the drop in demand was a consequence not a cause of the problem. Hence, the industry needs new solutions: business skills.

In my view, real estate is becoming more operational, with technology an important instrument. Marketing-wise, it moves from a push to a pull strategy (delivering individual solutions rather than cheap mass products). As a result, operators will have to not only lower rents to unlock demand, but also at the same time invest to innovate their products, which can then attract new customers and demand premium prices. A tough but unavoidable process. Even though balance sheet restructuring is inevitable, it is only part of the solution this time.

On the bright side, lower entry pricing elevates potential returns, while product innovation breaks down barriers to entry, so from an economic point of view ample opportunities should emerge for smart businesspeople. The only thing holding us back is risk avoidance, which is so abundant in today’s politicians and almost omni-present in the main media outlets. Unless we as a Western society embrace risk again, our patient will not recover.