Admittedly, the title is rather martial. However, it does illustrate the tense relationship between two asset classes that are currently highly prized by investors. Residential is the newcomer, office is the perpetual leader. Let’s take a look behind the scenes though: the fact that residential appears here at all comes at the cost of the perpetual runner-up: the retail segment. Among major investment groups, we are witnessing slow but steady growth in residential investments and a slow but steady decline in retail investments.
The dominant positioning of office investments on national and international markets over the past five years tied in with residential and retail swapping ranking places seems to be more structural than tactical. In simple terms: residential has come to stay—and retail will be at odds with its new place in investor hearts as long as the issue of “e-commerce” is still widely unresolved.
Which of the two asset classes will now provide the adequate profit contribution for investors? The traditional positions are “high cyclicity with the economy” for offices versus “high local/regional correlation” for residential real estate, “10-year rental agreements” versus “more frequent tenant changes”. This list could go on, but it does show that the element of capital market theory is often missing from analyses. In particular, the new appreciation of residential investments can be explained above all by the development of interest rates over recent years. To get straight to the point: uninteresting, but adequate returns from residential investments are suddenly enjoying a completely new appreciation as regards the long-term nature of real estate investments in a zero interest environment. Other push factors have been urbanization, demographic development, surplus demand in urban locations, and so forth.
Furthermore, at property level in the new building segment, we can definitely see very high construction quality—particularly when compared across Europe. Investors can thus make comparisons—and as long as the influx into urban agglomerations and metropolitan regions continues and the supply only grows slowly, the structural rent increase potential is an additional aspect. Direct comparisons with New York or London are not really appropriate, but we are clearly moving toward the international level when it comes to growth rates.
One further important aspect: a very heterogeneous sub-market structure is concealed within the residential segment, we are talking about things like “student housing”, “serviced apartments” and “urban luxury living”. Following the logic of investors, the diversification potential within this asset class is considerably greater than in the more uniform office structures. It seems that apartment investments win this round.
At the same time, the office market faces the supposed threat scenario known as “co-working”—this should be called “flexible workspace” to be correct. The pressure on long-term rental on the one side and the necessary flexibility of companies and employees on the other are becoming visible and above all measurable. Nonetheless, we definitely should not ring the funeral bell for the office segment and its 10-year rental agreement approach. Much of what distinguishes this structural transition occurs in economic boom phases.
The logic of investors comes into play again at this point. Of course, “co-working” may be cooler. However, there has been no market adjustment so far and these modern models are subjected to considerably more pressure during economic downturns than the traditional models. Any real estate valuer will see the “devaluation facts on the market” here. We know investors fear this, like the devil fears holy water. On top of this, the current excess demand on the office market (where are real new office building plots in city locations?) constitutes the economic driver per se. There is therefore no reason to lose faith in the office investment market.
To conclude, here is another major argument in the “asset class” battle: whether residential or office real estate, both have their economic and social function. The current boom in residential may be explained in tactical terms—and this can be seen at EXPO REAL from year to year in an increasingly impressive way. Nevertheless, writing off office for this reason would be a massive management error in view of the coming years.
Managing Director of Catella Property Valuation GmbH