BDO 10 Dec 2018 09:45am

Building to adapt: real estate in a time of change

Real-estate and construction have always needed a long vision. However, the shifts in the way people work, rest and spend their free time combined with the increased use of digital technologies have led to an increasingly widening mismatch between the timescales required for investment and the expected life of new real-estate projects

Caption: Tension between long-term investment and shorter-term usage is most visible in the retail sector

Appreciation of the risks associated with the changing structure of the property market is feeding through into sectoral sentiment. BDO’s recent survey on global risk found that almost all (95%) of UK business leaders in construction felt that the disruptive impact of changing customer behaviour made a successful innovation strategy critical to staying relevant. This was a factor for just 66% of respondents across all business sectors.

Most commentators are of the view that the UK commercial property market is at the tail end of an up-cycle with the latest Investment Property Forum forecasts predicting falling capital values in both office and retail over the next five years. The change in cycle will impose pressures that real-estate businesses will need to respond to, including potential inflation, rising interest rates and sluggish economic growth. Brexit and the slim majority of the current UK Government has also created political uncertainty with the possibility of a change to a Government with a less favourable view of the property sector.

The tension between the long-term nature of investment in real-estate and tenants looking for shorter term and more flexible working space is creating disruption in the office market.

In retail, the progressive shift of customers to on-line purchasing is driving change. long-established department stores such as House of Fraser and Debenhams are closing outlets; while the big-four supermarkets have re-considered plans to build superstores in their out-of-town land banks.

Those investing in real-estate therefore run existential risks if they fail to be agile in their investments, says Nigel Burbidge, Partner and Global Chair in BDO’s Risk & Advisory practice. “If you have properties that people do not want to let or buy, then you’re in a difficult situation – especially if you borrowed money to build or buy them. And if you bought land for one purpose and that purpose is no longer viable, you need ideas about what else to do with that space.”

Sector leaders see the benefit of greater operational nimbleness. More than three quarters (76%) of the construction respondents feel there is a strong appetite for agility within their organisation, while 81% feel that greater agility would help create a more successful innovation strategy that would enable the company to be more effective.

That agility is manifesting itself. Rising customer expectations for speedy delivery with the explosion in Internet shopping means that centrally located warehouses are making way for the type of big box and urban warehouses, located nearer to end consumers, that companies such as SEGRO provide.

“The demand for warehousing will also be driven by businesses looking for storage space while they rethink their supply chains post-Brexit,” Burbidge adds.

The question is, can the sector as a whole understand demand? The survey results suggest there is still some way to go here: 62% of sectoral respondents said they had only a limited or moderate awareness of customers and their needs.

These needs extend beyond warehousing to new solutions for residential and working environments. Debates are taking place up and down the UK on how to transform urban and suburban spaces, fuelled by the unaffordability of housing, particularly for millennials, and the changing nature of people’s needs for working and living space.

Tapping into the zeitgeist is American company WeWork, which offers virtual and physical shared and flexible workspaces in 30 countries, and which has expanded into residential space in a couple of US cities. Meanwhile UK company The Collective rents en-suite rooms in a number of shared central London spaces as well as co-working hubs around the city.

This may represent just one of a number of trends found across generations and shows that there’s room for much more agile and innovative thinking to combat market risk, says Burbidge. “There is still reasonable demand for office space but companies are encouraging employees to work flexibly. That has an impact on the way homes are designed.”

Mixed urban developments have a role to play. Large-scale projects such as the Battersea Power Station redevelopment offer a mixed use of office, retail, leisure and residential facilities. More new space will be created to be multi-functional. “The businesses that manage to create very flexible space are going to be the ones that are most resilient to changes in taste and demand than those that are fixed into a rigid way of thinking,” says Burbidge.

Real-estate companies that are nimble and successful in creating flexible usage still face other types of business risk. About 85% of survey respondents in the construction sector were concerned with increasing competition while 81% cited macroeconomic risks. Neither of these are new, says Burbidge: the real-estate and construction sector has always been highly competitive and its fortunes closely linked to those of the wider economy.

The bigger problem, he thinks, comes from the risks associated with computer crime, which 76% of survey respondents identified. “Say you create a building that is populated with gadgets using the Internet of Things. The danger is that these gadgets can all be hacked. Companies that are putting up wired properties need to understand the risks associated with this and keep on top of them.”

Be agile, create innovative and flexible products, and keep on top of emerging risks, are Burbidge’s main pieces of advice for real-estate companies. “Most of all, companies have to stay one step ahead to be able to meet the transient needs of a constantly changing market,” he concludes.

To find out more about the survey findings and BDO’s insights into their implications for risk management, download the full Global Risk Landscape 2018 report