Living sector investing during the pandemic cycle
The reverberations of the Covid-19 pandemic will be felt throughout real estate markets long after a successful vaccine defeats the virus. It is already six months since most of the world first entered quarantine, which has upended real estate asset management strategies, equity and debt liquidity as well as performance expectations. But within the Living sectors – from Build-to-Rent (BTR) (or the Private Rented Sector (PRS) more generally), to Student Accommodation and Senior Living – while near term strategies have shifted, the long term investment thesis broadly remains intact, albeit with notable sector variation.
In this context, the Living sectors are a microcosm for the broader real estate markets; with a mixture of resilience (e.g., BTR and PRS), uncertainty (eg., student accommodation); and some distress (eg., care homes). While most managers contend the fundamental long term demand drivers supporting Living sectors will endure, supported by demographic trends, new downside risks need mitigation, and previously unlikely opportunistic acquisitions may come into play. For private equity real estate investors, this is the chronological focus of attention.
First, due diligence assumptions underpinning existing portfolios need revision – with a forensic focus on tenant covenant strength, occupancy and rental growth assumptions, delaying capex and development plans, refinancing and seeking loan repayment holidays as required. These revisions all create some uncertainty around valuations which together will influence revised asset, portfolio and fund-level return expectations. The priority will be to identify where distress may emerge within existing portfolios and adjust asset management strategies accordingly. Likewise, lenders will be vigilant of sector exposure which will influence future finance liquidity, LTVs, margins and covenants. Second, private equity investors’ attention will turn to opportunities that may arise from the liquidity crisis impacting some commercial landlords. While the pandemic has reaffirmed the resilience and long-term growth potential of Living sectors such as BTR and PRS, some distressed opportunities may emerge as corporate liquidity pressures prompt sale of relatively stable assets.
Within the student accommodation sector, near term downside risks to international student demand have tempered long-term demand drivers optimism. Investors need time to determine how much demand reduction is temporary and permanent. The long term impact on future demand for campus-based student learning is not yet knowable. For example, if the legacy of the pandemic cements permanent behavioural shifts in higher education, student accommodation spaces may require reconfiguration. The Senior Living sector is also ripe for accelerated change. For example, new health and safety regulations may impose higher operating costs such as in a possible increased requirement to store more personal protective equipment (PPE) and regular, comprehensive hygiene. However, these sectors’ potential need to adapt does not undercut their future investment appeal, and investors will be ready to capitalise on existing owners that believe otherwise or who become distressed sellers. Indeed, many private equity funds have raised fresh dry powder to exploit anticipated dislocations to come. The skill will be in identifying opportunities that disentangle distressed owners from temporarily distressed assets; differentiating between short term liquidity problems and long-term solvency crises.
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