Institutional investors in real estate: have you moved on from thinking in terms of sectors?

A fresh look at Dutch city centres

Institutional investors with an allocation to real estate, especially pension funds and insurers, usually invest via sectoral property funds. Yet in today’s society working, living, shopping and recreation merge seamlessly together thanks to a process of spatial function blending that has been visible for many years. This blog argues that it’s better to move away from compartmentalisation and instead seize opportunities for repurposing city centre properties.

Lower demand for shops is here to stay

Structural changes such as online shopping have led to a steady decline in demand for retail real estate in city centres - often referred to as the high street - in Dutch cities over the past few years. This trend has been accelerated by the Covid-19 pandemic. As a result, more shops are expected to become vacant, which will in turn push down average general rents and values. A potential problem for investors in property funds with a sector-specific retail strategy. This raises the following questions:

You won’t find the solution to high vacancy levels in inner city areas in an allocation to a single specific real estate sector. To structurally improve city centres, it’s essential to stop compartmentalising and thinking in terms of sectors and to actively set out to transform unused floors of buildings and vacant retail spaces.

Mixed use in the city centre

We’ve seen function blending in urban areas for many years: people like to work, live, shop and play together. They prefer to do so in city or neighbourhood centres, which continue to be attractive areas, precisely because there’s more to do than just shop.

• Central locations with good amenities that are often also easily accessible are highly sought-after among house hunters. There’s a severe shortage of housing for first-time buyers or renters and it’s precisely this group that wants to live close to a wide range of amenities;
• At the same time, retailers seek customers and are happy to see residents spending more time in the city centre. Much of the space above shops is already empty - add vacant shops and this could be turned into residential space.

Transformation into residential properties therefore provides investors with attractive opportunities. There are plenty more options though. Mixed-use buildings that combine functions, like combining shopping with working or living with recreation, are also popular.

Core investments in sustainable real estate

In today’s uncertain and flexible world, most institutional investors seek what are known as core investments: real estate with a relatively low risk profile, or in other words properties with a stable rental income. Many investors currently view retail real estate as too risky because of the uncertain and volatile rental income. Yet changing or blending functions can reduce this risk profile. Mixed-use buildings offer more stable rental income and from that perspective are ideal for inclusion in a future-proof portfolio. There are also plenty of options for making the portfolio ‘greener’ because of the many ways of making buildings more sustainable during their transformation from shops into, for example, homes.

Supply of mixed-use buildings

Mixed-use new builds are already being completed on a small scale, one example being The Valley in Amsterdam Zuidas. Such buildings rarely find their way into the portfolios of institutional investors because they traditionally still think in terms of sectors. Those mixed-use buildings that do end up in institutional hands are often legally divided and their ownership split across different sectoral property funds. This is often detrimental to the design and/or use of the building. In the long term, there’s the potential for conflicts of interest, for instance if one of the funds wants or is forced to sell or redevelop part of the building or make it more sustainable. 

Successful transformation is a challenge

Creating a mixed-use building is a complex process and it certainly isn’t necessary or even an option for every shop or location. The main obstacle is the difference between the retail property’s book value and the value of homes, hospitality venues or workplaces. Whether transformation is feasible depends on all kinds of factors, such as the building’s location, its current use, the profile of the tenant(s), available floorspace, parking facilities, physical layout, façade or historical value. The best candidates for transformation are generally larger properties in city centres, but in some cases unused spaces above solitary shops also offer opportunities for creating apartments, for instance.

A couple of examples of city centre transformations from shops to mixed-use buildings:

• Shopping centre In de Bogaard in Rijswijk is to be partly redeveloped, with the former V&D store and part of the old shopping centre making way for homes;
• the former Hudson’s Bay site in Zwolle is to be transformed into a supermarket, hotel, hospitality venues, apartment complex and underground bicycle park;
• the former Hudson’s Bay site in Rotterdam is to be turned into an office block with retail spaces on the lower floors.

Many of the buildings that need to be transformed are in the hands of institutional investors but often end up being sold to developers as transition doesn’t match their sectoral investment strategy or the fiscal aspects of redevelopment wouldn’t be a good fit in the fund. This sometimes means that opportunities remain untapped. Finally, the transformed buildings are later often sold back to institutional investors and divided across (different) sectoral funds. This division of functions reverses the reduced risk profile of the mixed-use building.

Conclusion: seize the opportunities offered by mixed-use solutions and stop thinking in terms of sectors

In the right location, transformation yields fantastic opportunities for retail properties. To take advantage of these we advise institutional investors to move away from traditional compartmentalisation into sectors. This paves the way for earning more stable returns, making portfolios more sustainable and creating a social impact by contributing to themes such as solving the housing shortage.

If you’d like to discuss this topic in more detail, please don’t hesitate to contact me via Casper.vanGrieken@cbre.com.