A Successful Real Estate Strategy – Both Global and Local
Despite its vast size, the European real estate market remains highly fragmented and localised. Major trends, such as the increasing importance of sustainability, remote working, online shopping, and the shortage of housing in major cities are global, and their impact has been accelerated through the Covid pandemic. Yet the specific impact of these trends on cities, neighbourhoods, and buildings is local and shaped by each country’s history, culture, regulatory environment, and existing infrastructure. That means a successful real estate investment strategy needs to be at once global – informed by a broad understanding of how the world is changing – and local, with each investment grounded in deep knowledge of local circumstances. At Arrow, our local-local approach helps us to apply this local expertise to these global trends in order to identify the best granular opportunities for our investors. We’ll now look into what some of these macro trends are and how they should shape investment thinking.
A Vast, Yet Fragmented Market
Property is the world’s biggest store of wealth with and estimated total value of $326.5 trillion in 2020. It is larger than the global equity and debt market combined, and almost four times the value of the world GDP.
Most real estate is still privately owned. The size of the professionally managed real estate market reached $10.5 trillion in 2020 – only 3% of the total market. Whilst the US and the EMEA market are roughly the same size ($4.1 trillion and $3.6 trillion respectively), the European market is more fragmented: it is spread across more than 40 countries each with its own market dynamics, shaped by each country’s culture, history, and legislation, creating substantial barriers to entry. For example, there are more than 40,000 legal acts currently active in the EU, more than 650 different tax categorisations in force, and no equal access to legal frameworks and financial instruments due to language barriers and the need for local expertise.
Abundance of Capital, Lack of Certainty
There has been a multi-decade trend towards private capital, which we expect to continue as investors expand more and more into alternatives, driven by growing retirement savings, low interest rates and a rise in public market valuations. Between 2010 and 2020, alternative investments across strategies grew from $4.1 trillion to $10.7 trillion (Preqin), with private real estate funds growing from $443 billion in 2010 to $1.0 trillion in 2020.
European equity funds alone currently have $300 billion of ‘dry powder’ (Preqin as of December 2020). Low interest rates and abundant capital have led to intense competition and yield compression across countries and asset classes.
At the same time, the demand picture has become more complicated: technology, sustainability, and demographic change are impacting real estate markets at an ever-increasing rate. The uneven speed of the economic recovery across Europe and recent uncertainty around the inflation and interest rate outlook further add to the complexity.
The challenge then is no longer raising capital, but rather finding innovative ways to source assets and navigate the complex web of global trends and local circumstances. I will now look to explore how these global mega-trends and the Covid pandemic have impacted major real estate asset classes.
Residential: The Way We Live
An estimated 700,000 people left London during the Covid pandemic, and it is not clear how many have so far returned. Other European cities have experienced a similar trend, with residents prioritising green space and larger homes over proximity to their workplace.
Nevertheless, there is still excess demand in every major European city, with cumbersome local planning rules a universal obstacle to the creation of sufficient supply. Indeed, it is standard to see hierarchical planning systems with key decisions made at the local level within a nationally determined policy framework. For example, local planning in England is made by larger local planning authorities and is not legally binding, which allows for more negotiations ahead of planning permission whilst in other countries planning systems tends to be more regulated through land policies and processes.
Despite the considerable uncertainty about future demand, institutional investment in European residential real estate grew substantially during the Covid pandemic, as hotel, office, and retail became too risky for many institutional investors. In 2020, and the first three quarters of 2021, residential investments accounted for 23% of total investment volume, compared to an average of 16% in the five years prior.
While the housing shortage and increased institutional investor demand are universal, the local circumstances are very different in each country – both in terms of what residents’ demand and how building is restricted. One example of how demand differs is the large difference in homeownership rates among European countries, ranging from 41.5% in Switzerland to 73.8% in Portugal in 2019.
At Arrow, we have been supporting innovative housing solutions through, among others, investments in iLiv, an Irish rental housing business, and our partnership with UK residential development lender Maslow Capital.
Office: The Way We Work
The Covid pandemic, with mandatory remote working for months at a time, has changed the way we work. As a result, going to the office five days a week is no longer the default way of working. Employees demand flexibility and employers have to entice staff to the office by offering high-quality space. The office has become a place to collaborate, innovate, and represent. Remote working has thus created substantial uncertainty about the future of office demand, as many companies are only starting to understand their teams’ new work patterns and what that means for their office needs. According to a recent CBRE survey of European office occupiers, 85% of respondents expected the Covid period to have a significant impact on their long-term real estate strategy. As a consequence, there has been a wait-and-see approach with an increase of renewals, for example in the US, before Covid, renewals accounted for 29% of all office leasing activity whilst by the end of 2020, it was estimated to be circa 70% with 43% of these renewals in Q4 2020 being 5 years if shorter.
Regional differences in the approach to remote working are well illustrated by the pre-pandemic starting point. While in Switzerland only 4.1% of the workforce regularly worked from home, in the Netherlands it was already 14% in 2018 and is now 17.8%.
Offices have also been substantially impacted by sustainability considerations driven by tenant demands, investor requirements and government regulations. More than 80% of institutional investors expect sustainability to grow further in importance in the next five years. This in our view creates a substantial risk especially for large suburban building, and interesting upgrade opportunities for centrally located multi-tenant buildings.
At Arrow, we have been cautious in our approach to investing in office buildings, focusing on lending against high-quality buildings in major cities in the UK and Ireland, with a thoughtful approach to sustainability upgrades
Hotels: The Way We Travel
The global hotel industry is comprised of some 18 million rooms, of which approximately 50% are operated by hotel chains, with the other 50% comprised of independent operators. In Europe, the market is even more fragmented, with chain affiliation ranging from 35% in Spain to only 5% in Italy.
During the Covid pandemic, governments offered generous support to the hospitality across Europe, leaving many family-owned hotels with excessive debt burdens as a result. This, combined with the continued pressure from online travel agents on margins, provides a substantial opportunity to aggregate over-levered and under-managed hotels, upgrade them, and manage them professionally making use of technology and selective brand franchises.
Recognising this trend, we recently hired renowned hotel expert Francisco Moser to lead our Southern European hotel strategy and expect to announce our first investment in the sector in Q1 2022.
Retail: The Way We Shop
Covid has had both positive and negative effects on the retail sector. Essential shopping such as grocery, pharmacies are sustaining consumer access to essentials—food, medication, toiletries, etc. At the same time, store closures and large declines in discretionary consumer spending have crippled non-essential retail, such as fashion. As a result, rents and capital values of shopping centres have declined, resulting in many cases of financial distress and the need for large capital injections to recapitalise and re-develop failed centres.
The large regional differences in the retail environment are well illustrated by the chart below: while online retail in the UK accounts for more than 25% of total retail spending, Italy remains below 10%.
The amount of retail space per capita is similarly disparate: while the UK has an average of 4.6 SF per capita, Germany has only 2.3. 
At Arrow, we have been very cautious about retail investments, focusing on high yields, deep discounts, and exit optionality.
Conclusion: Combining Global Insight & Local Execution
Across all property types, despite its size and powerful global forces driving change, real estate remains a deeply local market. Therefore, local expertise is ever more important to execute a successful real estate investment strategy. At Arrow, our “local-local” approach including our origination and pricing expertise helps us to identify and evaluate interesting real estate deals that may not be apparent to other asset managers who only have a presence in London or New York. Generally speaking, the winners in navigating globe trends in real estate alongside local circumstances are those that can harness data, regulatory authorisation, conduct and risk management, local relationships and a scalable operating expertise.
 Savills Research, September 2021, GDP and Population: World Bank as of 2020
 Tomorrow’s Office: Future Directions for Portfolio and Workplace Strategy. CBRE report, February 2021
 Eurostat Employed persons working from home as a percentage of the total employment, by sex, age and professional status (%)
 PWC: Emerging Trends in Real Estate, 2021
 [Add specific STR report referenced]
 Statista Share of chain hotels in Europe in 2019, by country