How to identify future-proof cities for real estate assets

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Alice Breheny
By Alice Breheny*
The best commercial real estate opportunities are likely to be in cities that are poised to benefit from long-term megatrends. TH Real Estate explains how these opportunities can be identified after ranking several hundred world cities. It is not all about population growth.
In real estate investing, as with all investing, it is important to ensure that a portfolio is well poised for the future. For us, that means spreading a portfolio across cities that are most clearly beneficiaries of the megatrends that will drive investment performance over the next 15-20 years. These megatrends include urbanisation, rising middle classes, ageing populations, technology and the shift of economic power from the West towards Asia.
This is not to say that economic cycles do not have an impact on rents, capitalisation rates and values in the short term; they do. But to the long-term investor, they probably matter far less than the megatrends. A future-proof city is one where commercial real estate investments are less likely to be affected by fluctuations in the global economy or in the national economy in which they are located.
To download a paper on the subject from TH Real Estate research, “THINK Europe: Picking Tomorrow’s World Cities”, click here.
At TH Real Estate, we gather global data on several hundred cities, and assess them on the basis of traditional real estate investment benchmarks such as real estate liquidity, transparency, income security and volatility. We also consider the qualities that make them attractive to people and occupiers of commercial real estate, both today and 15-20 years in the future. We look at their current size, wealth, demographic profile, use of technology and way of life. We also consider how each of these aspects are likely to change.
This approach highlights the diversity of cities, even within one broad geographic area, and some surprising facts. Here are a few of the long-term trends in Europe that we have considered.
3 THRE graph 1a
We concentrate our research efforts on those cities that are particularly attractive. In Europe, for instance, we focus on fewer than 50 cities of the 200 for which we have data. These are the cities that have the greatest potential to attract talent, tourists and (international) tenants.
We then group the cities into three categories. Defensive Growth Cities are most attractive, in that our analysis shows them to look attractive now and in terms of their future prospects. Good examples in Europe include London and Munich. However, there are also opportunities in Defensive Cities, whose fundamentals today are extremely strong – such as Madrid, for instance.
Then there are cities whose likely expansion over the medium-to-long term is so great that they simply cannot be ignored. This is in spite of the fact that, in terms of traditional real estate fundamentals – such as lack of liquidity or lack of transparency – they are often fairly challenging places in which to invest currently. As several of the answers to the question in the box indicate, Istanbul is a classic example of such a Growth City: rents should rise and yields should fall as perceptions change for the better over time.
We like to diversify our investments across large (Tier 1) and smaller (Tier 2) cities. This is because the largest real estate markets (such as London and Paris in Europe) often behave in a more similar way than one might expect. This is because they tend to be dominated by business and financial services. It is often the Tier 2 cities – and the Growth Cities – that provide the best diversification benefits.
Sometimes we only focus on one particular sector in a particular city and tend to avoid the rest. Tier 1 cities are generally attractive for all sectors, while Tier 2 cities are usually attractive for retail or logistics. In Growth Cities, rising consumer spending (or tourism) means that the best opportunities are usually in retail.
In short, we aim to build a diversified portfolio across opportunities in selected sectors in the most future-proof of the cities for which we have data. And those cities are varied.

Future-proof cities are not all alike

3 THRE graph 2
*Alice Breheny is Global Co-Head of Research at TH Real Estate, London

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