Investing in real estate: what to do with the highest rates

In a market environment characterized by rising rates, high inflation, volatility, and significant economic and cultural changes, it is crucial to understand what opportunities the real estate sector can offer. In the face of a stock market that started 2023 on the upside and a bond market characterized by bonds and BTPs offering attractive yields, what role does housing occupy today within the portfolios of Italians?

We Wealth asked Alessandro Lombardo, the chief commercial officer of the Gabetti Group, who outlined an exciting market for the current year, especially if one invests in specific and selected sectors.

REAL ESTATE, EQUITY, OR BONDS

Lombardo, compared to equities and bonds, which are more exposed to the turbulence of the current economic environment, with rising inflation and rising rates, what are your expectations for the Italian real estate market?

Compared to the stock and bond markets, which are more exposed to turbulence in the macroeconomic environment, the real estate market has been more resilient. In fact, as Gabetti Group, we observe that the real estate sector remains in positive territory precisely because of the effect of inflation itself on the growth of property values. Not only that, the consequences of the pandemic and high energy prices have produced a new increase in demand thanks to the presence of new drivers driving the market.

In particular, residential is showing different characteristics than in the pre-pandemic period: there are, in fact, new needs for those who have stabilized their working condition between the office and smart working and will need an extra room to work in; moreover, the increase in energy costs will push many families to replace their home with a better performing one; and, again, the growing sensitivity to home automation and technology will lead many toward the purchase of new or recently renovated buildings.

As for rates and mortgages, at the moment, the rise in mortgage rates is not of such concern that it will have a significant impact on buying and selling.

ASSET ALLOCATION

What is best to do in this market environment: buy, decrease the weight of real estate in portfolios, or wait?

In an international environment still dominated by galloping inflation, real estate investment is still considered by many to be a haven asset, especially from a long-term perspective. Nevertheless, the turbulence of the geopolitical situation and the current economic environment are prompting many players to adopt a cautious, wait-and-see attitude.

In this scenario, the investment opportunity lies precisely in the ability to anticipate events, which means anticipating competitors and urban transformation processes.

When demand is contracting, market spaces increase, allowing operators to enter them more quickly, especially in terms of greater supply availability; therefore it is already positioned on the different asset classes when the geopolitical and economic environment will soften and investment demand will return to growth; reducing market spaces is advantageous.

A second dynamic, which is growing on the Italian scene, is to bet on so-called secondary locations with a high concentration of infrastructure projects (such as Genoa, for example), whose grounding is planned over a long-term horizon (10-15 years).

REAL ESTATE X-RAYED

Real estate is wide-ranging-what sectors, cities, and trends are worth focusing on in 2023?

In the year just ended, among the best-performing asset classes in terms of investment volumes were confirmed to be offices, followed by logistics. Asset classes that, thanks to their adaptability and resilience, were still attractive to institutional and professional investors, taking the podium of the most profitable investments. Thus, office space has expanded, and the occupation of new spaces marks an increase in this asset class, likely affecting the future.

Other trends that will drive demand for new real estate products in the short term-such as the aging population, the emergence of new models of living, and new forms of hospitality that have arisen post-pandemic (experiential, smart, and co-working rooms, digitization)-open up significant investment prospects on asset classes such as income-earning residential (co-living, private rented sector, known as Prs, multifamily), senior living, and hospitality, with higher returns than in 2021 and 2022.

In the hotel sector, several transactions-which as Gabetti Group, we have followed-show that renovation and re-branding are the most influential determinants in property revaluation transactions, with values as high as +35% compared to pre-renovation value.

Even the retail asset class, which, along with hospitality, has suffered the most from the restrictions of the pandemic, will return to be a significant player in the real estate market in 2023.

Finally, the issue of ESG, which cuts across the commercial real estate world, has proven to be an excellent opportunity for the sector given the supply that cannot meet the high demand for products with high ESG standards.

It will also be crucial to follow the geography of these trends.

Milan, the preferred city for international institutional investors, is the metropolis experiencing the most buzz, thanks partly to the Olympic event expected in 2026.

It is followed by Rome, which is increasingly trying to attract institutional investors and expand its offerings of innovative housing products (mostly income housing, student housing, and hospitality).

But attention will also have to be paid to some secondary cities, such as Genoa and Bologna, markets in which we are also present in light of the many innovations affecting them.

THE RETURN ON BRICKS AND MORTAR

How much would a residential investment yield (on average), both in the case of rental and resale on the market? And again, in the case of renting, what strategy do you suggest adopting: better short or long leases?

It depends on the type of product and the target audience. Right now (as anticipated above, ed.), we see strong interest from investors for residential income, which in real estate jargon is recognized as living.

Depending on the rental strategy one intends to adopt, whether short- or long-term, one turns to two different but still-performing market models precisely because they meet the needs of new demand.

Long-term residency is a model offered through a private rented sector (Prs) product, with service models designed for the individual, which respond to those who, for work reasons, need to spend long periods in a city other than their city of residence.

Short-term residency, short-rent business, or vacation, on the other hand, responds to short-term but frequent stays in the same city.

Both strategies cater to a high-income target (entrepreneurs, teachers, professionals, managers) increasingly present in several Italian urban areas.

Income-earning residential, whether in the form of the private rented sector (Prs) or short rent, guarantees the investment for two reasons: real estate revaluation in the long run and high returns sustained by the rent.

PROS AND CONS

To conclude, what are the pros and cons of real estate investment in the current market environment?

The real bogeyman is rising interest rates. Those who buy or build income-producing residential by resorting to structured financing will have to consider the weight that the rate will have on the income produced by the rental to check the marginality of the investment in advance.

However, this type of investment can count on some fundamentals: higher rents than traditional residential, a fast-growing demand pouring into prime and secondary Italian locations, and yields around 5.5 and 6.5 percent.

Alessandro Lombardo, chief commercial officer of Gabetti