High inflation and geopolitical concerns have dealt a double blow to the real estate sector globally. As China continues to suffer under the weight of a collapsing real estate market, raising alarm of a potential domino effect across geographies, JLL CEO and president Christian Ulbrich weighs in on the risks and the opportunities, and where India stands. Interview by Rajeev Dubey.
What is the current state of real estate globally?
Real estate values are influenced by cost of capital, which is influenced by interest rates. What we have seen globally are extremely low interest rates for a very long time, which then spiked up in a very short period. This means values have to adjust to the new interest rate requirement, which takes a bit of time. There is a lot of pain in the system because mathematically, if the interest rate for a 10-year bond in the U.S. moves up to 5% from 1.5%, there is an increase of more than 300%, which has to reflect in real estate values. This has led to a situation where the transaction volume — how much real estate is being transacted from a commercial perspective — has dropped more than 50% for offices, and if you go over a two-year period, it's actually 80% on a global basis. That is a crisis in the global real estate market.
World over, very few pockets have been doing better. For instance, in Japan, a little bit of inflation has helped create interest in the market. The economy is not doing badly there. India, on the other hand, is a massive beneficiary because of the tension between China and the U.S.
What do you see as the biggest geo-political risk in realty?
The amount of risk that has come to surface in the last couple of years is impacting the real estate market globally. If we start off with the Russia-Ukraine war, it has driven a massive spike in energy prices, along with supply chain issues coming on the back of the Covid crisis. Real estate is an illiquid asset, and if you invest in an illiquid asset, you have to have a long-term perspective. Over the last couple of years, with so many global crises, the world has become a very unpredictable place. Look at the long-term geo-political conflicts between China and the U.S., and Western Europe. Those kinds of conflicts drive uncertainty and have repercussions on the real estate market worldwide.
How are consumer preferences changing for the industry?
Let's take retail. From physical shopping to online buying, there's been a massive impact on real estate and retail assets. Building owners have had to beef up their game and create an experience for the retail customer. Why would the consumer come into the store to pick up a good that they can buy online? The whole experience that a consumer gets in a store has to be different. Hence, we have much better stores now, much better shopping experiences and much better real estate to provide that experience. Similarly, if the only reason you are coming to office is to do work by yourself in a dull environment, you can argue, why do I go to office? You have to have a broader experience, a chance to collaborate and innovate with your team members. Today, behavioural patterns drive what real estate is delivering and what buildings have to offer.
High interest rate and inflation are like a perfect storm for the industry apart from disruptions caused by changes such as energy transitions. How are real estate firms dealing with them?
We have to separate interest rates from inflation from a real estate perspective. Interest rates have a huge impact on the cost of capital and the way you refinance your investments, so you need prices to come down if the cost of capital goes up. Inflation depends on whether industries have a pricing power so that they can raise prices and absorb inflation. A good example is food stores. Usually you have an indexed rental contract, so you could argue from a landlord’s perspective, if I have a successful food chain in my building, and as long as it is able to raise prices, they can still pay a higher rent. Consumer goods and software companies have been very good in raising prices, but there are other industries that have been unable to do so. So, they cannot pay a higher rent driven by inflation. Whether you have the right tenancy profile in your building decides whether inflation can become a risk.
What is your view of the Chinese real estate crisis?
China is a very large country, and, traditionally and culturally, a high focus is on people to own their apartments and housing. People have to make down payments before they actually receive the finished product. A large number of Chinese citizens have made down payments and their products have not been delivered. They are at risk of losing all their savings, a very disturbing situation for them and the government, which has a negative impact on the economy. Going forward, the Chinese government will try to bring in more regulation so that there is less speculation coming out of the residential property market.
You are saying India is one of the few markets seeing growth. What kind of vibes are you getting here?
India has a very large population, the largest in the world, and a massive amount of young people coming into the workforce. Most Western countries have a shortage of educated workforce, and hence, it is a plus for India. India has been very decisive in investing in digital infrastructure and bringing a lot of tech-savvy talent out of its universities. Most of the problems in the world can be solved by technology. You need a lot of smart people, and India is delivering those smart people. In that sense, India plays a super important role for the wealth of the world, as an important place for production and technology development. India's development will continue because all the metrics are in its favour.
What demands are being placed on real estate firms and managers with regard to sustainability? What are the ways this has to be dealt with?
JLL is first and foremost an advisor. You are advising your clients on how they can create value not only in the short term, but in the long run too. If you invest in an asset that's going to be there for 50/100 years you have to be very good in looking ahead. We trained ourselves and our people massively. In some cases clients need convincing because a developer will say what's my benefit? If I develop a green building do I get a higher rent or a higher value now? It needs a lot of convincing that they shouldn't see only the next two-three years, but long term as well because that building needs to be leased for 40-50 years at least.
One of our tasks is to widen the perspective of our clients that they should do these investments now in order to have the right returns in the long run. The built environment is responsible for 40% of carbon footprint, which has a lot to do with the construction of the building and its operation. So, it's important to create buildings that are sustainable in their life cycle and can be used for long. If you go to Paris and see their architecture, those buildings are more than 100 years old and everybody strives to own one of them. That is sustainable architecture.
Going forward, we will see a lot green concrete usage. Also, if you want to have light but just plain windows, it's difficult from an environmental point of view. You have to deal with the impact of the sun and cold. So again, a balanced building is more sustainable than going to the extremes on either side.
Right now there seems to be an inclination towards glass façades…
It's not environmental-friendly. Maybe we get to a point that glass facades are solar panels and you can look through them, so if the sun is getting on to a glass façade, you have to make a lot of effort to maintain the temperature level. We have seen buildings in the past with little windows, which people don't want now because they want light. They had an era with a lot of glass windows. So, a plain glass façade is quite challenging from a sustainable perspective.
At JLL, you've been doing a lot of plugging in of segments in terms of acquisitions across your ecosystem…
As in every industry, we are faced with a lot of cost pressure. Inflation is a big challenge for us because our income is derived from the value of the underlying assets we operate with. If asset prices come down, rental levels come down, income streams get reduced. At the same time, people expect higher salaries, and it's not a pleasant squeeze for us. We have to offset that by scale and efficiency. What concerns me about not just our industry but the world is that we have been deglobalising for more than 10 years since the 2008 financial crisis. We see an increasing amount of local regulation. Think about a global company being faced with a lot of local regulation. We have to constantly adapt to the local regulations, which is expensive. What it will do is to lead to global companies reducing their footprint in smaller countries. New York has a different ESG regulation than San Francisco or Dallas. In Europe, different regulations in different countries are concerning and a massive disadvantage to global wealth creation.