The Return to Cannes: Takeaways from MIPIM 2022
Head of European Investments Christopher Mertlitz discusses the major themes emerging from one of real estate's biggest events
Following a pandemic-induced hiatus, MIPIM, Europe’s largest real estate event of the year, finally returned to the idyllic city of Cannes. More than 20,000 attendees eagerly came out to meet in-person and discuss the most prevalent topics and issues impacting the real estate sector. During my experience at the four-day event, the following major themes unsurprisingly dominated most of the conversations: rising interest rates and inflation, the conflict in Ukraine and ESG. Here’s my take on how those may impact our business and the broader European real estate market.
Interest Rates and Inflation
Similar to the U.S., inflation in Europe is reaching highs not seen in several decades with euro area inflation hitting 5.8% in February, driven primarily by rising energy prices and supply chain challenges.
As a result of fast-rising inflation, central banks worldwide will likely pursue an increasingly hawkish strategy, bringing forward interest rate increases. All-equity buyers like W. P. Carey may be better positioned to execute on deals in this environment since they are not reliant on third-party debt financing. From a seller’s perspective, the timing to pursue a sale-leaseback may have never been better – locking in a long-term rental rate now while cap rates remain low, and before interest rates begin to rise significantly.
War in Ukraine
We are incredibly saddened by the events unfolding in Ukraine and are committed to doing our part to support those in need. As of now, it’s difficult to say how exactly the war will impact the real estate market but it will likely continue to stoke the flame of rising inflation globally due to economic disruptions which could further impact interest rates and borrowing costs. It’s also possible that some companies may take a “wait and see” approach to investing in neighboring countries to Ukraine and Russia until there’s more clarity on when the conflict will end.
Focus on ESG
ESG remained a prominent topic, particularly as regulatory and disclosure requirements continue to increase, forcing companies to define concrete, measurable goals. With the main theme of MIPIM being “driving urban change,” there was certainly a lot of discussion surrounding how the real estate industry can tackle climate change and net zero emissions as well as ensuring sustainability of new developments.
At W. P. Carey, we are intensely focused on ESG. In 2021, we invested in several green buildings, including the acquisition of a 1.1-million-square-foot, BREEAM-certified logistics facility in the U.K., net leased to Jaguar Land Rover. We also issued our first green bond offering last year with $350 million of proceeds earmarked for green projects.
From an asset management perspective, we take a proactive approach to communicating with our tenants on sustainability projects that can reduce their environmental impact and reduce operating costs, such as solar panels and building efficiency retrofits. For example, we worked with our tenant Sonae MC in Portugal on the installation of a solar roof which was completed last year. We also worked with our tenant Nippon Express on the installation of a one-million-square-foot solar roof, which is now one of the largest solar rooftops in Europe. While we still have much progress to make, we are focused on reducing the carbon footprint of our portfolio and believe that green buildings are not only beneficial for the environment but can also have a significant business impact for W. P. Carey, including increasing property values, driving higher rents and attracting high-caliber tenants.
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Fighting Back Against Inflation with Real Estate
Inflation is at its highest point in 40 years. The consumer price index – a key indicator of inflation – rose 7.5% in the 12 months ending in January, far surpassing initial predictions from economists. For CFOs, this has meant a rapid increase in the cost of raw materials, manufacturing and overhead which significantly cuts into a businesses’ cash flows. In addition, the US is currently in the midst of a labor shortage stemming from the COVID-19 pandemic. This has forced CFOs to increase wages and other compensation in order to secure and retain talent – another big blow to a company’s cash flows. To fight mounting costs, CFOs need to take a look at their company’s assets and find ways to free up capital on their balance sheets. One often overlooked asset is a company’s owned real estate. For companies not in the business of owning real estate, these assets add a significant weight on the balance sheet. However, through a sale-leaseback, companies can sell their real estate to an investor for cash while simultaneously entering into a long-term lease. The benefit of this type of transaction is that companies can realize 100% of the value of an otherwise illiquid asset and can immediately invest that capital back into their core business. In today’s high-inflationary environment, this capital could be used to offset immediate rising wholesale and labor costs in addition to funding long-term growth initiatives. Furthermore, companies can retain full operational control of their assets following a sale-leaseback, meaning there’s no disruption to day-to-day business. Now is also a particularly attractive time for CFOs to consider sale-leasebacks due to a number of macroeconomic factors. First, the U.S. Federal Reserve has signaled that they plan to raise interest rates as early as this month to counteract inflation. However, if a company pursues a sale-leaseback now, they can lock in today’s lower rates on a long-term basis. Second, competition for high-quality real estate – particularly industrial assets – remains at an all-time high due to investors seeking long-term, stable cash flows. As a result, corporate owners can secure a high price for their real estate, in addition to attractive lease structuring, giving them the opportunity to fully maximize the amount of proceeds they receive. Inflation certainly won’t last forever, but even a few months, or years, of rising prices can be devastating for businesses. While there are a number of tools CFOs can leverage to mitigate the impact of inflation, sale-leasebacks should not be overlooked. Unlocking the value of corporate real estate and reinvesting those proceeds back into the business can not only help companies ride out the current wave of rising prices, but also set them up with the capital needed for long-term growth and success.
W. P. Carey's Approach to Sustainability
Net Lease REITs are unique because our tenants typically retain operational control of the property. This structure has enormous benefits for both landlord and tenant. The landlord is not exposed to operating costs or capital expenses and is able to own and manage a large and growing portfolio very efficiently. Meanwhile, the tenant retains operational control, enabling them to adapt the property to their specific operational needs. W. P. Carey prides itself on its proactive approach to asset management. Our goal is to create long-term relationships with our tenants, proactively working with their management teams to optimize their real estate to meet their evolving needs. In recent years, sustainability has grown to be a top priority for W. P. Carey and our tenant base alike. While the net lease structure has many benefits, it presents some challenges when it comes to helping our tenants reduce their carbon footprint. First and foremost, without direct operational control, it can be difficult for net lease landlords to access property-level emissions data in a scalable way. However, with real estate being one of the biggest contributors to global greenhouse gas emissions, net lease REITs must create the systems and processes to facilitate collaboration with our tenants to reduce the carbon footprint of the portfolio. To tackle the challenge, we employ a three-phased approach to quantify and reduce our portfolio’s global carbon footprint: Step 1: Data – Scalable systems to collect and analyze our portfolio’s carbon footprint data The first step – and perhaps the most challenging for net lease REITs in general – is to collect tenants’ energy usage data to accurately analyze and benchmark our portfolio. In 2021, W. P. Carey launched a program to leverage a suite of SaaS platforms to collect utility data in an automated and scalable manner. The data feeds into our proprietary business intelligence platform, enabling us to track energy usage, identify outliers and opportunities, and integrate with third-party benchmarking organizations. It also enables us to equip our tenants with tools to better manage and benchmark their own energy consumption. As of December 31, 2021, we’ve collected data from tenants representing over 30% of annualized base rent (ABR). In 2022, we intend to further expand this program throughout our portfolio. Step 2: Engagement – Systematic tenant outreach and collaboration The next step is to proactively engage with tenants to jumpstart actionable conversations that lead to projects that reduce carbon footprint. At W. P. Carey, each asset manager is responsible for a portfolio of tenants across all property types and regions. Our asset managers develop long-term relationships with tenant management teams, providing a direct and ongoing dialogue about the tenant’s business and how they can operate more effectively in their real estate. These conversations have created direct opportunities to pursue sustainability projects that both lower tenant operating costs and enhance W. P. Carey portfolio value. Step 3: Action – Targeted sustainability projects that lower carbon footprint The final step is to act on the insights and identify property-level sustainability opportunities within the portfolio. Sustainability projects fall within five key areas: renewable energy opportunities, building energy retrofits, existing building green certifications, new construction green certifications and tenant energy audits. In addition to the primary goal of reducing carbon footprint, collaborating with our tenants to invest in sustainability projects has several key benefits. For the tenant, a more efficient building reduces operating cost and helps reduces the tenant’s scope 1 and 2 emissions. For W. P. Carey, sustainability projects provide an enormous addressable opportunity set of accretive investments within our existing portfolio. These projects enable us to extend leases, enhance criticality of properties and improve the overall value of the portfolio. Conclusion Reducing the carbon footprint of a global net lease portfolio is an enormous long-term challenge. However, by developing a scalable, technology-driven approach to collecting data and engaging with tenants, we can systematically identify sustainability opportunities that are beneficial to the planet, attractive to tenants and improve our broader portfolio. At W. P. Carey, we’re committed to scaling up this effort and being an innovative sustainability leader in the net lease industry.