In Italy, offices, hotels, retail, and logistics absorb the majority of investments in commercial real estate and are facing important challenges today. Offices, that have been transformed by the new methods of hybrid work, have seen an evolution in the offer of the product and services associated with them; hotels, the facilities impacted the most by the pandemic, represent those with the greatest potential, in a country with a very strong tourism sector such as ours; retail, which was already declining in the pre-Covid-19 era, could soon return to the agenda of investors; logistics is a true rising star, with volumes of investment that in 2021 exceeded even those of offices in 2021.

Offices, hotels, logistics, and retail; the evolution of demand in the offer of spaces, technology, and ESG; inflation, raw materials cost increases, the pandemic, and climate change. These are the principal asset classes in the area of commercial real estate, the main trends underway, and the main macroeconomic variables that are having a significant impact on our lives and the spaces we use daily to work, travel, and go shopping (physically or online). For those who are not old enough to have concrete memories of the 1970s and 80s, perhaps it is legitimate to say that that never before has a set of global events, together with a different sensitivity of investors and users, had such a significant and sudden impact on an industry such as real estate, typically characterized by a slow and gradual evolution. Today, though, it is undeniable that the latest events have triggered an unforeseen acceleration to phenomena that were already underway, but that we did not expect to be so rapid and disruptive for real estate products and its methods of use. How do we find the needle in the haystack in the apparently chaotic movement? The response is always the same: back to basics.

Back to basics

First of all, unlike the residential sector, commercial properties often represent an asset for investment, in particular when they are of significant dimensions and value. The value thus depends on the returns requested by the market, that are difficult to predict, and on the income they can generate thanks to the users, and thus the methods and preference of use.

Not different from any other business, property income depends on the sale of the service it produces – the use of space – whose attractiveness, and thus price (i.e. the rent), varies over time as a function of supply and demand.

Since the offer of space is relatively rigid, at least in the short term, it becomes important to focus on the trends that determine the demand for space. The activity of real estate development, on the other hand, will determine the future supply, but this is also linked to current values and future prospects, as well as the costs of realization, both direct costs linked to construction and the cost of capital.

Although lease agreements are fairly long, despite possible derogations,^[1] their relationship with actual demand is increasingly relevant. In fact, excessive contractual fees beyond those generally used in the market lead to a greater risk of litigation between the parties, increasing the risk of the investment as a consequence, but above all they must be sustainable for users.

The lockdowns imposed by the recent pandemic have in fact demonstrated how weak a contractual agreement is in the presence of difficulties of the lessor, even if they are objective, and the correct assessment of risk linked to the business conducted in the property, and well as the counterparty, has become central again. But in ordinary situations as well, an excessive rent with respect to market value becomes an element of tension and risk. Therefore, the understanding of the dynamics in the utilization of properties, of how needs change for customers (tenants) and their customers as well (the end users, such as employees of the company or customers of stores), becomes central.

Economic growth is certainly a decisive factor in the demand for space, but changes in methods of use can lead to results which may go in different directions. Given an economic expansion that leads to more production from companies, it is normal to also expect an increase in the use of the productive factor of real estate, the space where activities are carried out, but technological and social changes can in any event lead to consuming space in different way and quantities.

A new utilization of space

Think of the effects of the spread of remote working, that has led to both the use of the home as a workplace, and a search for greater flexibility among companies, with the use of alternative solutions to the classic long-term lease. Furthermore, technological changes have made possible a staggering development of e-commerce, the evolution in modern terms of mail order sales, but making the buying experience considerably more gratifying and the delivery efficient in terms of times and costs. Other examples can be cited, but what is important is that there are changes that lead to using the space differently, and above all with spillover between one sector and another, from offices to residential, from traditional retail to logistics.

So we find that all commercial properties increasingly become trade-related properties, that is, properties/activities in which the production activity carried out by the user of the property coincides with the offer of the product/service, as in the case of hotels or premises destined for sales activities. In these cases, the activity of the business using the space depends on the characteristics of the space itself, in terms of both location (soil) and of physical configuration (building). Think of a luxury hotel, whose central location and high quality of the building contribute to the price of sale of the room and thus the income results for the hotel manager, the user of the property. For this specific type of goods, the operating margin generated by the activity carried out in the premises must be sufficient to pay the price for the use of the space, i.e. the lease fee or rent for a business unit. It thus becomes crucial to understand how the modes of use of the space change and how much they allow for sustaining a rent that exceeds the level in the contract.

Going into the merits of the single types of real estate, the four mentioned at the beginning – offices, hotels, retail and logistics – represent the vast majority of investments in commercial real estate in Italy (with alternative investments and residential still being marginal, although they have seen constant growth in recent years). The different types are each characterized by some peculiarities and by some common dynamics.

Offices, hotels, retail, and logistics

As regards offices, the presumed crisis of the traditional model with respect to the emergence of a new type of supply (that of co-working), has been added to the spread of hybrid modes of work (remote working) that have led to an evolution – more than a revolution – in the offer of products and services associated with the same.

Hotels are certainly the properties that felt the greatest impact from the pandemic, yet they represented the type with the greatest potential, in a country with a strong tourist bent, in which, though, the offer of quality facilities and those that are part of hotel chains still represents a minority given the fragmentation of ownership.

Retail, which was also strongly affected by the pandemic, is in reality a sector that was already going through a period of difficulty in the pre-Covid-19 era; but considering the presence of very varied products (from “high street” to shopping centers to outlets), that have been affected in different ways by the growth of e-commerce, it could soon return to the agenda of investors.

Finally, logistics represents the true rising star in commercial real estate today, the sector which has done the best in exploiting the post-Covid-19 dynamics, with investment volumes that in 2021 exceeded those of offices for the first time, but that certainly is also facing some unforeseen criticalities, such as the significant growth of raw materials costs, and as a consequence, development costs and uncertainties in the sustainability of the current supply chain model with extreme delocalization.

The common challenges

All four types are characterized by a series of common challenges. First of all, the spread of what we could define as “an ESG compliant culture,” but with the need to develop a new real estate product, or to renovate existing buildings that are able to effectively and efficiently face the great challenge of climate change. In this sense, the greater sensitivity of various stakeholders – from investors to tenants, from public administrations to various types of users of properties – beyond certain well-known phenomena of greenwashing, will certainly contribute to a significant acceleration. Secondly, the incessant evolution of technology, that is leading properties to be increasingly interconnected, starting from the development phase to the operation phase, and in which the software component is thus growing rapidly compared to the hardware component. Lastly, there are some very recent challenges, such as high inflation and the increase of energy and raw materials costs, that in various ways will lead investors and tenants to again have to rethink the development and use of spaces.

The needs of users and consumers lead to an evolution of products and services. The same happens for properties, where over time the needs of those who use them change. The true difficulty is in predicting trends, given that compared to other services such as consumer goods, the production of space requires long periods of time, and adaptation is particularly costly.

Once again, the quote from Charles Darwin, “It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change,”^[2] can be applied to this historical moment for commercial real estate, with the need to also deal with new challenges, and at the same time, the emergence of new opportunities that, as always, will be able to interpret them in advance.