The future of cities

Pandemics are not new to cities. We can look as far back as 430BC when the Plague of Athens devastated the city-state, or more recently to Spanish flu in the early 20^th century. In every crisis, cities do what they do best – innovate. These dramatic events led to innovations such as running water, sanitation, sewers and open space, all of which led to disease rates falling dramatically. The COVID-19 pandemic will be no different. Cities will innovate, invest and emerge stronger. But it has prompted the question: What does the city of the future look like?

In answering this question we need to remind ourselves that cities are always evolving. For example, there has been a continual improvement in public transport which has allowed more people and goods to move efficiently in and around a city. This has generated huge efficiencies and is one of the key reasons for the agglomeration benefits found in the world’s best cities. A city is a rare organism that becomes more efficient the larger it becomes, sadly the same cannot be said for myself.

When we analyse how cities will look in the medium to longer term there are no new trends that we had not discussed before. In our opinion, all the COVID-19 pandemic has done is hasten and magnify the trends that were already present in the market. E-commerce is now a more significant element of retail sales, but it is not new. Similarly, working from home is now adopted by far more employees but it was not invented in the pandemic.

It is clear that the pace of change has been accelerated and that makes the evolution of cities taking place today, incredibly exciting. From an investment perspective we have long focussed on owning assets that are hard to replicate in sectors aided by structural trends. This means that we will always have pricing power, essential in inflationary episodes or rising interest rates. There are two obvious trends emerging in cities which we believe will continue to impact pricing.

Firstly, the relentless rise of e-commerce is leading to increased demand for logistics space. Importantly, not all logistics assets are created equal. Those located in ‘low barriers to entry’ locations will see a rapid supply response. However, in mass points of consumptions like cities, the ability to create more supply is almost impossible. We continue to believe these true, last mile, logistics assets will become more valuable.

In contrast, working from home trends are far greater today than we envisaged. The quantum and type of demand for offices will change and unfortunately for office landlords they are unlikely to have pricing power. The one exception to this will be the very best located assets that can offer tenants a net zero carbon building. We believe demand for offices will reduce and alternative uses will be considered, residential being the most obvious. We believe that people still want to live in a city, especially the young. If more apartments can be created for a younger demographic the dynamism in a city will become even greater.

Perhaps the most important evolution that cities will experience over the medium to long term will be focused on sustainability. We think cities will determine whether we succeed or fail in our battle to arrest climate change.

The UN predicts that almost 70% of the world’s population will be living in urban areas by 2050. To enact the most powerful change, cities have to be at the heart of any action taken. Whilst we will see changes in the type of real estate we use in a city to reflect increasing trends (such as, e-commerce and working from home), the rise of the sustainable city will be the most dramatic impact we will witness.

Increasingly, cities are sharing policies and strategies to reduce their impact on the environment and in many cases, they are far more ambitious than national governments’ policy. One of the best examples is an organisation called C40. C40 is a network of 97 cities comprising more than 700m people and is aiming to halve the emissions of its member cities within a decade.

We believe that a city has to have a sustainable economy, a strong economy is no longer sufficient. Over the coming years leading cities will evolve into smart, sustainable cities. Technology will provide much of the innovation that allows cities to transition to net zero carbon. From commuting in clean public transport and smart traffic, or waste management systems, to buildings using artificial intelligence to optimise heating and cooling.

A number of cities are leading the way. I would highlight Amsterdam, Stockholm, and even New York as having ambitious policies. But in order to harness the potential of these cities, we need to find the right companies operating on the ground with similarly aggressive net zero carbon targets, or even energy net positive targets. Because like cities, we believe the best companies have environmental policies which are far more ambitious than local or national policies.

Investing globally means we are fortunate. We have a large opportunity set and can access the most sustainable real estate companies in our preferred cities. We think it’s impossible for a real estate company to generate strong rental growth without doing it in a sustainable manner. Tenants across all real estate sub sectors are looking to reduce their carbon footprints and they are therefore only willing to sign leases on buildings that can facilitate their transition.

We believe that the future for cities is bright. The top 50 cities account for a quarter of world GDP and it’s exciting that can you now find an economy the size of Australia or Iran in one city -like Tokyo and Los Angeles.

It is clear to us that the network effect of cities will lead to continued growth, and data indicates that a number of ‘mega cities’ are emerging in Asia. We are increasingly excited about the opportunities in this region over the coming years. For example, the Greater Bay Area in China consisting of cities like Shenzhen, Dongguan, Guangzhou, Foshan and Jiangmen will soon have an economy larger than New York.

Just like death and taxes, evolution in cities is certain. The key is being able to use data to establish which cities will emerge stronger. Structural trends will continue to reshape the cities we live in, and we believe that cities will provide the much-needed innovation to meet climate targets. It is time to be optimistic about the future.

Tom Walker

Co-head of Global Real Estate Securities

Schroders Asset Management

The views expressed in this article are those of Tom Walker and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact, nor should any reliance be placed on them when making investment decisions. Any stock examples used in this article are not intended to represent recommendations to buy or sell.