The Future of Cities

Investors will be looking closely at long lasting effects of the pandemic

We won’t, says Adrian Lowcock, head of personal investing at the Willis Owen platform, want more Netflix when this is all over.

Lowcock says that whenever lockdowns are lifted and bleary eyed populations begin to emerge into the world, the likelihood is that they will want to do those things forbidden to them over the past year, such as travel, and visit pubs and restaurants, rather than buy more of the products or services they have consumed during lockdowns. 

He says this is why the increased optimism around vaccine programmes has translated into a stronger performance for stocks that are more sensitive to economic activity, and relative underperformance for those companies that performed strongly during the pandemic. 

But while the public embracing the habits of old amid a burst of economic activity is one of the few certainties investors can find in markets right now, the longer-term picture is more complex, says Ed Smith, head of asset allocation research at Rathbones Unit Trust Management. 

Lockdowns have led to the sight of normally crowded city streets being deserted, as a greater portion of economic activity has become digitised, rendering physical location less relevant.

This has had the effect of making the economic downturn that came with the pandemic somewhat less severe than might have been expected.

In the early days of lockdown, in March 2020, Peter Toogood, chief investment officer at Embark Group, described an economy where “GDP has stopped”, as we were not permitted to leave our houses and engage in many forms of activity. 

But the activity levels were actually switched online, as people discovered they could easily work from home, and firms discovered that online sales significantly increased to replace the physical sales that were lost. 

This meant that rather than activity being confined to a comparatively small corner of the economy, it turned out that far more of the country could operate, and instead it is specific areas of the economy that could not operate.  

Bank of England chief economist Andy Haldane outlined the consequences of this change in emphasis recently when he gave a speech outlining how the UK economy is presently operating at much closer to its level of potential now than was the case during the Global Financial Crisis. 

He said this is because, during the global financial crisis, many areas of the economy contracted, and there were no areas of the economy where growth expanded, but in the pandemic, while many areas contracted sharply, new types of growth emerged. 

For Haldane, this means the prospect for the short and medium term is that the economy will return to operating at its full level of potential more quickly than in 2008, and so inflation will rise sharply. 

Smith says the key will be to understand how, as working patterns change, people and companies spend their extra time and income, he believes this question will be key to determining two of the questions that matter most to investors in the years to come, the level of growth in the economy, and the level of inflation. 

The inflation question 

Smith says that if people begin to work from an office only two or three days a week, this would typically be expected to have a massively disinflationary impact on the economy, with lower inflation keeping bond yields low and boosting the returns for growth stocks over the longer-term. 

If people are working from home some of the time, this would also likely mean that city centre focused assets, such as offices, pubs, and shops in prime locations would suffer a decline in demand. 

Smith says it may be that the consumption which no longer takes place in city centre locations switches to suburban and rural locations; this means demand or spending falls in prime central areas but the overall level of growth in the economy would remain the same but be less concentrated on cities and spread more evenly around the country. However, if people simply spent less, then the long-term outlook for economies as a whole would be for lower. 

Zsolt Kohalmi, global head of real estate for Pictet Alternative Advisers says: “Sustainability has been an underlying trend that has been greatly accelerated through the pandemic. There is no turning back.

“Real estate is responsible for 40 per cent of all global emissions, and with over 70 per cent of buildings in Europe over 20 years old, improving the environmental footprint of buildings will be one of the key areas of focus for occupiers and investors in the coming years. 

“Investors in turn will be pushed by their retail or institutional investors to be more ESG-focused. I expect this to show up in the capital value of a green building being superior to a non-green building at an increasing pace.

“Essentially non-green buildings will be increasingly penalized, a bit like diesel cars have been over the last few years. 

“By investing in commercial offices and facilitating a significant transformation – making it more environmentally friendly, facilitating innovation and collaboration, embracing technology – there is the scope to achieve better returns while doing good at the same time. 

Fahad Kamal, chief investment officer at Kleinwort Hambros, says the desire shown by many as a result of the pandemic to move out of cities and to the countryside is “a very old one”, and something which he says has always happened, but that city centre economies will always be strong. 

He says that while many of the existing uses to which city centre property is put will be redundant, new purposes will be found for those outlets, though unemployment will be higher until that happens, and rents likely will be lower.

Kamal believes it is inevitable that these factors will keep inflation low. He adds that it may be that, whereas in the past, individuals lived in the suburbs and went into the cities for work, in future it may be that people work from the suburbs and travel into city centres at weekends for their leisure time.

But he does not at present find commercial property an attractive asset class, as he believes valuations remain too high to properly reflect the looming changes. 

He said these changes could mean people spend a greater portion of their income away from city centres, and as city centres tend to be more expensive than suburbs, this causes disinflation.

Smith says another factor could be that wages do not rise very much for those who work from home, as employers will be able to avoid pay increases because inflation is lower, and commuting costs are lower.

The technology issue

Peter Michaelis, head of sustainable investments at Liontrust says increased urbanisation has been a major theme in the global economy for many years.

“Today, around half of us (55 per cent) around the world live in cities but by 2050 this proportion is expected to reach as high as 68 per cent. 

“This would mean a doubling of the urban environment and equivalent to 70m people moving to cities every year for the next three decades, with close to 90 per cent of this increase taking place in Asia and Africa.”

He says city living as it is currently constituted is significantly bad for the environment, and as governments around the world strive to reduce emissions, he believes cities in the future will have a greater focus on energy efficiency, and will be largely free of cars.

He says cities in future will be largely capable of generating their own energy supply, while social housing will also be a major theme.

Among his holdings is Optivo, a social housing provider which also has a focus on the energy efficiency of its dwellings. 

David Harrison, who runs the Rathbones Global Sustainability fund says the cities of the future will have charge points for electric vehicles as a central feature of street corners. 

Alex Illingworth, who jointly runs the Artemis Global Select fund and Mid Wynd investment trust, says: “People have been talking about ‘Smart Cities’ for years without making a huge amount of progress. That’s because, unless you’re creating somewhere virtually from scratch, you are lumbered with an existing infrastructure.

“Cities are difficult things to change. However, the pandemic has opened up the opportunity to think radically, and it’s changed working practices for many people. We don’t think everyone will suddenly be moving from London to the countryside and opting for home working.

“It’s a factor, but it has been overplayed. Cities are centres for art and culture and the best paid jobs will still be most likely from companies in metropolitan areas.

“But a city does have to be somewhere you want to live because many of us have more options. That means cities have to have green spaces. We will see less retail. We may see fewer cafés and restaurants, but we will still need them – the idea that we’re all going to start bringing Tupperware to work sounds implausible.

“And as we’ve learned in lockdown, restaurants are an important part of social life and the culture of the city.”

In terms of what this means for investors he says: “Some of the transformations required will depend on government subsidy, and that always introduces an element of risk. Governments are fickle and you can suddenly find a subsidy removed.

“Sometimes the smartest thing you can do as an investor is identify the companies you should not be investing in – those facing disruption from new technology. When Edison opened his lab in 1879 to demonstrate his new incandescent light bulb and power generator, there were several competing technologies available from scientists like Sawyer, Man and Maxim.

“Edison’s first bulbs had a 15-hour life. His triumph was not a foregone conclusion, but natural gas stocks plummeted on news of his demonstration.

“Our thematic approach to investing and our ESG principles enable us to capture in a lower-risk way the benefits of the trends shaping the modern world. Just as importantly, they help us avoid areas that face a headwind or obsolescence.”

The global equity fund manager Nick Train is another who believes the key to investing in the future is to find those companies that can be resilient in the face of change, rather than trying to identify the winners from the changes before they happen. 

While Train and the tech managers are thinking about where our cities will be, the value managers are avoiding those judgements; the question is who will be right in the long term.