Blog | 07 Aug 2024

Will renewable energy and digital infrastructure (REDI) become the next golden child of CRE?

Nicholas Wilson

Associate Director, Real Estate Economics, Asia

Infrastructure and natural resources have outperformed real estate funds over one-, three-, five- and ten-year timeframes.
Since 2021, investment activity in renewable energy has overtaken commercial real estate in APAC.
Over the next 20 years, the APAC region will account for more overall energy growth and more renewable energy growth than the rest of the world combined.

Traditional real estate investors are accelerating the move towards new sectors outside of their traditional domain of office, retail and industrial. And renewable energy and digital infrastructure (REDI) is emerging as a particularly attractive alternative.

Investors are showing heightened interest in areas related to new energy assets like solar, wind and hydro as well as new economy assets including data centres, battery storage and cloud computing facilities.

The fact is, the distinction between CRE and sectors like renewable energy and digital infrastructure is becoming increasingly blurred. The sectors share similarities, from valuation techniques, operations, and financing structures, not to mention the tangible nature of the asset class. The two also derive much of their capital from a similar set of investors, with further overlap at the operator level in some instances. These days, these asset classes are often merged under the banner of ‘real assets’ within institutional investors, private equity funds and other financial corporations.

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Drivers of evolution

A combination of economic, environmental, and technological factors is propelling this evolution. The shift to REDI can not only allow investors to diversify across markets and sectors, but also to shield returns from some of the structural headwinds facing traditional CRE assets.

We previously examined the potential impact of GenAI on employment by the CRE sector in the US. Our research revealed that offices are likely to be most exposed to GenAI, yet another blow to the market, exacerbating the already weak demand-side fundamentals felt from the flexible work trends. Conversely, the rise of GenAI creates supportive headwinds for new REDI asset classes like data centres. And the usage of GenAI is driving a lot of growth in energy consumption. The IEA estimates that AI-powered Google searches increase electricity demand 10 times.

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The push towards renewable energy and digital infrastructure sectors is also driven by the promise of returns. The traditional CRE market has faced volatility due to economic downturns, shifting policy rates, changing work patterns (such as the rise of remote work) and shifts in retail consumption patterns. In contrast, assets like data centres and renewable energy facilities, while not without their own risks, have strong potential to provide long-term, reliable income streams.

In fact, both infrastructure and natural resources (including renewable energy) have outperformed real estate funds over one-, three-, five- and ten-year timeframes. In addition, these sectors have the potential to smooth volatility of returns for those with long-term investment horizons, thanks to their operational intensity and long-term operator contracts, often supported by government initiatives.

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APAC will be a hotbed for growth and diversification

Investment activity in renewable energy has overtaken commercial real estate in APAC since 2021. APAC’s appeal lies in its growth momentum, driven by a growing middle class, ongoing urbanisation and technological advancements, which are creating a surge in demand for energy and data processing power.

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We expect that over the next 20 years, the APAC region will account for more overall energy growth and more renewable energy growth than the rest of the world combined.

Strong demand-side fundamentals come into play. Over half the world’s population resides in the APAC region across a diverse range of economies. In addition, the region is home to the critical raw commodities for new energy assets in places like China, Australia, and Indonesia. It is also dominant in raw commodity processing, which is necessary to build the critical materials for the new energy sector.

The large Asian markets of China, India, Japan, and Korea are among the largest net importers of fossil fuels in the world. The shift towards these new energy assets is therefore driven not only by environmental considerations, but by economic and energy security challenges.

For investors, these sectors also offer stronger diversification characteristics, allowing them to access allocations to the emerging markets of APAC, which has proven challenging within traditional CRE sectors.

A playground for giants, at least for now

Renewable energy and digital infrastructure sectors position investors well to capitalise on the growing importance of new technologies and new energy advancements, aligning their investments with future market demands and global sustainability goals.

However, challenges remain. Much of the investment will need to target development, rather than acquisition, because most of these sectors are still in the early stages of growth. Large institutional investors will likely have a competitive advantage in these sectors, given the large deal sizes and long-term view needed to both build and operate such critical infrastructure. Commercial real estate typically has an average asset size of USD50mn. By comparison, renewable energy projects are on average USD230mn, and data centres/telecommunications infrastructure are even larger at USD330mn.

This offers institutional cross-border capital an advantage over smaller domestic investors, who are unlikely to have the appetite for such large ticket sizes. This should help to develop the investment structures for these asset classes, with an avenue towards open-ended funds likely to grow. More large investors will also set up their own platforms and grow their internal capabilities for managing global portfolios of new energy and digital infrastructure assets.

The analysis and forecasts in this blog are backed by our Real Estate Economics Service, which enables businesses to understand the implications of macroeconomic, geopolitical, financial and climate change developments on private and public real estate performance. To unlock the power of real estate insights, request a free trial by clicking here.

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Author

Nicholas Wilson

Associate Director, Real Estate Economics, Asia

+65 6850 0129

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