Trading activity across world real estate markets is unlikely to grow in 2017 but will not plummet either. Real Estate as an asset class has taken on a new role in many investment portfolios across the globe and is unlikely to fall out of favour quickly.
A new world order for real estate?
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Trading after the crisis: a brief history
As the world adjusted to low interest rates and yields in the wake of the 2008 global financial crisis (GFC), the appetite for real estate grew. In the early years after 2008, it was economic recovery, distressed sellers, yield shifts and asset price growth which encouraged more, and new, investors to the market. Activity picked up earliest among Asian buyers, followed by Europeans, and finally US investors returned to the global real estate markets.
This initial recovery activity has been followed by a more concerted search for income. After 2010, the availability of high-quality, long-term revenue streams from gilts and bonds was made scarce by quantitative easing, so investors looked for alternatives. Some found it in real estate and this is partly behind the growth in transaction volumes from their 2008 lows to now.
Source: RCA, Savills Research
Global transaction volumes are now down slightly on late 2015 levels. Some commentators will put this down to the scale of political uncertainty which has dogged the markets after the surprise UK Brexit vote, followed by Trump’s US election win and the recent Italian referendum result. However, this misses the fact that activity was already slowing at the tail end of 2015 when it had built to a post-2008 slump high.
While there are plenty of geopolitical uncertainties providing excuses for investors not to trade, the established real estate of developed countries is still a reliable, transparent and safe place to store value. That’s why we think 2016 will prove to be the first year of a ‘wobbly plateau’ in transactions rather than the start of a steep decline.
The rise of Alternatives
Prime yields for core assets in gateway cities have moved in rapidly since 2010 as investors have found a new role for real estate in their portfolios and the competition for assets has mounted. Over the past two years this competition has intensified. This has meant that the search for real estate assets, even among institutional investors, has turned to classes hitherto considered ‘alternative’.
Yield compression has been marked in these alternative asset classes over the past five years or so. Residential, hospitality and student housing are good examples of such sectors, some of which have seen record levels of global investment activity. Conventional classes are now fully invested, yields have moved in to record lows and some markets look very fully valued. The move to alternatives means that secondary markets – and even tertiary ones – have been characterised by falling yields too.
The legacy of the Western ‘Baby-Boomer’
More subtle than this shift from prime to secondary, from core assets to alternative (something that might be expected in any late-cycle investment play) is a shift in the nature of real estate investment risk. We think that there has been a shift that will be longer lived than the usual increased appetite for risk seen after previous bull runs.
This is because there has been a longer-term, profound change in the nature of investors themselves. At the root of this is a demographic shift in developed countries. The large baby-boomer generation (born between 1946 and 1964) are becoming pensioners and are no longer mass savers. This means that investing institutions like pension funds and insurance companies are no longer just focused on receiving savings premiums with which to grow funds. They now have to generate income to pay pensions and this has broadened their focus on the nature of investment assets themselves. An increasing number of assets need to be able to produce stable, long-term income streams.
All this has been part of a recalibration of risk and returns in the property world. Some types of hitherto ‘alternative’ real estate is actually very good at producing this type of income stream. UK social housing, for example, has become increasingly valued for its ability to provide large, predictable net rent rolls linked to RPI and behaving at scale, rather like a long-dated or undated gilt.
Because the income return on bonds in safe jurisdictions has become so low – or even disappeared – it can be argued that the status of real estate as an investment class has changed. Low bond yields have left many investors looking for other, cheaper ways of generating cash, so attention has turned not only to dividends on equities and coupons on corporate bonds but also to the income-generating potential of real estate. The search is not just for income but for sustainable income streams. The fundamentals of economic recovery, employment growth and occupier demand are now more closely scrutinised than they may have been in the pre-GFC era. Rarely have real estate investors been more focused on the rental growth potential of buildings.
Value is the new Quality
We think that the search is still on for new real estate assets which will fit these new investor requirements. Our researchers from all over the world have tipped some of the locations and new asset types which will fulfil this brief in 2017 and beyond. They may have labelled their tips ‘value-add’ or ‘opportunistic’, but these categories will be increasingly considered more mainstream by hitherto conservative buyers. Investors will be looking for sound demand and occupier fundamentals rather than old conventions. 2017 could see ‘value’ stocks becoming the new ‘quality’ stocks.