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Our research points to important market movements that will determine how and where investors can earn attractive returns in real estate in the future.
These changes can be put into two categories: 1. Cyclical Shifts and 2. Secular Trends.
The cyclical shifts will likely dominate investment performance over the near term (the next three to five years). They are driven by changes in economies, real estate supply-demand fundamentals and by capital markets. The secular shifts are longer-term drivers of real estate values that supersede cyclical shifts over a longer time horizon (seven to ten years or longer).
Real estate is a cyclical asset class. In many countries, property prices are rising for the sixth year in a row, after hitting a cyclical low in 2009-10. Asia-Pacific markets (ex-Japan) and technology-driven markets in the US have grown the fastest in terms of underlying fundamentals since the global financial crisis.
But, properties in major west European cities and coastal US markets have grown the fastest in terms of capital values. Here is what we see: The strength of the dollar (versus a weaker euro and a devalued yen), the slowing of China, upgraded prospects for European growth (despite negative headlines about Greece), and, finally, lower energy prices, disinflation, and low interest rates — all these factors will alter the cyclical dynamics in important ways.
The biggest cyclical trend that is driving positive real estate performance is the “lower for longer” trend in interest rates and inflation. This trend will likely continue for several years more, as wage growth, producer prices, and consumer prices are all well below long-term trends.
The US and the UK are two countries where this trend could reverse earliest, but likely not until 2017 or thereafter. Meanwhile, other major economies like Japan, Germany and France could remain in the lower-for-longer environment until 2019 or 2020.
The supply cycle for commercial real estate remains below long-term averages in nearly every major developed country that we follow. As economies recover, this will lead to scarcity of space in shopping centres, office buildings and logistics facilities. And as vacancy levels fall, rents will rise.
At some point, this will lead to a stronger cyclical supply response, which we see heating up already in the US and London. Investors should experience several strong years of rental growth, before supply starts to exceed demand.
The issue is that pricing already anticipates strong rental rate growth in the major real estate markets of the world. This means that real estate’s cash yield is approaching all-time low levels in many of these “gateway” markets.
One of the best ways to cope with ‘mid- to late-cycle’ investing is to focus on markets and assets that follow longer-term secular trends. These properties will be less exposed to cyclical downturns and should achieve above-average rent growth and occupancy.
We believe that the best strategies should emphasise demographic, technology and urbanisation (DTU) themes that will outperform over the next decade or longer. How do these trends work? They are often linked and self-reinforcing.
For example, technology companies need to attract younger workers, who in turn are entering the workforce in record numbers and earning a salary for the first time. This “millennial” generation of people in their 20s look for urban lifestyles where they can work-shop-live and play all within a vibrant walkable neighbourhood. The millennial generation delays both marriage and child-rearing, so denser, mixed-use real estate suits their needs better than sprawling corporate campuses that require long commutes.
At the same time, the wealthier baby boomer generation is ageing, but living longer, and expecting to enjoy active lifestyles well into their 60s, 70s and 80s. The types of real estate that this group will consume includes hotels, luxury apartments in cultural districts, high-end retail and restaurants, and eventually senior housing that emphasises the healthier lifestyles many of them will continue to pursue.
Refurbishment of older buildings will meet some of the rising demand, but in many cases this secular trend will also drive denser new development that is sustainable and transit-oriented.
Source: Jacques Gordon, Special to Gulf News
The writer is the Global Investment Strategist, LaSalle Investment Management.