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Global Investor Perspective -

Real Estate

June 2016

Introduction 

Global investors upbeat on US and Europe due to high upside potential

The global real estate market is recovering with stronger worldwide economic growth, resulting in greater tenant demand and improving real estate fundamentals. The World Bank expects global GDP to expand 2.8% and 3.4% in 2014E and 2015E, respectively, compared with 2.4% in 2013 and 2.5% in 2012. Vacancy rates are declining in many markets, while rental rates have started increasing. Although activity in the residential market remains primarily subdued globally (except in the US), the global commercial real estate market continues to grow, with 1H14 investments up 28% year-on-year (yoy) to USD297bn.

 

By region, the US and Europe continue with strong volume growth in commercial real estate investment, whereas Asia registered subdued activity due to overheating. Global investors are increasingly investing in Europe’s real estate market, with growing interest in those markets most affected by the financial crisis as they believe some of these markets have bottomed out. [1]Although investors previously preferred trophy buildings and core properties in the UK, France, and Germany, they are taking more risks and venturing into Spain and Italy, where risk-adjusted returns appear more lucrative as prices have been falling.

Prime asset values across 25 major markets globally increased 8.8% yoy in 2Q14, with Paris and Amsterdam witnessing the largest growth. In 2014, prime assets would rise 7%, with Tokyo expected to record the highest growth.

Commercial and residential markets in US continue to be strong

The US residential market continues to grow despite concerns about a burgeoning supply pipeline and overheating in occupancy. Apartment vacancy rates declined to a record low of 4% as the national homeownership rate reached its lowest level since 1995. However, the US residential rental rates have shown an uptrend, rising 3.1% yoy, with largest gains in the Sun Belt region, Pacific Northwest cities, and Denver. The outlook for the US residential market remains positive, with stabilizing economic growth and improving unemployment rate. The US economy rebounded strongly in 2Q14, as it grew 4.2% after declining 2.1% in 1Q14. Furthermore, the unemployment rate in the US declined to 6.1% in June 2014, the lowest since September 2008. ​

 

Interest in the US commercial real estate market has increased on consistent economic growth and improving real estate fundamentals. In 1H14, the US commercial real estate investment rose 44% yoy to USD129bn, driven by strong interest from domestic and foreign investors in direct equity investments. According to data from the National Council of Real Estate Investment Fiduciaries (NCREIF), returns on commercial real estate properties in the US are gradually recovering after declining in 2012.

Growing interest in Europe’s real estate market

Global investors are increasing their exposure to European real estate, with growing interest in those markets most affected by the financial crisis. Europe offers stable markets such as the UK and Germany as well as markets with attractive risk-reward profile such as France, Spain, Italy, and Portugal.

Residential market in Europe gradually opening up, with Germany and France leading in commercial segment

Although residential prices in many European markets would stabilize in 2014 amid improving economic conditions, a complete recovery appears difficult for housing markets worst affected by the downturn, such as Spain and the Netherlands. The UK and German house prices would continue their uptrend in 2014 as these economies are performing better than most European markets. Furthermore, the unemployment rate of 6.4% and 4.9% in the UK and Germany, respectively, are below the overall Eurozone unemployment rate of 11.5%.

Total European commercial real estate investment increased 25.4% yoy to EUR84bn (USD109.2bn) in 1H14, primarily driven by France and Germany, with the Netherlands, Sweden, and Spain making significant contributions. The UK continues to attract investors interested in safe assets as the country’s economy appears strong compared with the rest of Europe, with the unemployment rate dropping to 6.4% and economy expected to grow at 3.5% in 2014. In Germany, commercial real estate investment grew about 30% yoy to EUR17bn (USD22.1bn) in 1H14, led by strong 2Q14. Real estate investment in France rose 84% yoy to EUR11.1bn (USD14.4bn) in 1H14 as yield-starved investors invested in the country’s commercial real estate despite its fragile economic recovery. Although rental yields in London’s prime West End area have declined to as low as 3.8%, yields in Paris stood at 4.0–6.8%. Moreover, other countries recorded increased investment activity, such as the Netherlands (up 109% yoy in 1H14), Spain (106%), and Sweden (30%).

Of the USD11bn raised for real estate investment worldwide in June 2014, over 50% was invested in Europe, with sovereign wealth fund (SWFs) expected to spend nearly USD7.5bn on European properties this year. Furthermore, with USD1.64tr of assets, Chinese and South Korean investors are focusing their investment strategy on Eurozone’s real estate to diversify their portfolio. These investors plan to invest in the listed property sector, which offers attracting dividend yields.

Middle Eastern SWFs bullish on Europe

Middle Eastern SWFs plan to increase their investment in global markets due to need for diversification and lack of opportunities in the domestic market. SWFs are expected to spend USD130–140bn in commercial real estate markets outside of their own region over the next decade, with 80% of the investment (USD112bn) targeted at Europe. This indicates significant investment in the European market, as total investment in Europe’s commercial market stood at USD198bn in 2013. Nearly 90% of Middle Eastern commercial real estate investment in 2013 was in Europe, with Middle Eastern SWFs increasing their investment in the last two years. These SWFs are among the world’s largest and most influential sources of capital with AUM of USD2.2tr (about 35% of AUM of global SWFs) and invest about 8% of their capital in real estate.

Investors prefer non-conventional assets in Asia-Pacific

High-end residential sales in Asia-Pacific have been subdued, primarily due to flat economic growth. However, volumes in Hong Kong have improved, mainly led by relaxed conditions associated with the double stamp duty. Weak investment activity in the high-end residential segment is likely to continue in 2H14. Total commercial real estate investment in Asia-pacific declined 8% yoy to USD55bn in 1H14 as volumes in Japan and China declined. 

 

Investors are expected to focus on niche areas such as logistics, senior care, self-storage sectors, and green buildings as they face intense completion for conventional asset types and most assets are fully priced. Opportunity funds, a type of private equity funds, plan to invest in properties that are not completely leased and can be refurbished to boost occupancy and rental rates, which can be subsequently sold to a buyer with less appetite for risk. Recently, LaSalle, which manages real estate assets worth USD50bn globally, raised a USD1bn fund for investing in real estate assets in Asia, of which USD585m would be allocated for its fourth Asian opportunity fund. In 2012, LaSalle invested USD76.8m in an office building in Osaka, which it plans to sell to a Japanese real estate investment trust, with potential expected return of 20%.

 

Americas to primarily drive growth in hotel investment 

Global hotel investment increased 6.5% yoy in 1H14 to USD25.2bn. The Americas were the largest contributor, with growth in investments at 11.5%, followed by 3.8% in the EMEA region. However, hotel investment in Asia-Pacific declined about 4%. Private equity dominates the global market, both as buyers and sellers. Growing equity and strong debt markets as well as increasing revenue per available room are resulting in bullish view of investors and lenders. 

 

Higher economic growth to support strong real estate returns during 2014–18 

Real estate returns are expected to be 7–8% during 2014–18.  Higher expected global economic growth and relatively low global supply of real estate properties would lead to increased tenant demand, higher occupancy rates, and rising rents. Emerging Asia assets are expected to return 10.8% during the forecast period and would outperform North America and Europe.

About the author(s)

Harold Alby is a managing director and chief operating officer at Inova Capital. Justin Inniss is a managing director at Inova Capital.For more details on our insights please get in touch with us at Inova Capital AG on +41 415616905. Inquire about our ideas and nowcasting capabilities.