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Real Estate Summary
Edition 2, 2018
UBS Asset Management
Emphasize asset management amidst higher volatility and slightly slower growth
04 Global overview
16 European summary
10 APAC summary
22 US summary
2
Content
04 Global overview
10 APAC summary
Our research team
Brandon Best Melanie Brown Adeline Chan Christopher DeBerry Kurt Edwards Nicola Franceschini Kara Foley Zachary Gauge Tiffany Gherlone Paul M. Guest
3
16 European summary
Gunnar Herm Fergus Hicks Samantha Hartwell Amy Holmes William Hughes Alex Leung Declan O'Brien Joshua Rome Sean Rymell Laurie Tillinghast Shaowei Toh
22 US summary
4
Global overview
5
The global economic backdrop is supportive of real estate although growth has eased slightly. Central bank policy is diverging as the US leads the way with rate rises. Strong occupier and investor demand has fueled outperformance of industrial property and we expect this to continue into 2019. Some investors looking to alternatives and value-add to boost returns.
Real Estate Summary Edition 2, 2018
6
Macroeconomic overview The global economic backdrop remained broadly positive in
the first quarter of the year as the synchronized upturn of 2017 continued. However, economic data did soften,
particularly in Europe, and initial Q1 growth figures have been
weaker than Q4. The Eurozone as a whole reported growth of
0.4% compared to 0.7% in Q4. The weakness follows a
strong end to 2017 and may reflect concerns over a global
trade war following Donald Trump's implementation of tariffs on steel and aluminum in March along with other proposals.
The tariffs are aimed at making good Trump's election pledge
to curb the US trade deficit with China, and were greeted by the Chinese with potential retaliatory measures. However, in
May China agreed to take measures to reduce its trade surplus
with the US, reducing the potential for a full blown trade war.
Unemployment rates in the US, UK and Japan are at record
lows and continue to fall across the Eurozone. Inflation in the US is near its 2% target while in Europe and Japan it is below
what policymakers are aiming for. Headline inflation rates may
come under some upward pressure from the sharp pick-up in the oil price since the start of this year. Efforts by Russia and
OPEC to cut back production, along with worries over supply
from Iran, saw the Brent crude price rise above USD 70 in April and annual price growth rose above 50% in May.
A notable feature of the year to date has been a return of volatility in financial markets following a prolonged period of
calm. In January, already at elevated levels, stock markets got
nervous about inflation and prospective interest rate rises as US wage growth showed a slight spurt. As a result, faster
wage growth was revised lower, with the latest figures
showing annual growth of 2.6% in April. Typically equity market volatility spills over to the listed real estate sector, but
has little impact on private real estate markets.
Chart 1: Equity market volatility and prices
(Indices)
Source: Thomson Datastream; May 2018
More volatile markets made it a difficult yet crucial time for Jay Powell to take over as Fed Chair. However, so far the transition seems to have gone smoothly and the Fed pressed ahead with a widely expected rate rise in March. Setting policy will remain challenging as the Fed continues to normalize rates, with the next rise expected in June. Moreover, central bank policy is diverging around the world with the Fed pressing on with rate increases, the Bank of England delaying a rise until later in the year and the ECB staying its hand over weaker data. The Bank of Japan is the outlier, continuing with large scale asset purchases and has dropped its target of returning inflation to 2% by 2019 in preference for an open-ended time-frame.
Following the current period of reasonable growth it is natural
to expect some slowdown in the economy and, as the adage goes, economic recoveries do not die of old age. Rather, they
are normally cut short by policy-induced slowdowns to rein in
inflation or external shocks such as the bursting of credit bubbles. The key questions now are when the eventual
slowdown will occur and whether it will be gradual or
precipitous. Naturally, we think the former would be less disruptive for real estate markets, while the latter could create
some significant challenges with negative repercussions.
Several factors could be the source of a sharper downturn.
One is the potential for the US economy to overheat given its
unemployment rate is already below 4% and the lowest in 18 years. Donald Trump's USD 1.5 trillion fiscal stimulus is
boosting demand while his restrictive trade policies will reduce
supply. The combined squeeze may ramp up inflation and
force the Fed to raise rates more rapidly than expected and kill
the recovery. Although such a scenario is not our base case,
we see it as the most likely disruptor. A second area of concern is debt levels, as highlighted by both the IMF and
World Bank, with ongoing fears of a credit bust in China.
Higher levels of corporate debt are a risk, with concerns over household debt in countries previously thought safe such as
Australia.
Political machinations can also interfere with markets and the
economy, but tend to have a more muted influence than
originally expected. US mid-term elections loom later in the year and will provide a score-card for Donald Trump's
administration. More worryingly, the West's relations with
Russia have reached a new low following the murder of a former Russian spy in the UK, for which the international
community blames Russia, and Russia's support for the Bashar
al-Assad regime in Syria. A more positive development has been the rapid turnaround in relations between the West and
North Korea, which started as South Korea hosted the
Olympics in February. The North Korean leader Kim Jong Un subsequently travelled to Beijing to meet the Chinese premier
and a summit with Donald Trump is planned for June in
Singapore.
Overall our main message is that the global economy is in
reasonable shape and continues to grow. This is in line with expectations and positive for real estate markets. Risks are
present, some of which we have outlined, and we will
continue to monitor for emerging threats.
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Real Estate Summary Edition 2, 2018
7
Capital markets
Mirroring the reasonably healthy economic backdrop initial
data showed that real estate markets continued to perform
well in Q1. The NCREIF US all property NPI showed a 7% annualized return and the MSCI-IPD UK direct all property
index recorded an 8% annualized return. Preliminary data also
showed that underlying investment activity maintained a reasonable pace with little change from Q4. A lack of sellers
continues to hold back activity in some markets.
Industrial has been the clear outperformer over the past
eighteen months and for 2017 as a whole, industrial returns
reached double-digits in many markets. In the US, for example, industrial recorded a 13% return according to
NCREIF data, while UK industrial achieved a 20% return
according MSCI-IPD. The rapid rise in values has been driven by strong investor demand and rental growth and has gone
hand-in-hand with significantly higher investment volumes.
Global industrial investment volumes rose a massive 39% in 2017 in US dollar terms, compared to a mere 5% uplift for
offices and 9% fall for retail.
Industrial volumes were boosted by portfolio level deals, such
as the USD 14.6 billion purchase of Blackstone's Logicor
portfolio by China Investment Corporation. However, even excluding this mega transaction, industrial volumes still rose
23% in 2017. Moreover, the underlying tone of the industrial
market has been positive and one favored by investors, with value rises alone giving a significant boost to investment
volumes. Strong investor demand has seen industrial cap rates
and yields show a steady decline in recent years. Data from RCA show that the global industrial top quartile cap rate is
now around the same level as the global all commercial top
quartile cap rate. Similarly, the UK MSCI-IPD industrial yield was just 11 bps above the all property yield at the end of
2017 compared to a 147 bps gap in 2010.
Overall we remain positive on industrial property going
forward and our return forecasts show it as the best
performing sector over the next couple of years. Markets where online sales are less developed, such as Australia and
some European countries, have the potential for higher
returns as their logistics sectors evolve. Although our view on the sector is positive we are also wary of it becoming
overvalued and conscious that its growth and valuations must
be supported by underlying fundamentals.
Ultimately the robustness of the industrial story depends upon
the durability of underlying rent flows and it is worth considering the risks to them on both the demand and supply
sides. On the demand side a key risk is anything which could
cause a set-back in the rapidly growing on-line retail distribution model. However, with strong and growing
consumer appetite for the convenience and value that on-line
retail offers, fueled by constant technological advances, such a threat seems unlikely.
Perhaps a greater danger comes from the potential for
regulation and that the sector could be a victim of its own
success. For example, some traditional retailers are already calling for a "parcel tax", while environmental and traffic
congestion considerations could see moves to restrict delivery
vehicles which could interrupt last-mile delivery networks.
The supply-side of the market also presents a threat since
logistics facilities can typically be built rapidly. For the time-being we do not think that supply will hold back rents. Rather,
if anything, in many markets supply is catching up with
demand. Urban logistics facilities are competing with other land uses such as residential and other property types, with
the focus being on using land as efficiently as possible. For
example, in London plans have been announced for the first three storey last-mile logistics facility.
Chart 2: Global top quartile commercial and industrial cap rates and spread
(Cap rate % LHS, spread bps RHS)
Sources: RCA; UBS Asset Management, Real Estate & Private Markets (REPM); 1Q18
Overall we think that the stronger returns from industrial will continue through the remainder of the year and into 2019,
but that in the medium term the strong outperformance will
eventually come to an end. As for other property types, we expect industrial returns to slow moving into 2019.
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Real Estate Summary Edition 2, 2018
8
Strategy viewpoint We remain positive over prospects for real estate markets but
are aware of potential risks. The period of rapid capital value
uplift driven by yield compression is now behind us, with income set to provide the bulk of returns. The speed of
interest rate rises and differences between central banks
remain a key focus for investors. With slower property returns expected following several good years some investors are
looking to value-add and seeking opportunistic strategies to
boost returns. These strategies can complement a core
portfolio but investors must remember they are higher risk.
We think that specialist and alternative sectors supported by
fundamentals can also provide good opportunities.
The logistics and retail sectors continue to experience
significant structural change stemming from increased on-line sales and sentiment on retail is very cautious. Risks seem tilted
to the downside, particularly for high streets in smaller towns
and for secondary grade, non-dominant shopping centers. Ultimately surplus retail space will need to be repurposed to
other uses such as logistics or residential. This will create
opportunities for investors, but careful strategic planning for individual assets will be essential for success.
Offices are more steady, but still subject to their own structural change due the advancement of flexible workspace
operators and flexible working technology. Overall, for a core
real estate portfolio we recommend a slight overweight to industrial and underweight to retail. As ever, the general
principle of diversification of risk across sectors and
geographies should serve investors well.
Real Estate Summary Edition 1, 2018
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APAC summary
Real Estate Summary Edition 1, 2018
11
Near term risks to trade conditions may threaten growth. Robust economic performance a boon for office take-up across the region. Ongoing positive transactional activity in commercial property this quarter. Political and corporate developments in mainland China to impact Asia real estate markets.
Real Estate Summary Edition 2, 2018
12
APAC summary Demand & Supply
While the good, export growth-aided times mostly continued to roll throughout the Asian economy in 1Q18, the
momentum threatened to be halted by the prospect of a trade
war between the US and China. But this, fortunately, appears
to be easing at the time of writing. The fears of a reversal of
globalization, which have been lying dormant since late 2016,
threatened to come to the fore again when the US fired the first salvo on 8 March 2018, with an intention to impose
tariffs of up to 25% on steel and aluminum imports. This
appeared to be primarily directed at China, the world's largest steel exporter, especially as that was swiftly followed by an
announcement of new tariffs on USD 50 billion in Chinese
imports, with a possibility of upping that to USD 150 billion. Tensions appear to have eased for now with the consensus
sentiment being that both sides will negotiate a more
peaceable, less disruptive outcome. But the episode highlights the reliance of Asia's recent GDP run-up on trade, and how
quickly that could unwind should a trade war break out,
particularly for export-dependent countries like Singapore and Hong Kong (Chart 3).
Chart 3: Exports
(% of GDP, 2017)
Source: CEIC (data as at 2017)
Export growth will likely continue to support near-term GDP
growth for most countries in the region, but we note that it
may be slightly tempered for the rest of 2018 given the high base in 2017 as well as a normalization of the global
electronics cycle, as indicated by a recent softening of the
semiconductor book-to-bill ratio.
Notwithstanding the impact of a potential trade slowdown,
China's 1Q18 GDP held steady from 4Q17 at 6.8% year-on-year (YoY) in spite of expectations of a slight moderation.
Household consumption improved, and reduced infrastructure
investment was offset by stronger services investment, particularly in the education, healthcare and culture segments.
Despite a slowdown in property sales, property investment
rebounded in 1Q18, due in part to an increase in land prices.
This did not prevent a continued slowdown in the housing
market amidst tighter mortgage conditions.
Australia's economic performance is also likely to come in at a
steady pace in 1Q18 as early indicators point to sustained strength. Healthy business activity is also expected to bolster
growth for Australia in 2018, while the Reserve Bank of
Australia is likely to keep rates on hold in the absence of inflationary pressures. The run-up in the labor market,
however, appears to be stalling – after a record 12-month
gain of 415,000 jobs in 2017, the momentum has slowed with a contraction of 6,000 jobs in February and a meagre
5,000-job gain in March. With still significant spare capacity in
the labor market and the unemployment rate refusing to budge at 5.5% in March, this suggests limited wage growth
in the future and consequently, limited support for consumer
spending.
Japan's longest economic expansion run in 30 years looks set
to continue in 1Q18, similarly supported by positive sentiment among the corporate sector. The all-enterprise business index
in the Bank of Japan's Tankan survey continued to pick up in
March, in spite of recent bad weather (which disrupted business activity), yen strength (which appears to have
reversed at the time of writing) and financial market
instability. While wage growth is not spectacular (with monthly cash earnings posting an average year-on-year gain
of 1.1% in as at February 2018), there are early signs that the
recent labor market improvement is translating to increased
consumer spending. Retail sales saw positive, albeit mild,
growth in the four months to February, the longest spell of
retail sales expansion since 2015.
Singapore and Hong Kong have both been beneficiaries of
strengthened external demand. Preliminary GDP figures for Singapore show growth of 4.3% YoY in 1Q18, which marks
an acceleration from the 3.6% annualized growth in 4Q17
and full-year 2017. While performance has largely been driven by manufacturing and exports, growth is expected to broaden
out to the services sector over the course of 2018. Hong
Kong's economy has already been bolstered by strong domestic demand, while fiscal stimulus as announced in the
recent Budget will be an additional growth driver for 2018.
Industrial
Ecommerce and the corresponding rise in demand for logistics
space is generating investment demand in industrial properties. In Sydney and Melbourne, yields have compressed
to record lows while Singapore has also seen a flurry of deals
in recent times, and the strong performance of markets in the region lives up to the bullish investor sentiment.
Some of the strongest rental gains this quarter are seen in Sydney and Melbourne, where rents rose 3.9% and 5.5%
YoY, respectively. Decreased supply and healthy demand have
resulted in vacancy rates falling to a cyclical low in Sydney, and limited new supply in Melbourne will keep the rental
outlook buoyant for these two markets. Landlords are similarly
in a sweet spot in Hong Kong, with strong exports and steady
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Real Estate Summary Edition 2, 2018
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demand from third party logistics (3PL) companies resulting in
robust take-up. The vacancy rate of warehouses remains low
and rents edged up in 1Q18. There is market talk of a relaunch of the industrial redevelopment program which, if
materializes, will result in stock removal and will further shift
the demand-supply dynamics in landlords' favor.
Large, multi-tenanted warehouses across Greater Tokyo
received record net absorption but this was more than matched by record new supply in 1Q18. While the 7.2 million
square feet that came onto the market represents the peak in
quarterly new supply, the next few quarters will still see significant completions. These, however, are not evenly
spread; inner areas such as Tokyo Bay enjoy low vacancy rates
and continued occupier demand while the Ken-O-do area will continue to have vacancy rates that far exceed the other areas
(18.9% vs 6.9% in the overall market as at 1Q18).
High quality business parks in Singapore continued to draw
demand from technology and financial services sectors. With
there being no new supply for more than a year now, rents in the more desirable City Fringe locations ticked up for a third
consecutive quarter and limited pipeline supply will likely
support further rental growth in the near term. In China, rental growth is still strong in Tier 1 cities, but landlords have
relatively limited leeway to raise rents as occupiers tend to be
cost-conscious. Retail
Better economic conditions, tightening labor markets and
improved consumer confidence bode well for the retail market
and some signs of life are starting to emerge in a sector that
has otherwise been battered by structural changes in consumer behavior.
In Hong Kong, a resilient domestic market, a recovery in inbound visitor arrivals and increased spending during the
festive season boosted retail sales. This, together with the
recent downturn in rents, has prompted a rise in enquiries by retailers. In a reversal of fortunes, watch and jewelry tenants
appear to have made a comeback and were particularly active
in 1Q18. Overall high street rents rose by 0.3% quarter-on-quarter (QoQ) after a 13-quarter downturn and the outlook is
bright given steady local consumption. Confidence is also
returning to the retail market in Singapore with leasing activity seeing a pick-up. There are signs that the market has
bottomed and both the prime and suburban submarkets
recorded rental upticks after multi-year declines.
The retail market in Shanghai continues to see rents recover,
and main pedestrian street Nanjing Road East saw the vacancy rate drop amidst strong occupancy. Decentralized areas have
seen supply increase over the past two years but given the
presence of online companies and their growing forays into the physical retail space, the decentralized areas in Shanghai
could become a testbed for retailers to experiment with omni-
channel offerings. The integration of online and offline retail appears to be even more apparent in Beijing with take-up in
1Q18 coming from online players opening physical stores. A
large amount of new supply is expected to enter the market in
China in 2018 but with the growth of the middle class and
changing dynamics between online and offline shopping, the
retail scene will continue to evolve. Limited supply in prime areas in Sydney and Melbourne will drive rental gains but the
same cannot be said for sub-regional shopping centres, which
continue to experience store rationalization.
Tokyo continues to face some challenges despite the increase
in inbound visitors and their spending per capita. Leasing activity remains muted due to a lack of wage growth and high
rent levels which deter some retailers from proceeding with
store expansion plans. In recent months, however, there has been some indication of a recovery in demand among luxury
brands and rents could bottom later in 2018.
Chart 4: APAC CBD prime office rent growth (% p.a.)
Source: CBRE, 1Q18
Office
Positive economic performance in the region similarly was a
boon for office take-up in the region. Singapore was a standout performer in 1Q18 with an 11.1% YoY increase in
rents (Chart 4). Leasing momentum was strong, evident in the
high pre-commitment levels seen in upcoming projects both within and outside the CBD. Demand in the quarter came
from insurance, transportation and oil & gas sectors and co-
working operators. Rents are still in the relatively early stages of an upcycle but we note that the issue of secondary space
has largely been ignored by the market for now and may
eventually crop up once tenants start physically relocating.
Chart 5: APAC CBD office vacancy rates
(% of existing stock)
Source: CBRE, 1Q18
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Real Estate Summary Edition 2, 2018
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Leasing activity was similarly strong in Hong Kong and was
centred on the decentralization theme amid limited availability
of space and high rents in Central. Rents rose in all sub-markets and the uptrend is expected to continue this year
with positive economic prospects likely to support leasing
demand.
In Japan, Tokyo rents managed a marginal 0.1% QoQ rise in
1Q18 as strong corporate earnings boosted take-up rates but there were early signs that the market may soon feel the
impact of impending Grade A supply, with longer rent-free
periods granted to large occupiers. The Australian markets continue to be split; Sydney had the strongest rental growth
as stock withdrawals and tight vacancies drove prime net face
rents 3.1% higher QoQ in the CBD. Melbourne similarly saw rents rise and while Brisbane and Perth are still
underperforming, there are signs that the rental downturn
may be bottoming for both amid improved economic conditions.
Demand in Shanghai is healthy but substantial pipeline supply in 2018 could cap rental increase this year (Chart 5). In the
medium term, Shanghai will benefit as China pushes ahead
with liberalization of the financial sector. In Beijing, leasing demand remained strong in 1Q18, supported by technology
firms amidst the government's push for technological
innovation. Financial Street remains the most stable precinct but with new supply concentrated in non-prime areas, some
decentralization might take place in the coming quarters.
Capital markets
After achieving an all-time high in 2017, preliminary data from
Real Capital Analytics (RCA) suggests that transactional activity in commercial property (excluding sales of development sites)
in Asia Pacific continued its positive momentum in the first
quarter of 2018 (Chart 6). In terms of composition, activity was focused on the commercial real estate markets of Japan,
Hong Kong and China.
Transactional volumes for income producing commercial
assets in China were approximately 5% lower in 1Q18
compared to 1Q17. Hong Kong saw a 150% increase in
volumes year-on-year, while Japan transaction volumes also
surged by approximately 40% in the same period. In the case
of Hong Kong, volumes this quarter were propped up by the USD 3 billion portfolio sale of 17 retail assets by Link Reit to a
consortium. Also of significance were two major commercial
transactions; namely the W Square and 18 King Wah Road, of which we estimate yields to be at or around 2%. In particular,
the presence of Chinese capital continues to be felt in Hong
Kong and we expect that to intensify in the next two years.
As we engage with investors and market players, it is very
clear that Australia continues to attract significant investment interest. However, volumes have stayed steady compared to
the same quarter last year. With pricing tightening in the key
cities of Sydney and Melbourne, alongside solid occupier
performance, it appears that existing owners are reluctant to
sell given the costs involved and lack of alternative investments for recycled capital. In Japan, several major
commercial deals were transacted in Tokyo in this past
quarter, despite talks of an impending office supply influx. Unsurprisingly, domestic capital continued to dominate in the
Tokyo investment market and that is unlikely to reverse in the
near term.
General expectations are that the yield compression story
across major APAC markets will come to an end soon. However, we struggle to pinpoint when that turning point
might be. In the tier one cities of China, such as Shanghai and
Beijing, the inward shift of domestic capital has resulted in yields that are at historical lows, and spreads that are even
negative in extreme cases. The situation does not seem to be
finding relief anytime soon.
In Singapore, we have observed a clear divergence between
the occupier market and investment market. In the period before 2017 when the office market in Singapore started to
stir to life, rents were in steady decline but prime yields
continued to compress. Much of the yield compression was due to the uplift in valuations arising from significant
purchases by high net worth individuals and sovereign capital,
where the key investment goal was typically capital preservation with limited risk. Singapore fitted the bill very
well, and in this cycle where rents are starting to see a
recovery, we would not expect yields to come off either.
In markets such as Japan and Australia, yield spreads relative
to long term bond yields remain relatively attractive, theoretically extending the runway for further cap rate
compression in the next few years, at least. Even if inflation
finds its footing and we see rents improving, the weight of capital will, in the short term at least, continue to exert an
overwhelming influence on expected returns.
In this regard, we believe that expected returns are set to be
slightly lower for new capital buying into today's market,
particularly given the lack of forced sales and the risks for existing asset owners in reinvesting capital to achieve the
same expected return, either domestically or globally.
Chart 6: Commercial real estate transaction volumes (USD billion)
Source: RCA as at 1Q18
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Real Estate Summary Edition 2, 2018
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Strategy viewpoint
In this edition, we turn our focus to China which has
dominated the headlines for most of the first quarter of 2018. Most Asia economies ended 2017 with stellar report cards as
the recovery in global demand directed a synchronized uplift
in economic growth across the region. Importantly, China was a key influence with robust growth in domestic demand
underpinning a revival in imports from Asia throughout 2017.
As we alluded to in our earlier editions, the dominance of China as a key player in the global economy in recent years
has 'regionalized' and ring-fenced Asia's trade and capital
reliance, weaning Asia off its dependence on non-Asian foreign capital. It is just as true in the area of real estate
capital flows. These factors make China arguably the most
important actor and stakeholder in Asia, and it is timely that we examine the possible impact from recent political and
corporate developments in China.
The first session of the 13th National People's Congress (NPC)
was held in early March 2018 at the Great Hall of the People
in Beijing. This annual NPC session is widely watched for glimpses of and nuances in Beijing's policy stance and possible
policy changes in China. There are a few takeaways that
matter.
Firstly, as China refocuses on the quality of growth over the
quantity of growth, we are seeing a gradual slowdown in the
GDP growth figures. In the recently concluded NPC session,
Premier Li Keqiang announced China's growth target for 2018
at around 6.5% which is unchanged from 2017. In fact, China had a terrific year in 2017, clocking a 6.9% growth rate.
Obviously sceptics remain doubtful as to the China GDP
figures but in the absence of alternative measures, the GDP numbers do provide a continuous sense of the ebb and flows
in the real economy. Having surprised on the upside, the
minimum GDP growth now required to meet the government’s long-term goal of doubling GDP between 2010
and 2020 is 6.3% p.a. This means that China can now afford
to focus on its reform goals and deleveraging, and we do not expect real estate investment and construction to feature
highly in the growth inputs. At the very least, the age of
highly speculative real estate investing is behind us. Secondly, China has endeavoured to keep macro conditions
stable, as it continues to pare down debt levels while
maintaining overall economic growth. Anecdotal evidence and our ground checks suggest that financing channels for real
estate have become increasingly limited since 2017, as
commercial banks come under pressure by the regulators to increase scrutiny on real estate related loans. In the
opportunistic space, there are some opportunities for investors
to take assets off the balance sheets of cash-flow constrained developers or landlords. We have also seen some interest by
foreign investors looking to provide private debt or mezzanine
financing to cash strapped domestic property players.
Thirdly, 2018 marks the 40th anniversary of China's "Reform
and Open Up" (改革开放) policy and Beijing is likely to want
to make significant gains in the modern reform agenda this
year. Supply-side reforms, in the China context, refer more to
the elimination of excess capacity than plainly the reduction of taxes in Western classical economics. What that means is
China will deepen state-owned enterprise reforms, expand
pension and healthcare insurance coverage to ensure better labor mobility, and also make further headways in the
legislation of a nationwide property tax. The amplified
liabilities associated with the expanded pension and insurance systems will indirectly drive pension funds and insurance
companies in China towards higher yielding alternative
investments such as real estate, both domestically and internationally. It is hardly an exaggeration to say that Chinese
capital is lining up at the gates, waiting for greater clarity and
permission to invest outbound. The recent corporate takeover of financially troubled Anbang Insurance, however, sent a
clear message that the newly merged banking and insurance
regulator, China Banking and Insurance Regulatory Commission (CBIRC), will not allow any reckless and
aggressive capital outflows into non-productive and non-
strategic sectors, or risk having any major financial fallout jeopardize China's deleveraging efforts. We believe the
corollary of this is an increased inward looking real estate
sector, as domestic capital jostles with foreign investors for a piece of the core real estate pie. To the extent that outbound
capital flows are permitted, markets which fall within the
scope of the Belt & Road Initiative will be given greater priority. Hong Kong, being seen as an extended market of
mainland China as well as offering investors a natural currency
hedge, could be a key beneficiary of any limited outbound
capital flows. To that end, we can expect yields in Hong Kong
to harden further in the next year, despite being at almost
record lows.
The recent trade skirmish between China and the US warrants
some attention here. When the US fired the first salvo during the early part of 2018, the situation appeared to be somewhat
dismal. However, we would hesitate to assume the worst.
China has been very restrained in her response, and we expect that negotiations will instead be the preferred outcome for
both sides. In fact, at the time of this writing, both China and
the US have come to the negotiation table and the ensuing trade talks are looking more positive than previously expected.
There has not appeared to be any knee-jerk reaction or impact
on commercial real estate in the region, although real estate markets in Korea and Taiwan, which are tightly embedded in
the China-US supply chain, might face some immediate
pressure in the short term if trade negotiations fail. In the alternative scenario, while unlikely, China can also resort to
non-tariff retaliation such as curtailing the movement of
tourists and students to the US, or imposing administrative measures on US companies' direct investments in China. In
the worst case scenario, a once-off devaluation of the RMB
would send ripples throughout the region. In all these scenarios, Asia Pacific is unlikely to remain unscathed.
All eyes are on China this year and for good reasons. We advocate that investors in APAC continue to be nimble and
maintain a watching brief on key developments in the region.
16
European summary
17
Economic data has come down slightly from heightened levels. Tenant demand remains strong as take-up increases further. Investment volumes moderate slightly following a strong end to last year. But yields remain stable and show no sign of moving out yet.
Real Estate Summary Edition 2, 2018
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European Summary Demand
Following the giddy heights reached the previous year, the Eurozone economy hit a patch of soft demand in 1Q18, with
growth expected to slow down to around 0.4% (YoY), based
on a raft of soft sentiment indicators. However, while this is
undoubtedly a moderation in growth, the indications are this
is unlikely to be sustained; manufacturing surveys, for
instance, point to capacity constraints rather than falling demand, while consumers remain bullish in spite of the weak
growth in retail sales. The consumer side is unlikely to
deteriorate further as inflation remains largely subdued and employment growth continues apace.
Political risk has also declined over the course of the previous year, with investors more sanguine about events in Europe
and the rest of the world. The market appears to be pricing in
a softer Brexit as the value of sterling has recovered somewhat, while fears of President Trump initiating a trade
war in Asia have retreated. The situation further improved by
the possibility of a historic peace summit between the US and North Korea. Though 2018 started with anti-establishment
parties winning the general election in Italy and most likely
forming the new Government, it still early to say whether the campaign promises of such parties will be fully pursued. If that
happens (even partially) there will likely be fears about a
further expansion of the already enormous Italian Government debt, with consequent financial instability in Italy and potential
chain effects on the Eurozone markets. Meanwhile, the ECB
appears to have taken a step towards normalization by removing its pledge to continue with the asset purchase
program. This could affect more countries with a weaker
financial situation, such as Italy. That being said, the Eurozone remains behind the UK and the US in terms of its key
indicators and we are, as such, not expecting any rate rises
until at least 2019.
Office take-up remains healthy despite appearing to flatten
out. Total European take-up rose by 2.8% on an annual basis,
which- while apparently modest- remains at high levels having
risen steadily over the past few years. UK regional cities saw
big increases, with rolling annual turnover increasing in Birmingham (93.2%), Liverpool (90.2%), Glasgow (57.7%)
and Edinburgh (56.8%), however as these are small markets a
few deals can cause large swings. Similarly Marseille saw volumes increase by 81%, while Luxemburg City saw volumes
rise 74% on a rolling four quarter basis. Of the more sizeable
markets, demand was high for offices in Frankfurt (+41.6%), Madrid (+34%) and somewhat surprisingly Central London
(+15%). Much of the demand in London is not "true" take-up
as it is being driven by the growth in flexible office providers, such as WeWork. The inflexibility of UK lease structures has
provided a boon to this sector as occupiers are willing to pay
slightly more to avoid being locked in for 10-year terms with
upward only rent reviews. At the other end of the spectrum,
take-up in Dublin stalled being almost two thirds below levels achieved in the previous four quarters, while Milan (-11.1%)
and Amsterdam (-14.6%) also saw relatively weak outturns.
Given consistently high levels of demand and low levels of
incoming supply, it is hardly surprising that rental growth
remains healthy across Europe with prime office rents increasing by 5% YoY across Europe. Much of this is being
driven by strong regional rather than capital cities. Marseille
for example saw growth of 21% on the back of very strong turnover, while Zaragoza in Spain (23%) and Bristol in the UK
(14%) also saw rental values increase impressively. However, it
wasn't only the regional cities, as Berlin continues its structural transformation on the back of impressive TMT demand with
prime rents climbing by 12.7%. Brussels also saw rents
increase 10.5% YoY, while Milan saw rents increase by 7.7%.
Chart 7: Aggregate European office take-up volumes
(including Central London)
Source: JLL 1Q18
In the retail sector, consumer confidence remains high in the
Eurozone as the recovery has already driven wage growth in
tighter labor markets, a trend that is expected to continue. An additional boon is that inflation remains relatively constrained
which will likely support retail sales growth. The UK is a
slightly different story as economic growth and wages have been muted over the past year, with spending further stifled
by higher inflation following sterling's depreciation. This,
combined with ongoing structural issues related to the growth
of ecommerce has meant UK retailers have endured a tough
start to the year. Several have already sought company
voluntary arrangements, while even some of those who are more robust have selectively sought to renegotiate leases on
reduced rents or a turnover basis. It appears the demand
balance has very much shifted in favor of tenants, especially for any secondary assets.
Prime assets continue to remain in demand, however as rents increased 1.9% to 1Q18 (YoY). We believe cities with high
tourist flows and strong university towns are well-positioned
to benefit from rental uplifts. It is not surprising therefore that Italian cities Florence (+33.3%), Rome (+17.2%), Verona
(+13.6%) and Milan (+16.7%) all saw strong rental
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performance in 1Q18. In the UK, regional cities appear to be
offering better performance than the capital as Birmingham
saw rents increase by a third and Scottish cities Glasgow and Edinburgh saw values increase by 14% and 9% respectively.
At the other end of the spectrum, rents fell in the major
German cities by 4-5% as well as the City of London by around -8% with affordability concerns likely playing a role.
We are hearing anecdotally that many retailers are taking a
closer look at the profitability of their Central London stores as high rents are becoming harder to justify in the current
environment; as a result some retailers are looking to assign
leases on Oxford Street and Regent Street.
Chart 8: Consumer confidence – Outlook next 12 months
(Balance – Seasonally Adjusted)
Source: Datastream, DG ECFIN, May 2018
Retail's loss has been to the advantage of the industrial sector
as ecommerce operators, 3PL firms and of course retailers
themselves have been forced to boost their distribution capacity to try and maintain market share. The positive story is
not only about the internet, as only around 10% of total
logistics activity is ecommerce-related. Another massive driver has been the growth in global trade, which has grown at
almost double the rate of GDP over the past 20 years. This has
compelled B2B logistics operators as well as manufacturers to invest to make their network as lean as possible. The relative
weakness of the euro and strong outturn for European
manufacturing has driven this further.
The net effect of these levels of demand has been a 2.3%
increase in pan-European industrial rents. While this may seem fairly modest compared with the high levels of tenant
demand, it should be remembered that European logistics
units are not generally inclined to rental growth and that values are still only around 14% above where they were in
2000. The lack of standing availability and strong presence of
purpose built units is one factor which limits growth, as developers are generally competing for tenants rather than
tenants competing for assets, which limits rental growth.
More significantly, industrial rental growth was higher than retail.
The exception to this has been urban logistics, where the twin drivers of requiring space close to population hubs and
competition from residential has driven double-digit rental
growth. Major cities- particularly London- continue to see a
net loss of industrial land which indicates this stellar growth could continue, although several recent insolvencies in this
sector serve as a reminder that this growth may hit an
affordability ceiling soon.
Supply Europe continues to be in the midst of a 'development puzzle'
as the usual link between higher leasing and rents and
accelerated building appears to have broken down. Stockbuilding remains at very low levels and- in locations
where there is a more active pipeline- the majority of it is pre-
leased. Paris and Dublin are both seeing high levels of construction at present possibly in the expectation of a Brexit
bonus, while Stockholm currently has the highest levels of
development in Europe. The Swedish capital has seen incredibly strong rental over the course of 2017, which raises
the possible concern of a supply shock. Both the City and the
West End of London have also fallen down the pack in terms of development, with new supply seeing good absorption. The
real test will come later, however, as occupiers may move out
of more secondary stock having taken space in a newly completed scheme. However, these are rare examples and the
majority of major European cities are currently seeing less than
5% of total stock being built out.
As a result vacancy has continued to fall in 1Q18, with the EU-
15 prime vacancy rate now standing at 7.1%, its lowest level since the financial crisis. However, there remain large
variations by country and city. The German cities remain the
most constricted; Stuttgart (2.1%), Berlin (2.9%) and Munich (3.2%) are the top 3 tightest markets in Europe. Elsewhere,
the West End in London has seen occupancy hold up despite
concerns over Brexit, with a vacancy rate of just 3.9%. There are still some cities with above average vacancy. Rotterdam in
the Netherlands has around 16% of space empty, while the
Schiphol area of Amsterdam is still around 11% vacant. Barcelona and Madrid remain in double digits as do Milan and
Rome, however all of these cities have seen improvements
over the last quarter.
In the retail sector, development appears to have fallen off the
agenda completely as landlords remain concerned over issues facing the sector and a possible oversupply of retail space. In
Western Europe, very few new shopping centers are being
built although extensions of dominant schemes remain common, such as the recently completed addition to Westfield
London. A significant amount of refurbishment has been
taking place as well. Recent research into the sector indicates that the amount of capex undertaken by the largest owners of
retail space has increased strongly since 2013. While these
landlords have generally been successful in moving rents up with asset management, they have been required to invest
significantly to do so. Going forward, the question will not be
so much where to build retail space, but which locations to
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convert to other uses. Anecdotally, some landlords are already
exploring schemes to convert city center assets to residential
or edge of town assets to last mile distribution centers.
Once again, retail's loss has been industrial's gain. Industrial
supply is difficult to track as there is no comprehensive data source, however it does appear that development activity has
trended up in Europe. PMA estimated that at year end 2017
around 10 million sqm was thought to have come on-stream, a 17% increase on the previous year. Speculative development
activity has been focused on the UK and the Netherlands,
although 2017 it was mostly located in Germany, the Netherlands, Italy and Spain. By sector, the demand is still
being driven by retailers, who have accounted for almost 50%
of new space developed since 2010. The biggest participants in 2017 were the major food store groups (e.g. Lidl and
Carrefour), ecommerce retailers (e.g. Amazon, Zalando) and
non-food retailers (e.g. The Range)
Chart 9: Prime rent index (1Q00 = 100)
Source: CBRE: 1Q18
Capital markets Investment markets appeared to take a pause in 1Q18
following a bumper finish to last year, as volumes in 1Q18 saw a like-for-like decline of -2%. This coincides with a
sobering of some of the jubilant economic data and could well
be indicative of investors taking stock of market conditions.
While this is plausible considering the late-cycle dynamics,
there is evidence to the contrary. For instance, real estate
fundraising continued apace in the 1Q18 and most investors appear relatively bullish on the near term prospects. A further
aggravating factor is that Chinese capital flows appear to have
subsided somewhat as SOEs have been restricted from making "reckless" investments outside of China. It appears the regime
is keen to encourage inward investment on the One Belt, One
Road project, although there is still a significant amount of dry powder waiting to be deployed in Hong Kong.
The sectors where the slowdown was most prominent are fairly predictable. Retail saw quarterly volumes decrease by
13% as investors continue to remain concerned over
headwinds facing the sector, while Offices also fell back by
6%. The strong areas were industrial which saw an increase of
20% in turnover, while the alternatives also saw volumes increase by 12%. On a geographical basis, investment in the
core countries has cooled with investors probably being
deterred by elevated pricing. Germany was flat, while the UK, Italy and France all saw volumes drop off. The Nordics also
saw volumes drop by around 23% as pricing has become
stretched following a few years of strong outperformance. Spain remains popular, however, as volumes there rose by
about 32% compared with the previous quarter last year.
Ireland saw a stellar increase of nearly 90%, although this is such a small market where changes tend to be very volatile.
The Benelux countries also saw inflows up by around 18%,
particularly the Netherlands which has seen its outlook upgraded significantly.
In spite of the disappointing outturn from investment flows, prime yields continued to trend downwards in the quarter,
albeit at a slowing rate. The pan-European office prime yield
compressed by a further 4 basis points, now standing at 3.82%. At a city level, UK regional cities have had a strong
start to the year as more or less everywhere apart from
London saw prime yields compress by -25bps. French B cities also saw strong performance as prime assets in Bordeaux and
Toulouse compressed by a further 25 bps. Overall the vast
majority of locations remained flat which is probably indicative of the elevated pricing levels for prime European assets.
The outlook for capital markets is also relatively flat, with most
of the added value expected to come from rental growth over
the next few years. One area in which there is possible further
capital appreciation are select fringe locations which are slightly off pitch but well connected have seen a resurgence in
investor interest. This is particularly true of the German cities
where assets are particularly in demand at the moment and the supply prime stock highly restricted (and expensive!). The
East, South and Eschborn areas of Frankfurt have all seen
investment volumes significantly above their long term average, as has the south area of Dusseldorf and the south-
eastern periphery of Munich. Secondary markets in
Amsterdam and Oslo have also seen significant inflows. It remains to be seen whether this is a savvy play or just late-
cycle behavior, but it represents an interesting shift in a
market where investors have long been focused on core assets.
The biggest risk for current investors is being caught on the wrong side of the yield gap as government bond yields return
to normal levels. In the US, this process is well underway with
10-year treasuries reaching 3%, although there has as yet been no noticeable impact on yields. In Europe investors have
slightly more comfort, however, as the ECB is only just
winding down its QE program with interest rate rises not thought to be in the agenda for quite a while yet. This lend
some encouragement to nervous investors looking at prime
yields of 3% for core assets in A-cities.
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Chart 10: EU-15 Yield Index Chart 11: European investment volumes
Source: CBRE 1Q18
Strategy viewpoint The growth of the alternative sectors
While there is a lot of uncertainty surrounding markets, investors are all certain about one thing: we are in a very
mature phase of the cycle. As explored in the previous section,
this has prompted some capital flows to more good quality secondary office markets, however investors have also become
more acquisitive in the higher-yielding alternative sectors.
Investment volumes into alternative sectors increased by over
14% in 2017, having seen large surges the two previous years
as well. Investment into hotels has been strong as well as flows into student housing, both of which have now become
institutionally preferred sectors in many European countries.
All told, the alternatives are now an established part of the investment set having represented 35% of total transactions
last year, up from just 18% in 2007.
The popularity of the alternative sectors stems partly from a
late-cycle hunt for yield, as their niche status generally
provides a higher income return. However, most of these sectors also have a compelling case based on structural shifts
in the market. Senior housing is well positioned to benefit
from Europe's aging population, while urbanization and
declining home ownership provide a supportive backdrop for
the PRS sector. Student housing taps into popularity of
Europe's universities with international students, while a growth in international travel will most likely boost the hotel
sector. Finally, data centers will be essential for efficiently
storing and managing 'Big Data', while the shift to ecommerce has driven the industrial over the past 10 years.
These positive tailwinds stand in stark contrast to the
traditional sectors, which as a rule are being negatively impacted by structural drivers. As has been well documented,
the retail sector is struggling due to the growth in ecommerce,
while the office sector may be about to undergo a disruption of its own based on challenges from digitally savvy serviced
office providers such as WeWork.
While this a very compelling story, there are certain aspects of
these sectors investors need to be aware of. Firstly, unlike offices and retail the majority of alternative sectors are
operating assets, meaning the landlord needs to take more
responsibility for the day to day functioning of the business. This either means hiring an in-house team with expertise in
this area or partnering with an operator in that industry
sector. Investors would therefore need to consider whether the premium these sectors offer over traditional sectors is
enough to justify the added cost.
Secondly, while RCA puts the total share of alternatives as
35% last year, there are big variations in liquidity. For
instance, a significant amount of this total investment turnover comes from logistics and hotels. Whether or not
logistics remains an alternative is debatable as it is now
comparable with the traditional sectors in terms of capital flows, investor composition and pricing levels. Leased hotels
similarly have characteristics more akin to the traditional side,
such as signing over the operations and yields comparable to offices and retail. For investors entering the senior housing or
student accommodation market for instance, there would
need to be serious questions asked about the hold period and exit strategy.
Chart 12: Investment in alternative asset classes
(EUR bn)
Source: RCA, May 2018
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US summary
23
Two years have gone by since US properties transitioned from appreciation-driven return to income-led return. Capital market pressures offset by economic optimism. Industrial supply still growing bolstered by logistics-intensive consumption, while retail must contend more with new virtual space than brick and mortar developments. Apartment and office construction to peak in 2018, implying incremental demand to be more impactful in coming years.
Real Estate Summary Edition 2, 2018
24
US Summary
Real estate fundamentals
One of the biggest stories for the first quarter 2018 was the
volatility in US equity markets. A rise in interest rates and
discussions about new tariffs caused two abrupt declines in the S&P 500, one in late-January and another in mid-March
(Chart 13). While more stock market volatility is likely, we do
not expect any spillover effects to private US commercial real estate in the foreseeable future. Fundamental growth in
property-level income continues to follow the strong US
economy and labor markets. Historically, the correlation between stock market performance and private real estate is
low.
Chart 13: Daily S&P 500 and 10-year Treasury rate
(%)
Source: Axiometrics and CBRE-Econometric Advisors as of March 2018. Supply is shown as a completion rate (i.e. completions as a percent of existing inventory). Shaded area indicates forecast data.
Occupancy rates are high relative to the past ten years and
now are facing a small degree of downward pressure with
supply growth matching or exceeding demand across most real estate sectors. As there is little room to increase
occupancy, rent growth is the driving force behind income
gains. Economic conditions create some optimism that growth will continue to reflect positive momentum for the US.
Chart 14: Property sector rent growth
(%)
Source: Axiometrics and CBRE-Econometric Advisors as of March 2018
Apartments
Vacancy rates are increasing slowly in the apartment sector,
under pressure from a peak point in new construction. At 5.5% vacancy remains below the 20-year average of 6.1%. As
shown in chart 14, apartment rent growth remains positive at
2.5% in the year ended March 2018 (source: Axiometrics).
US homeownership is unchanged at 64.2% during the first
quarter. This is a pause in a two year tend of rising rates of homeownership, a continued upward trend could slow
apartment demand. However, the current strength in the
labor market has been high enough to offset changes in
homeownership and maintain below-average apartment
vacancy.
Industrial
Growth in net rents is strong but decelerating, as new supply
begins to increase. Rents grew by 7.1% in the year ended March 2018, the highest of any property type.
The industrial availability rate was 7.3% in the first quarter 2018, which is as low as it has been since 1Q01. We
anticipate 2018 to be another good year for US industrial. As
we progress into 2019, the sector will have to contend with higher construction levels, chart 15, that could bring strong
rent growth figures down toward inflationary levels.
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Real Estate Summary Edition 2, 2018
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Office
Heading into 2018, deliveries of new office buildings are
increasing especially in tech markets, causing rent growth to slow faster than other sectors. At 1.3%, office rent growth
underperformed inflation during the year ended March 2018
with slightly lower rents in Downtown locations and 3.6% rent growth in the suburbs compared to a year earlier.
Average office vacancy increased 30 basis points over the year ended March 2018. The gap between downtown office
vacancy at 10.8% and suburban vacancy at 14.5% remains
wide. Rent growth trends suggest that suburban offices are holding space vacant a little longer to achieve growth in rents.
Downtown locations are likely to sacrifice some rent growth
to keep space occupied.
Retail
Retail sales in brick and mortar stores increased by 4.1%
during 2017, nearly twice the rate of inflation. Consumer spending is up due to increased disposable income and low
unemployment, which should support US retail sales
throughout 2018.
The mall/lifestyle and power center retail segments are facing
higher availability with space-for-lease increasing by 60 bps and 40 bps to 5.8% and 6.5%, respectively, over the year
ended March 2018. Stability in high-quality properties is offset
by deterioration in others. At 9.4%, availability in Neighborhood, Community and Strip (NCS) retail is up 30 bps
over the past year with landlords likely sacrificing some
occupancy to grow rents by 2.7%.
Chart 15: Supply trends
(Year-over-year completion rate in %)
Source: Axiometrics and CBRE-Econometric Advisors as of March 2018. Supply is shown as a completion rate (i.e. completions as a percent of existing inventory). Shaded area indicates forecast data.
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Real Estate Summary Edition 2, 2018
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Capital markets
US commercial real estate is two years into a period of sustainable, income-driven returns. Historically, the income
return component has generated 70% to 90% of property-
level total return in the US. Unlevered property returns have been relatively stable, trending between 1.5% and 2.0% per
quarter since mid-2016. First quarter 2018 saw the NCREIF
Property Index rise by 1.70%, chart 16.
Chart 16: US property returns
(%)
Source: NCREIF Property Index as at March 2018
Past performance is not indicative of future results.
Transactions volume showed signs of leveling off during the first quarter 2018 with total volume up by USD 7.5 billion
compared to the first quarter of 2017. Markets remain liquid
in aggregate with the absolute volume of sales of USD 439 billion in the year ended March 2018, chart 17.
Broad trends remain similar to 2017 with sales of retail and
office properties decreasing over the year and sales of apartments, industrial and hotels increasing.
Chart 17: US transactions
(USD billions)
Source: Real Capital Analytics as of March 2018
Real estate debt capital is low cost and generally available, but
not free-flowing, as was the case prior to the last downturn.
Increasing interest rates compress spreads available to lenders in a competitive marketplace. The spread between property
yields and the cost of debt also further compressed in early
2018. On the whole, US debt markets can be described as operational, but not excessive, which encourages development
but not an abundance of supply.
Chart 18: Commercial real estate spread
(basis points)
Source: NCREIF Fund Index-Open-end Diversified Core Equity and Moody's Analytics as of March 2018.
Core real estate spreads over the 10-year Treasury rate
compressed during the first quarter as interest rates rose and
cap rates were flat, see chart 18. While the real estate spread is well-above historic lows, it is already low enough to be
putting upward pressure on cap rates. We expect office and
retail to be the first sectors to experience small increases in cap rates. Transaction volume is trending lower in each of those
large sectors.
Long-term interest rates remain low relative to US history but
increased 50 basis points in early 2018. The 10-year US
Treasury rate was 2.4% at the end of 2017 but rose above 2.9% by mid-February 2018 (refer back to chart 13). With little
movement in cap rates, the upward move in Treasury rates
condensed spreads available in US real estate. Recent spreads offered by real estate investments are below long-term
expectations, representing a change from the wide spreads
that drew capital so quickly in the wake of the last recession and relieving one of the pressures that had been pushing cap
rates lower.
A growing economy and tight labor market should continue to
generate demand for real estate. Growth in demand and,
subsequently, in real estate income directly offsets upward pressure on real estate cap rates. Recent economic growth is
positive and near the high-end of recent years, US Gross
Domestic Product (GDP) increased by 2.3% during the first quarter 2018, chart 19.
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Real Estate Summary Edition 2, 2018
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Chart 19: US real GDP growth
(%)
Source: Moody's Analytics as of March 2018
In March 2018, the unemployment rate was 4.1% for the sixth consecutive month. A tight labor market generally makes it
tougher to fill open positions and eventually should put some
upward pressure on wage inflation. Job growth was lumpy during the first quarter with a spike in February followed by a
muted March, see chart 20. Over the past year, average
monthly job gains approached 190,000 per month.
The tight labor market is one reason wage growth is expected
to continue to accelerate in the US. Higher wages and consumer spending should reinforce expectations for more
inflation. Over the year ended March 2018, consumer price
inflation was 2.4% in the US.
Chart 20: US job growth and unemployment rate
Change in employment (thousands of jobs) (%)
Source: Moody's Analytics as of May 4, 2018
The labor market is strong enough and inflation is just high
enough to justify expectations for continuing the Federal
Reserve's (Fed) monetary tightening through the balance of the year. In March 2018, the Fed increased the target range
for the short-term Federal Funds Rate from 1.5% to 1.75%.
Even as capital markets face some pressure on the cost of
debt, fundamental strength in the US economy, labor market
and confidence measures support relatively good occupancy rates and continued rent growth in the real estate sector.
Strategy viewpoint We can now look in the rear-view mirror to see the transition
from appreciation-driven to income-led performance. Chart
16, shows the relative stability in returns since 2016. Investors should be reassured that slower appreciation was expected
and the transition happened without market disruption.
Today, property values are increasing at about the pace of
inflation. As anticipated, the spread available on real estate
condensed as interest rates have risen. Cap rates are not currently increasing in most sectors; however, we expect a
small upward movement in cap rates by the end of the year.
Appreciation now relates back to the positive income generated by properties, as opposed to the heated capital
market conditions the US experienced in 2014 and 2015.
As long-term investors, we take comfort in income-generated
performance. The positive outlook for economic growth
reinforces our view that income should continue to grow faster than inflation.
Current market conditions highlight the benefits of moving investment allocations toward strategic, long-term positions.
Fairly level occupancy rates and moderate rent growth leads us
to conclude that most property sectors are near or moving toward equilibrium levels of supply and demand.
With less variance in real estate performance across sectors, diversification is only growing in importance. We expect
markets will continue on a stabilized path, which will likely
result in continued convergence in expected performance and, relative to past years, limit the investment opportunities that
seem "obvious".
-4
-3
-2
-1
0
1
2
3
4
5
6
3Q09 2Q11 1Q13 4Q14 3Q16
Quarterly annualized Annual growth
1Q18
3.5
3.9
4.3
4.7
5.1
5.5
5.9
6.3
6.7
0
100
200
300
400
May-14 Feb-15 Nov-15 Aug-16 May-17 Apr-18
Job growth (L) Unemployment rate (R)
Real Estate Summary Edition 2, 2018
28
For more information please contact
UBS Asset Management
Real Estate & Private Markets Research & Strategy
Paul Guest
+44-20-7901 5302 [email protected]
www.ubs.com/realestate
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