- We believe the U.S. commercial real estate recovery still has room to run amid reflation and resilient rental yields.
- The Fed raised rates. Stocks rose, bonds rallied and the U.S. dollar fell on Chair Janet Yellen’s perceived dovish remarks.
- U.S. durable goods orders could provide another sign of the disconnect between sentiment surveys and hard economic data.
1. Make room for real estates
The U.S. commercial real estate recovery is in its eighth year, but we believe it still has room to run amid reflation, competitive rental yields and potential for operating income growth.
Chart of the week
Components of commercial real estate return during U.S. rate hiking cycles
Sources: BlackRock Investment Institute and NCREIF, March 2017.
Notes: Total return is represented by the total return of the NCREIF Property Index (NPI), which tracks commercial real estate properties held for investment purposes. The income yield is based on the cash flows generated by the properties in the NPI. Other components are net operating income (NOI) growth (year-over-year growth in NOI) and changes in the capitalisation rate (which is NOI divided by the property's value).
Resilient rental income has helped support U.S. real estate returns during past rate-hiking cycles, especially during more gradual ones like today’s. See the green bars in the chart above. And commercial properties are typically able to raise rents in reflationary periods, albeit often with a lag, providing some inflation protection.
Reasons for real estate
U.S. commercial property prices have returned to 2008 peak levels, yet we see key differences with the debt-driven previous cycle that ended in a bust. Real estate development activity is lower and credit access is tighter. Valuations, measured by the ratio of operating income to property values versus 10-year U.S. Treasuries, are around the 20-year average.
We see U.S. commercial real estate delivering attractive total returns over the next few years in a low-return world. We expect capital appreciation to slow but see operating income growth due to the reflationary backdrop and the potential for property managers to add value by upgrading buildings. Average yields of 3.5% are competitive with 3.4% for U.S. investment grade and an S&P 500 dividend yield of 2%. Demand is strong: Nearly half of institutions in our most recent Global Institutional Rebalancing Survey intended to raise allocations to real estate this year.
We favour industrial and office properties that should benefit from reflation. We are neutral on apartments due to elevated supply and avoid retail properties due to e-commerce competition. We like selected publicly traded U.S. real estate investment trusts and commercial mortgage-backed securities.
- The Fed raised interest rates as expected. The U.S. dollar index fell to a one-month low on the perceived dovish tone of Chair Yellen’s remarks. U.S. Treasury yields fell and global shares rallied.
- Dutch Prime Minister Mark Rutte looks set to form the next Dutch government after his centre-right party beat Geert Wilders’ far-right populist party. European stocks rose and the euro strengthened.
- Oil prices stabilised after sharp declines, supporting energy-related stocks and high yield bonds.
|March 22||Japan trade balance|
|March 23||Eurozone and Germany consumer confidence; Fed Chair Yellen speaks|
|March 24||Global PMIs; U.S. durable goods orders|
U.S. durable goods orders could provide another sign of the disconnect between economic sentiment surveys and economic activity data. Recent surveys have pointed to accelerating U.S. growth, but a pickup hasn’t yet shown up in actual economic activity reports, possibly due to the typical lag between hard and soft data.
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Sources: Bloomberg unless otherwise specified.
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