The global real estate market – a part of many portfolios that totals $13.2 trillion, according to MSCI data – is perking up. We had long expected a tough backdrop for core real estate due to the fastest central bank rate hikes in decades. That’s why we went underweight U.S. open-end funds, those that allow periodic investment and redemption, in strategic portfolios in Q2 2022. Property values have declined in line with our view across developed markets (DMs). See the chart. While values are still falling in the U.S., they are bottoming in Europe and rising in the UK. Tremors in this market can have an economy-wide impact, seen last year in the selloff of regional banks on worries about their exposure to commercial real estate mortgages and mortgage-backed securities. Yet broad real estate concerns have started to ease on policy rate cuts: Transaction volumes are rising from recent lows in most sectors.
As rates come down, lower financing costs and reduced yields in other markets like credit and money markets should boost real estate’s relative appeal. Capitalization rates for public real estate investment trusts had surged as real estate values retreated in recent years, but now they are starting to fall, reflecting rising valuations on expected cash flows, Green Street data show. Yet some open-ended core real estate vehicles don’t yet fully reflect the past drop in public real estate values, according to MSCI and NCREIF data. As a result, we think real estate funds deploying capital in coming years can benefit from better starting values. Outcomes can vary widely, making implementation key. We see mega forces – structural shifts impacting returns now and in the future – driving demand long term in areas such as logistics. Geopolitical fragmentation pushes companies to bring production closer to home. New green building regulations are spurring energy-efficient refurbishments or new builds. The supply disruption from mega forces underpins our view of sticky inflation – and also makes real estate attractive as the asset class benefits from inflation-linked cash flows. We find opportunities by getting granular by region and sector. The real estate recovery looks further along in Europe and UK than the U.S. Private markets are complex, with high risk and volatility, and aren’t suitable for all investors.
Evolving views on China
Falling property prices have been a key factor in China’s sluggish growth and deflation. We favored U.S. and DM stocks over China – even as China’s valuations turned attractive – as policy support to the economy proved piecemeal. The policy signal from the September politburo meeting suggests major fiscal stimulus may be on the way. That doesn’t change the long-term, structural challenges we are concerned about. But we see room to turn modestly overweight Chinese stocks in the near term given their near-record discount to DM shares – even with last week’s surge – and a catalyst that could spur investors to step back in. We stay nimble and could change our view if the stimulus details disappoint or a ratcheting up of trade restrictions appears likely. The structural challenges include risks from geopolitical and economic competition, the need to reform its indebted economy and an aging population. We do not think the latest policy announcements will address those challenges.
Our bottom line
We see a brightening outlook for real estate. We look for opportunities in areas that took a bigger hit from higher rates – and from nuances at the regional and sector level. We upgrade Chinese stocks on expected fiscal stimulus.
