A new year always brings change, whether a sense of renewal or uncertainty. This year is no exception for real estate investors.
Whether it is political strife, financial market volatility or weakening economic data, 2019 already feels as ambiguous as any. You can add to this a seeming consensus among real estate investors that we are ‘late in the cycle,’ though there is debate about what ‘late’ might actually mean.
At the end of last year, our team addressed some of the key questions facing the industry over 2019, as well as what we got right and wrong when we undertook the same exercise a year earlier. I will summarize what factors we believe will move markets this year.
The synchronized rise in long-term bond rates is a major question mark for the industry, even though the rise in the US has recently been checked and in Switzerland and Japan near-zero rates will remain the norm for some time. As we move further through the year, and beyond into 2020, more markets will join the US in having below-average risk premia for real estate. This does not necessarily mean prices must adjust, but it does mean investors need to reconsider the price of real assets against what can be had in other asset classes. According to recent surveys, this has not changed the desire for a higher allocation to real estate among investors, but this adjustment in the risk premium will be an important factor for consideration going forward.
Political uncertainty has been a key feature of the outlook for real estate for some time, arguably forever. But with events in the US, UK, and continental Europe, not to mention China, it does feel like it is having a greater influence than a few years back. Typically, the impact of political risk is overestimated in the short term and underestimated in the long term. We do believe it is important. However, in our view, the direct impact for commercial property values in the short term will be relatively small, despite politics taking up a lot of column inches. In contrast, we believe there are two factors whose medium- to long-term impacts will be underestimated, although the exact timing is impossible to predict. Technology and environmental, social and governance factors both have the capacity to radically alter how the real estate investment market functions, and are arguably already doing so. Many ESG factors have simply become part of best practice. In our view, the current cycle will reinforce the conviction of the leaders in this field, while the late adopters will find it increasingly difficult to engage with the growing number of capital sources that have made ESG a priority.
In the technological space, e-commerce and flexible working have already influenced occupational patterns. Autonomous vehicles, artificial intelligence, 3D printing and other innovations will alter how we live, work, and play. In the near-term, we believe that technological evolution will push CapEx requirements higher. At the same time, there will be some offset in operational costs through tech solutions and investors will ultimately require slightly higher yields if they are to maintain their returns.
In addition to these broader trends, we are also questioning when the industrial bull run will come to an end and whether we are witnessing the end of retail as we know it. In the case of industrial, we expect those already invested to see strong demand and solid rent growth, but investors should consider shifting from ‘buy’ to ‘hold’ as in some instances pricing looks tight, even against optimistic rent growth assumptions. With regards to retail, we expect the coming year to mark only a step toward its full transformation. Retail will remain an important, albeit reducing part of portfolios, but what we call retail today may well be different in the years ahead. This year represents a step on that road, but not the final destination, as it will not be for any real estate asset class.