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MSCI: Capital growth in RE takes center stage

New buyers in overheated markets are moving toward capital appreciation and away from income-oriented returns, MSCI said.

As more asset managers allocate to real estate than ever before, the purpose of buying into the asset class in some top markets is changing, according to research firm MSCI’s annual report released last week.

Similarly to the period just before the global financial crisis, capital appreciation now comprises the larger component of MSCI’s total return index compared with income growth as real estate prices rise faster than income. Last year, capital appreciation accounted for 53 percent of MSCI’s global property index return total, compared with just 18 percent in 2000.

“We’re starting to see the tipping point in certain markets in terms of additional liquidity risks you take on for real estate,” Colm Lauder, a vice president at MSCI, told PERE. “Up to this point, real estate has been a healthy, income-producing asset class but crucially it’s been priced quite attractively. We’re now at a stage in the cycle where markets, especially places like New York City and London, are at a pricing level higher than in 2007, so you’re at record pricing levels – but income returns at record lows.”

Lauder said this trend has changed many investors’ rationale for purchasing real estate in certain heated markets. Now, investors are acquiring real estate for the value of the property, rather than for the income it generates.

“In 2016, one of the key focuses is the question ‘will real estate still remain a friendly option for income-focused investors?’” Lauder said. “If not, you’re going to be dealing with a market that’s much more volatile because the (capital return-focused investors) have no consistent short-term or long-term strategy.”

In London’s West End, for example, he said traditional institutional investors such as local pension funds are selling properties to sovereign wealth funds and other overseas buyers that value parking large sums of capital away from their home markets, many of which have been hit by varying degrees of volatility.

These market swings will only continue, Lauder said, noting that political events are affecting even relatively stable countries, such as the UK vote to leave the European Union and the US presidential election.

“Many investors will be hoping to just get through 2016,” he said.