This article is sponsored by MSCI Real Assets
After the global financial crisis, not all markets recovered equally. Global cities like Manhattan and Central London were among the first to rebound, both in terms of transaction volume and investment performance. They were the first markets that international investors turned to once the immediate crisis was over, and the first to see significant levels of price appreciation.
Now, as we emerge from the covid-19 pandemic, the effect on commercial real estate has been similarly unequal across global locations, with the New York and London metros among the locations where liquidity and deal volumes have fallen below their prior peaks. At the same time, other markets gained ground and attracted more capital flows than the traditional powerhouses.
Volume rankings hold despite slower growth
The top 20 global cities accounted for 44 percent of the total real estate investment volume from 2008 to the end of June 2022, MSCI Real Assets data shows, illustrating how strong investor preference has been for these large centers. In the aftermath of the global financial crisis, their share increased gradually before peaking at 48.5 percent in 2012. However, since then there has been a gradual decline, exacerbated by the pandemic, and their share dropped to 40.7 percent at the end of June 2022.
While the top 20 cities (as ranked by 2008-19 deal volume) held a lower share of the overall volume after 2019, not all reported lower volumes individually. In fact, many posted significantly higher deal volumes in the two and a half years since the onset of the pandemic.
Among the top 20, Los Angeles, San Francisco and Dallas all moved up the rankings as their transaction volumes were bolstered by strong growth in the industrial and residential sectors. From 2008 to 2019, the Los Angeles metropolis reported an annual average transaction volume of $25 billion, which increased 53 percent to $39 billion from the start of 2020 to the middle of 2022. During the 12 months ending in June 2022, volumes accelerated even more as $57 billion of income-producing real estate assets were transacted.
Besides Dallas, which ranked as the third most transacted metropolis globally over the 12 months to June 2022, there was also a substantial increase in transaction volumes in other Sun Belt cities such as Atlanta, Phoenix, Austin and Miami. In general, these cities are in states that adopted a different approach to containing the virus, meaning the work-from-home trend is less embedded. The region of the South was also subject to net-inward internal migration for the period from June 2020 to June 2021, according to census data.
The main beneficiary of these trends has been the apartment sector. The US stands out as one of the few countries where apartment investment outstrips offices, and that gap has grown through the pandemic because of the huge flows of capital into these Sun Belt cities. Close to $30 billion was spent on Dallas metro apartments in 2021, which made it the second largest city-sector investment segment globally in 2021. This momentum continued into 2022 and Dallas apartments were the number-one segment in the first half of the year.
Cities that reported a decline in their annual average transaction volumes between 2008-2019 and 2020-H1 2022 included New York, London, Tokyo and Hong Kong – all cities with a traditionally higher percentage of offices and retail in their transaction mix and a lower percentage of apartments and/or industrial. Other mega-cities such as Paris and Singapore reported positive growth in average annual volume – at 3.8 percent and 5.9 percent, respectively – but this was not enough to stop them losing ground versus other, faster-growing markets.
Most liquid markets lost ground
In line with the trend observed in deal volume, Manhattan, Central London and Tokyo 5 Wards all experienced declines in their market liquidity positions, as measured by the Capital Liquidity Scores from MSCI Real Assets.
Manhattan ranked as the most liquid market globally between 2008 and 2019, but in the most recent period it dropped to eighth place among 155 global markets tracked. (Rolling 12-month transaction volume is one of six inputs for the scores.) At the same time, Central London dropped from second to third place and the Tokyo 5 Wards markets slipped from third to ninth position.
While these markets all saw their volumes remain relatively consistent across the two periods, their liquidity scores declined as a result of two other inputs for the scores: a smaller percentage of institutional investors and fewer unique buyers.
As of June 2022, Berlin ranked as the second most liquid market globally, boosted by the city’s apartment market finishing 2021 ahead of Dallas as the number-one investment segment globally. While Berlin’s overall volume was bolstered by a one-off entity deal, trading of apartment buildings had been booming prior to the pandemic. The city’s liquidity score also increased on the back of a larger share of cross-border capital, more unique buyers and a higher percentage of investment by zonal and global market makers.
However, Berlin’s deal volumes tumbled in the first half of 2022, largely in response to the change in the macroeconomic outlook. Accelerating inflation, rising interest rates and high energy prices have all played a part in this deterioration. Germany is particularly exposed to Russian gas supplies, with the possibility of energy rationing a major downside risk through the winter months.
Returns diverged in the last year
Changes in liquidity and asset values impacted investment returns, and while the pandemic initially led to a deceleration of returns across all markets, we have seen a wide variety of outcomes on the rebound. Some of the largest global cities saw a significant deceleration in investment performance during the depths of the pandemic, as social distancing, remote working and changing mobility trends affected property income growth and investment returns.
According to the MSCI Global Quarterly Property Index, London, New York, Paris and Sydney all ranked outside of the top 15 global cities on a total return basis for the 12 months to June 2022. While the investment returns of these cities led the way in the years immediately following the GFC, their relative outperformance put downward pressure on their yield, causing a larger percentage of purchase expenditure to flow to secondaries markets since 2017 – a trend that the pandemic accelerated.
In the last 12 months, the performance of the top returning cities was mostly driven by either – or both – the industrial or residential sectors. For example, Riverside – located in California’s Inland Empire area – counted among the top performers from 2008 to 2019, but its return skyrocketed during the pandemic as the demand for industrial assets compressed yields to record levels. Industrial also contributed strongly to the returns in cities like Los Angeles, Baltimore and Philadelphia.
As was the case with their transaction volumes, the investment performance of US Sun Belt cities benefited from greater demand. Dallas, Atlanta, Phoenix, Austin, Orlando and Miami all moved into the top 10 on their 12-month total return to the end of June 2022.
What next for global cities?
The world’s major cities continue to form the backbone of the global real estate market, and while the pandemic resulted in lower volume growth in some of the traditional mega-cities like London, New York and Tokyo, it also kickstarted the emergence of a new grouping of globally significant investment destinations.
The strong growth in e-commerce and fulfilment benefited the industrial property sector, while population shifts boosted the apartment sector in markets such as the US Sun Belt cities. This shift in deal volume impacted liquidity and performance alike, with many previously overlooked locations closing the gap to some of the traditional mega-cities.
Now, as the global economy enters a period of higher inflation and lower growth, we might see a change in dynamic once again, as investors have tended to move towards larger, structurally more liquid markets during times of uncertainty.
Tom Leahy is head of EMEA real assets research, and Will Robson is head of real assets solutions research at MSCI