Appetite for real estate among the world’s biggest investors remains strong, putting pressure on pricing in many of the globe’s core markets. The response from the most sophisticated capital allocators has been to move to growth markets, such as China, India, Brazil and Indonesia. Brett Robson, global head, real estate private capital markets and head, Asia real estate at Macquarie Capital, explains what pull factors are dragging investors into these markets.
PERE: Competition for real estate investments gets more intense with every passing day. How are investors adapting to the challenge of making sensible real estate investments?
Brett Robson: What we are seeing from the major investors around the world is a focus on opportunities where there is more growth embedded, particularly in the income streams. That reflects where we are in the cycle. It’s late and cap rates have recompressed to a large degree and people are looking to the actual net operating income growth to drive greater returns.
They are looking at that at a macro level, which is what most global investors do, before diving down into sectors and individual countries and cities. The big macro driver in the developed world is population growth. This is often an overlooked fundamental surprisingly. We are also seeing interest in growth markets; we have seen a number of deals this year in China and India, interest is coming back for Brazil with people feeling that the market has re-set and that it is a good point for entry. For all these markets and other growth markets, ongoing structural reforms, some of the tougher decisions are playing out for a better longer-term future.
PERE: What structural trends are real estate investors focused on?
BR: What we are seeing is an increased focus on what I would call the longer-term structural drivers that underpin how people live, work and play: the themes of urbanization, demographic shifts and, of course, the omnipresent technology. There are now a broader range of issues that get pulled into the technology category, from automation and robotics to ecommerce and extending into renewable energy. They’re all changing how we use real estate and driving a collective focus on sectors that are beneficiaries in respect to one or more of those structural drivers or macro trends.
You are also seeing the other side of that and people looking for resilience of income through cycles. Where the demographics may play a part through the cycle, rental residential is an obvious example. It should perform relatively better in downturns than traditional core real estate sectors, which are much more linked to the economic cycle. There is a level of people building resilience into their portfolios, and I think that has been an ongoing trend.
PERE: There are also challenges to investing in these growth markets. Are all investors able to take advantage of the opportunities?
BR: We are seeing capital go into all markets. In some ways it has broadened with investors moving more into the growth markets including China and starting to do India and starting to look at Brazil.
On the flip side we are still seeing good capital flows into core markets and sectors. That comes back to business sophistication, if you don’t have the resourcing your investment options are a bit more limited. You may feel that we are towards the end of the cycle and so you won’t want to take on too much more risk, and so will continue to invest in markets/sectors where you feel confident that if the markets do have a dip you feel like you will have a level of resilience in that investment.
Most of it comes down to resourcing, which is a function of scale, and the bigger investors generally have the capacity to really study a new sector and determine whether or not it is one that they feel makes sense for them to invest in. They are the first movers.
We have done a lot of work with investors on sectors across the rental residential sectors and data centers, which you have and are seeing large institutions complete transactions in. Then there is that next tier of investors that subsequently follow. The best example of that is logistics, 10-15 years ago very few investors had any meaningful exposure to logistics property and were maybe not as big believers in the globalization of trade, supply chains and e-commerce. But, you had the big groups lead that through partnerships with the leading operators such as Prologis and Goodman. What you have seen subsequently is that most investors have decided that they need to own logistics. The same thing is happening in rental residential sectors like student accommodation, where you have groups like CPPIB, APG and GIC leading the charge and now you are seeing that next tier of investors coming in to invest.
The big investors are quite often directly investing, including into platforms. This has two broader benefits: it educates the market to the opportunity and also endorses the manager’s credentials in the market. That is what leads to the institutionalization of these sectors. Asset consultants and smaller investors then jump.
Similarly you see investment managers come in, mid-later cycle, and this is how the next tier of investors access the niche and again rental residential and logistics are great examples, with the big investors essentially locking up a lot of the opportunity with the leading operators. So, your ability to get invested if you want to get in is quite hard.
PERE: What effect is moving into these growth markets having on return expectations?
BR: As a generalization there is an acceptance that returns will be lower in a lower-longer interest rate environment. I think that has been a big driver this cycle. I don’t know anyone who could honestly say they thought rates would stay this low for as long as they have. What this has meant is that there was a level of return investors wanted, and kept wanting for a period of time that was achievable. But, as the cycle has moved on we have seen investors still overestimating where interest rates were going to be at every point.
At some point that will change, but what it has meant is that there is a lag on investors adjusting their expectation on returns, but they are adjusting them. The longer it has persisted the more recognition we are seeing that investors can’t get the same returns without taking on a lot more risk.
What we have seen, and again right across the spectrum, is this mentality of not wanting to take on a lot more risk to just keep getting that higher return, but rather getting a lower return but for a risk level you are comfortable with. The ongoing trend to develop-to-core strategies in sectors like rental residential and logistics are good examples. It’s become more about the risk on achieving a return than maintaining the absolute return itself.