Private real estate’s collision course with geopolitics

Whether it is the widening conflict in the Middle East, the now two-year war in Ukraine, China rattling the saber against Taiwan, or a record number of elections slated for 2024 globally, geopolitical risk is everywhere. And it has taken a prime spot on the priority list for private real estate investors.

Indeed, in Chicago-based global industry organization The Counselors of Real Estate’s 2024 Top Ten Issues Affecting Real Estate report, political risk was cited as the biggest concern, up from second place in last year’s survey.

Senior real estate executives such as Kieran Farrelly, head of real estate global solutions at Schroders Capital, agree with that assessment. Of the London-based asset manager’s three key investment themes of decarbonization, demographics and deglobalization, the third is the most cyclical, he notes.

“The way that geopolitics influences sentiment, it is very heightened at the moment,” Farrelly remarks. “So, for me, it would be number one in terms of importance right now.”

Hugo Llewelyn, chief executive of UK-based manager Newcore Capital, calls geopolitics “the topic in terms of investment.” Speaking to PERE as Houthi rebel attacks on Red Sea ships mounted in late December, he adds: “For the last decade or more, people have ignored the need to get paid for geopolitical risk, and yet it is there in spades.”

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PERE spoke with nine managers, investors and advisers on how a more volatile geopolitical environment has been shifting real estate capital flows in terms of geographic markets, sectors, asset types and strategies globally.

A changing landscape

The most prominent way geopolitical concerns have redirected real estate capital is in terms of markets, thanks to the rise of onshoring.

“Just the concept of more conflicts creates a little bit more nationalization, instead of globalization,” says Ward Fitzgerald, chief executive of EQT Exeter, the real estate investment arm of Swedish private equity firm EQT. “It creates a mindset where it’s risk-off. Companies will do more onshoring, do more nearshoring, hold higher inventories than maybe they otherwise would, so that they do not have shortages of supplies or shortages of end-product to sell to consumers.”

Top 10 issues affecting real estate

 1. Political unrest and global economic health

2. Occupiers, obsolescence and devaluation

3. The global housing shortage

4. AI – how intelligent is it?

5. The labor shortage

6. Migration’s impact on real estate

7. Economy, interest rates and inflation

8. Supply chain, logistics and US onshoring

9. Do markets need a pricing reset for values to normalize?

10. Finding ‘a third way’ to advance America’s infrastructure

Source: The Counselors of Real Estate

Mack Real Estate Group (MREG) is one manager that has altered the geographic composition of its equity investment portfolio partly because of geopolitical concerns and the onshoring trend. Where the New York-based firm’s largest allocations for equity investments previously were in its home city and Los Angeles, Phoenix has now emerged as the firm’s dominant market.

MREG began ramping up investing in Phoenix about five years ago, first because of demographic shifts, later because of the region’s ability to attract onshoring opportunities, says co-founder and chief executive Richard Mack. To date, the firm has committed to projects that upon completion will amount to over $1.25 billion of investment in the city, the majority of which is in ground-up development of industrial, multifamily and single-family-rental properties.

“Onshoring is a reaction to two things: one, supply chain disruption during covid, and two, more recent geopolitical concerns,” he observes. “Phoenix was an area that benefited from the two things coming together, and of course, they are somewhat related. Supply chain challenges became prominent during the covid disruption. Geopolitical issues have been here for a long time, but they have been heightened recently by regional conflicts and global economic and political competition between nations, compounding supply chain concerns.”

One of the most high-profile examples of onshoring activity in Phoenix is Taiwan Semiconductor Manufacturing Company, which is investing $40 billion to expand its chip manufacturing operations in the area. The chip maker’s commitment comes amid a wave of semiconductor investment spurred by the CHIPS and Science Act of 2022, which is intended to boost American semiconductor research, development and production and has safeguards to ensure “recipients do not build certain facilities in China and other countries of concern.”

With Taiwan Semiconductor, “it’s not just bringing chip manufacturing back to the US,” Mack says. “It’s also ensuring chip supply does not become part of the geopolitical conflagration in the event that China decides to invade Taiwan.”

A significant amount of onshoring activity in the US is also expected to be generated by the Inflation Reduction Act of 2022, whose objectives include investing in domestic energy production and manufacturing.

“I think some of the biggest points of growth are the intersection of geopolitical concerns and the Inflation Reduction Act,” Mack adds. “If you look at the onshoring that is happening, and companies locating businesses in the US, those are major demand drivers and they are generally happening in high-growth markets.”

Indeed, Phoenix leads the top 15 manufacturing growth markets in the US in terms of both jobs and facilities announced since 2020, according to a January 2024 report from New York-based commercial real estate services firm Newmark.

By bringing more manufacturing to the US, the Inflation Reduction Act stands to create a host of new investable markets in the industrial sector, notes Elisabeth Troni, fund manager of New York-based CBRE Investment Management’s flagship global indirect real estate strategy.  “There are huge tax incentives encouraging production facilities in markets investors have not heard of. While much of the focus is on the boon to infrastructure, there will be modern real estate facilities in locations there wouldn’t be otherwise,” she says. “It’s not like an Austin or a Raleigh. There will be micro markets that institutional investors will not have a history or presence operating [in].”

Indeed, among the 15 growth markets cited in Newmark’s report, five are in small metropolitan or micropolitan areas with populations of fewer than 500,000 and 50,000 people, respectively. These include Brownsville, Tennessee; Elizabethtown, Kentucky; and Sherman, Texas.

Geopolitics are also a key consideration for CBRE IM’s flagship global strategy in the UK. “We hold little UK exposure in the portfolio, due in part to a view that the outcome of Brexit in preferred sectors like logistics was hard to price. Brexit has shifted some regional supply chains, and investors need to watch shifts when they happen,” Troni says.

She adds that global capital sources face other structural limitations to investing in the UK real estate market, such as higher volatility and a higher capital gains tax rate relative to other developed markets. “But from a geopolitical point of view, it was, ‘how do we price this changing trade relationship with Europe in the UK?’ And that’s hard to price,” she says.

Rethinking asset selection

Jessica Hardman, head of European real estate portfolio management and head of UK at German asset manager DWS, has been tracking the impact of geopolitics on demand for real estate. “Our main focus is on how geopolitical developments might change flows of people and goods in the long term,” she notes.

“These flows are more important to note for operational real estate such as hotels, student housing and co-living as these rely on shorter-term lettings,” Hardman explains. “A tightening in immigration policy in a particular country, for example, could change [its] attractiveness as a study destination and, therefore, affect the performance of student housing. Hotels are also more exposed to geopolitical risk as tourists are easily diverted from a destination deemed to be higher risk.”

For the most part, however, elevated geopolitical risk has not driven managers and investors to significantly alter their sector allocations, DWS among them. Instead, it has led buyers to shift capital within sectors and take a more nuanced approach to underwriting investments.

For CBRE IM, this has meant rethinking asset selection with geopolitical factors as a focus. In the industrial sector, for example, the firm has tilted away from older facilities connected to global seaports in favor of modern assets in inland industrial markets in the US.

Industrial accounts for 47 percent of the portfolio in CBRE IM’s flagship global strategy, with close to half of that comprising modern properties aimed at serving domestic markets and populations. Troni expects the latter proportion to increase as CBRE IM continues to divest older assets, which the firm began doing in 2021 in response to changing geopolitical factors. “That’s our largest allocation shift from a geopolitical standpoint,” she says.

As for Schroders, “on the geopolitical side, it’s really all around the inflationary impulse that’s been created,” says Farrelly. “We are underwriting above consensus or central bank-targeted inflation into the medium to long term. When it comes to pricing assets, markets and sectors, those that are more inflation sensitive are where we bias ourselves.”

As a ripple effect, inflationary pressure and higher energy prices have brought the energy efficiency and sustainability profile of buildings into greater focus, he adds. “When we consider potential investments in the residential sectors, we focus on the total occupational costs for the residents and their ability to cover these,” Farrelly says. “It’s really delineated and it’s having some real impacts on how we look within sectors at a granular level.”

Investors look to de-risk

Geopolitical conflict has also changed the direction of capital flows from investors. “With the Taiwan situation, there’s definitely been some hesitancy around some of the broader Asia-Pacific programs,” particularly from US and European investors, one manager says.

“The way that geopolitics influences sentiment, it is very heightened at the moment”

Kieran Farrelly,
Schroders

The manager is quick to add that Asia-Pacific as a region is not off the table for these investors, and the hesitancy is around specific countries, namely China and Hong Kong, because of heightened tensions between China and Taiwan. “Now, the focus is obviously what’s going on in the Middle East, but the China-Taiwan piece has not gone away either,” the manager says.

Indeed, in his New Year’s Eve address, Chinese president Xi Jinping said Taiwan would “surely be reunified” with China. His comments came just two weeks ahead of Taiwan’s January 13 presidential and parliamentary elections, which saw president Lai Ching-te’s pro-sovereignty Democratic Progressive party win an unprecedented third term in power, further stoking tensions between China and the US.

Aversion to mainland China investments on political risk grounds was already a theme in private real estate before now, but has intensified of late. In early conversations about EQT Exeter’s pan-Asia logistics strategy, some investors asked about opting out of the strategy’s China investments, Fitzgerald says: “There is specific discussion along the lines of investors being concerned about the risk in China.”

PERE revealed in January that Hong Kong-based Phoenix Property Investors had removed deals in China, Malaysia, Indonesia, Philippines and Vietnam entirely from the strategy of its latest opportunity fund after discussions with its investors across the globe. Founder Ben Lee would not discuss fundraising, but said while the decision was partly due to investor concerns over geopolitical risk, the firm will not invest in emerging markets in general with the new fund. He noted that emerging markets currently face more unpredictable changes in macro policies and tax and legal frameworks, larger currency fluctuations and increased interest rate volatility.

Meanwhile, Newcore welcomed multiple new investors amid a more volatile geopolitical landscape. “Geopolitics drove capital flows and is continuing to do so,” says Llewelyn. “We are definitely impacted by geopolitical changes and how people look at risk, and it comes from two drivers: what might deliver sensible risk-adjusted returns in a more risky world and what has a chance of delivering real returns to beating inflation in a similarly risky world.”

Llewelyn points to the UK-based manager’s capital raise for its fifth fund, Newcore Strategic Situations V, which coincided with geopolitical events that included Russia’s invasion of Ukraine in February 2022 and the ill-fated “mini-budget” under former UK prime minister Liz Truss in September of that year.

“The risk came flooding back, and in that marketplace, we went from having about £30 million of committed capital at the beginning of the year to, in the first quarter of 2023, £190 million of committed capital for our fund,” he recalls.

“There will be micro markets institutional investors will not have a history or presence operating [in]”

Elisabeth Troni,
CBRE Investment Management

With Fund V, Newcore saw an influx of investors shifting capital from the office and retail sectors into residential, social infrastructure and other lower-risk strategies. At the same time, the vehicle also attracted institutions that previously invested in infrastructure operators but now looked to de-risk by investing in the assets the operators occupied rather than the operators themselves.

“We saw institutional infrastructure investors segueing from a higher risk-return in social infrastructure to a lower-risk, income-cashflow-driven model,” Llewelyn says, noting that such investors accounted for 11 percent of the total capital raised in the fund.

“If you think about the service provision of some of that social infrastructure, the costs go up with inflation. I think some investors took the view that the revenue line in the operating businesses might be squeezed a bit and the costs might go up. So, actually, that cashflow which had been stable and growing with inflation could get inverted.”

Hardman similarly expects investors to shift to lower-risk strategies in the face of negative news in the geopolitical environment. Although DWS has not yet seen the Middle East conflict have a major impact on its real estate business, “if things intensify or become more disruptive, then there is an argument in favor of core real estate as both an inflation hedge and as an attractive risk-off option,” she notes.

Pushing out a recovery

While geopolitics have helped divert capital flows in certain instances, they have also raised the prospect of capital remaining in stasis. “I think the geopolitical situation today definitely puts more caution in investor minds,” Farrelly says. “And so with the capital markets, a recovery in activity and transaction volumes probably is pushed out a little further.”

Geopolitical risk has both direct and indirect effects on investor activity. The direct impact is on general sentiment, he notes: “In a market that’s already going through this period of adjustment, with the unfortunate events unfolding in the Middle East and all the geopolitical tension that brings, why do something now? We get asked that kind of question a lot and I’d say these recent events just become part of that conversation.”

On the indirect side, geopolitics is exacerbating the denominator effect that has left many investors overallocated to real estate, inhibiting new commitments in the asset class while also driving sales of existing holdings, according to Farrelly. “Some of the volatility going through an investor’s portfolio is definitely finding its way to us,” he says. “We’re worried about potential further denominator impacts and so these geopolitical events could have a bearing.”

In a market still struggling to find its footing, real estate executives already had plenty to keep them up at night. But with tensions flaring up around the world, they stand to lose even more sleep.

Mixed views on the US 

Traditionally seen as a safe haven, the country has its own set of headwinds – especially political polarization

Does the world’s largest property market become more or less attractive to institutional capital during times of geopolitical volatility? It depends on the investor.

“The more geopolitical risk there is in the world, generally the better the US fares as a safe haven,” says MREG’s Richard Mack. “There’s a rule of law and a judicial system that is arguably as fair as there is in the world.”

However, Stephen Tross, chief investment officer of international investments at Dutch pension investor Bouwinvest Real Estate Investors, finds the political conflict within the country to be an investment risk, especially in an election year.  

“The US market is getting more polarized, which we find a concern,” he says. “Who’s going to be the next president? Will it be a Democratic or Republican president? The policies are going to be quite different. Also, there are the fights between the two sides and the shutdowns we have seen. That impacts our assessment of the stability of such a market and, therefore, in the end, the risk premium we put on investment there.”

Instead of deploying more capital in the US, Bouwinvest has increased its focus on broadening its portfolio in Canada, given the country’s strong economy, stable government, banking system and skilled workforce. “When the US market is favorable, there is less need for people to look further and look at Canada,” Tross notes. “But when the US shows some increased risk, these types of markets become more interesting.”

Constantine Korologos, clinical assistant professor at New York University’s Schack Institute of Real Estate, adds that the US’s role in geopolitical conflicts elevates the country’s risk as an investment destination. “I think you can argue that the domestic political risk is definitely connected and part of the geopolitical risk, because how we act and the decisions we make here have effects globally, and vice versa,” he says. 

“The concern is, ‘Are we going to have something happen here as a result of our involvement in what is going on in Israel and the Middle East?’ That is probably a more localized concern to a real estate investor. If, all of a sudden, I have to worry about something happening in one of my shopping malls or office buildings, or to my employees coming into work, that might elevate where it resides in the mindset.”