UBS: 5 questions to ask of the real estate sector in 2019

Building a resilient portfolio with a focus on income is what will drive outperformance in the next stage of the cycle, the Swiss bank says.

During the next 12 months, the real estate industry will need to make resilience a top priority.

As changes in interest rates, politics and capital flows threaten existing portfolios, investors will need to find ways to control for sudden shocks, according to UBS Asset Management lead real estate strategist Paul Guest.

He recommended that managers focus on diversification and try to stay geographically neutral, since regional differences for core assets are shrinking. Exploring alternatives, such as senior housing, that are demographically driven and can provide steady income regardless of the cycle is also a good strategy. In 2019, returns will be largely driven by income growth out of existing assets, Guest said.

But he advised that real estate firms need to ask the following questions as they prepare to welcome the new year.

  1. How will interest rates change property valuation?

“We’re moving out of this decade of really easy money where central banks have been printing money that has gone into the economy,” Guest told PERE. Long-term interest rates are rising in all major markets at the same time – a result of strengthening economies around the globe. Guest believes that in 2019 European markets may start to look more like the US, where bond rates have increased over the last few years and real estate yields are adjusting. The next 12 months are largely expected to be a turning point in the European Central Bank’s monetary policy, and the competitive investment market is unlikely to continue for another year, according to his December 2018 research note.

  1. How will the political climate change investment decisions?

Brexit negotiations continue to unfold while in the US the president’s late-night tweets have hinted at potential policy changes. These political risks, highlighted by the media and industry experts alike, can be a central point of concern. However, Guest believes political shocks tend to be overestimated in the short term and underestimated in the long run. In the case of Brexit, the impact in 2019 will be relatively small. But over the coming years, adjusting supply chains and regulatory changes will leave a large impact on property markets, he explained.

  1. How will capital flows change?

Asian outbound investment was a huge theme in 2018 and the flow of capital across regions will be a continuing theme in 2019, according to Guest. Over the last few years, cap rate compression has been driven in part by the continuous investment into real estate by institutional investors disappointed by fixed-income returns, he said. Fixed income is becoming more attractive now, and the industry will have to consider how that might change investment allocations by these large institutional investors. At the same time, Japan’s pension funds are looking to become more active in real estate, and the report noted that 2019 could see billions of dollars in Japanese capital enter the market.

  1. Are niche property types now mainstream?

Niche strategies and sectors will continue to be a focus in 2019 as technology and demographics structurally change real estate use and demand. Sectors such as data centers and senior housing are driven by these fundamental changes and are seeing institutional maturity, the UBS report observed. Most niche property types require longer commitments from investors or present operational challenges. But as yields compress, investors may be willing to enter the specialized field. Some alternative property types still face short supply relative to future demand and offer relatively high yields, Guest said.

  1. Will ESG continue to gain ground?

ESG factors have become a part of best practice, and many leaders in the area are focusing on working closely with tenants and putting an emphasis on social impact. A tougher operating environment, lower returns and higher interest rates may deter some managers from continuing this practice, especially for areas that require more qualitative measurements. However, keeping ESG a priority will be necessary to win over institutional investors that have been making ESG a focus in their portfolios. In addition, ESG principles come with financial benefits. The focus on energy reduction for reduced costs and social impact to strengthen tenant occupancy both contribute to boosting income over the hold period.

“That focus on income is what’s going to drive outperformance in the next stage of the cycle,” Guest said.