The size of the professionally managed global real estate investment market surged to a whopping $11.4 trillion in 2021, while investors set a global record by completing real estate transactions totaling $2.1 trillion, according to research by Morgan Stanley Capital International.
Thanh Bui, a portfolio manager at Clarion Partners, a private real estate investor, observed at a November 2 Franklin Templeton webinar, “Real estate has historically performed well in periods of inflation and could be a good hedge, as favorable supply and demand market conditions allow for landlords to pass costs along to tenants in the form of higher rents.”
The value of real estate tends to either remain stable or increase in the long run. The Dow Jones U.S. Real Estate Index, an index designed to track the performance of real estate investment trusts (REIT) and other companies that invest directly or indirectly in real estate through development, management or ownership, including property agencies, had an annualized 7.34% total return over the past decade.
Addressing the rising rates and forecasted slower economic growth globally, Neil Cable, head of European real estate investments at Fidelity International, at the MSCI Real Asset Conference said, “Consensus in the market is that significant headwinds lie ahead,” said Neil Cable, head of European real estate investments at Fidelity International, when addressing rising interest rates at the MSCI Real Asset Conference on November 3. “[Though] in this cycle, repricing of assets could come more quickly than in past cycles due to a larger diversity of risk appetites and more global players in the overall investment market.”
While elevated interest rates hurt equity’s valuations by lowering future free cash flow outputs, a similar effect is witnessed in assessed property values due to buyers’ inability to finance large-ticket purchases. However, lower assessed property values, a consequence of higher financing costs, actually increase a property’s capitalization rate, making the same cash flows provided by a property more attractive as a return, when viewed as a yield-barring investment.
“I think we will see a lot of consolidation; this could be a particularly great opportunity for, say, a U.S.-based fund to buy into European assets, given the currency strength and long-term outlook of real estate,” said Ian Goldin, a featured speaker at the MSCI Real Asset Conference and professor of globalization and development at Oxford University.
Goldin views demographics as informative to any long-term real estate investment strategy. Demographic shifts impact the commercial and residential real estate market, as they inform of the behaviors of tenants.
“We are seeing vibrant growth in cities worldwide, and the reason is we have seen marriage ages occurring on average 10 years later than historical averages as fertility has tumbled in advanced economies,” Goldin said. “I think we will see retirement ages change and demographics continue to change in these economies, and this will change how we invest and invest in the future.”
Similarly, Bui looks extensively into demographics to inform her real estate investment strategy, researching, “where people are moving before they know they are moving there.”
One of the major demographics changes the business world has responded to is the change to how employees work, with hybrid and work-for-home policies becoming commonplace among employers.
The work-from-home movement has seen an increase in office vacancies worldwide, though the trend is most dominant in the U.S. Currently, San Francisco office vacancy stands at 25%, according to CBRE, and the New York City market is not fairing much better, with 16% of office space still available, according to Colliers.
Despite this change in the way people work, commercial real estate as an asset class and cities as they existed before the pandemic are not going anywhere, argued Elizabeth Szep, senior associate in the real estate department at the Abu Dhabi Investment Authority.
“Work-from-home trends have been very sticky since the emergence of the pandemic,” Szep said. “What we have learned with rebounds in rents in New York City is that you should never bet against cities.”
The move to hybrid work has not been a negative to Class A commercial, amenity-rich properties. Buildings with open roof terraces and green spaces that offer concierge services and on-site maintenance are still attracting higher occupancy levels.
However, Bui said, “Offices are bifurcated as a market at the moment, between obsolete or potentially obsolete Class C or B, and amenity-rich Class A buildings. There’s a real flight to quality, as everyone tries to figure out either work-from-home or hybrid office life.”
Class B and C spaces potentially present opportunity for real estate investors, if the price is right and the projects appealing.
Goldin indicated he thought much construction and renovation looms, but he posed the question, “Can we make retail in entertainment, office into residential?” He answered, “Yes, but I think we will see a lot of demolition [of] buildings that cannot be remodeled, so how some of these stranded assets get recycled will become a bigger focus in the future.”