Global Real Estate Market Outlook - Q1 2020 - Aberdeen Standard ...

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Global Real Estate Market Outlook - Q1 2020 - Aberdeen Standard ...
For professional investors only, in Switzerland for qualified
investors only – not for use by retail investors or advisers

Global Real Estate
Market Outlook
Q1 2020
02         Global Real Estate Market Outlook                                For professional investors only, in Switzerland for qualified
                                                                             investors only – not for use by retail investors or advisers

“Although the anticipated real estate returns over the next few years are
 likely to be lower than earlier in the cycle, the yield on real estate looks
 compelling compared with the low yields that are expected across a broad
 range of markets. With the expectation that interest rates are likely to
 remain at low levels and that uncertainty will continue at higher than
 normal levels, real estate assets with a reasonably dependable yield are
 likely to be highly sought after in this environment.”
                                                                    Global economic overview
                                                                    • The global economy is showing early signs of stabilisation.
                                                                      Central bank easing measures have loosened financial
                                                                      conditions and given a tentative pause in the US-China trade war,
                                                                      which have lowered global policy uncertainty. However, while
                                                                      downside risks have subsided at the margin, the Aberdeen
                                                                      Standard Investments Research Institute (ASIRI) view is that we
                                                                      are not expecting a strong rebound in global activity. Across the
                                                                      major economies, there is either limited scope for, or limited
  Executive summary
                                                                      willingness to use, additional monetary and fiscal stimulus.
  • Our economic forecasts envisage a broadly flat path from
                                                                      And while the most acute stage of global trade uncertainty may
    here for global growth. Downside risks have subsided at the
                                                                      have passed, absolute tariff levels remain high. Our forecasts
    margin as trade tensions pause. Our view is that growth will
                                                                      therefore envisage a broadly flat path for global growth
    be largely flat from here at levels that are disappointingly
                                                                      from here, at levels that are disappointingly low and indeed well
    low and well below consensus.
                                                                      below consensus.
  • Although pricing is looking stretched compared with earlier
                                                                    • Our forecasts envisage a further stabilisation in global economic
    in the cycle, we expect pricing to remain resilient as demand
                                                                      activity because the policy environment is turning slightly more
    for real estate continues to be high in the current
                                                                      supportive. For a start, central banks have delivered
    environment. Investors still value the relatively high yield
                                                                      considerable monetary policy easing, which has already seen
    from the asset class, along with the positive fundamentals
                                                                      interest-sensitive parts of the global economy tick higher.
    and the diversification benefits when compared with
                                                                      They have also signalled that they are prepared to do more.
    other assets.
                                                                      But we are also mindful that the transmission of monetary
  • In line with less economic uncertainty, concerns about the        easing is likely to be weaker than at earlier points in the
    real estate market have also moderated. But given the late        expansion. This is especially the case in those economies where
    stage of the cycle, the current levels of pricing, and the        policy space is very low (the Eurozone and Japan), capacity
    potential for a flare-up in economic uncertainty, we continue     constraints are becoming more binding (the US), excess leverage
    to adopt a low-risk approach to finding value. Having             is inhibiting credit demand and supply (India, Australia, Canada,
    conviction in an asset’s worth is absolutely key for fund         Sweden), or where financial stability concerns are preventing
    managers in this environment.                                     more aggressive policy easing (China).

  • Our preference is for sectors of the market that continue to    • In addition, the most acute phase of global political uncertainty
    benefit from long-term structural trends. These include           may be over. The US and China seem to be pulling back from
    industrial, residential and selective assets that are             their rapidly escalating trade war and the risk of a no deal Brexit
    categorised as alternatives. Industrials remain in favour         is receding. But we are also mindful that trade barriers between
    because of the long-term trend for changes in the way we          the US and China remain very high. And the 2020 US presidential
    are shopping. We expect residential to be resilient as the        election is likely to see a face-off between candidates with very
    propensity to rent continues to rise. We also anticipate          different visions for regulation.
    pricing for alternative assets remaining firm as it becomes
                                                                    • Regionally, we have modestly upgraded our growth forecasts for
    more favoured by institutions.
                                                                      developed markets. The trade détente and the removal of no deal
                                                                      Brexit from our baseline mean slightly higher forecasts for the
                                                                      US, UK and Eurozone – albeit the picture is still of subdued
                                                                      growth. Our forecasts for emerging markets are a fraction lower
                                                                      than before, but we still expect an improvement in emerging
                                                                      market (ex-China) growth in 2020, as several economies emerge
                                                                      from a very weak 2019.
For professional investors only, in Switzerland for qualified                                        Global Real Estate Market Outlook                             03
investors only – not for use by retail investors or advisers

“At this late stage of the cycle, real estate pricing is understandably
 stretched relative to pricing at the start of the cycle. However, we
 don’t see any immediate catalyst for a reversal in pricing. On a relative
 basis, referencing proxies for the risk free rate, such as long-term
 bonds, are not quite as stretched.”

• We also envisage a relatively subdued global inflation
                                                                            Chart 1: Aberdeen Standard Investments’ global
  environment. Underlying inflation is expected to undershoot
                                                                            pricing indicator
  target in most economies, as activity is generally growing around
                                                                            (Market price as a percentage of long-term worth)
  or below trend. Where wage pressures are present, it is being
                                                                             50
  absorbed into increasingly compressed corporate margins,
  rather than passed through into core inflation. Finally, oil base          40

  effects are soon set to become a modest drag on                            30
  headline inflation.
                                                                             20
• There are upside and downside risks around our view of the                 10
  future economic environment. To the upside, a widespread fiscal
  easing would make us more positive about the outlook,                       0

  although fiscal policy remains reactive rather than proactive at           -10
  present. And a lasting roll-back of tariff levels would be a cause         -20
  for upward revisions to our forecasts. On the downside, there is            Q4 10 Q4 11 Q4 12 Q4 13 Q4 14 Q4 15 Q4 16 Q4 17 Q4 18 Q4 19
  still a considerable risk of trade tensions re-escalating, given the       Australia      Canada        Eurozone        Germany         Japan      UK      USA
  unpredictable nature of the protagonists and the strategic                Source: Aberdeen Standard Investments, January 2020.
                                                                            Note: Market price is scaled against the long-term worth for each market at the same
  drivers of the conflict. A more severe downturn in labour                 date. Long-term worth is a proprietary estimate for Aberdeen Standard Investments. It is
                                                                            defined as the discounted cash flows provided by that market and is based on long-term
  markets and the global services sector could see economies                capital market assumptions, independent of currency or stock selection effects.
  slide towards end-cycle, especially given the sobering message
  from our recession risk models.                                        Market behaviour explained by short-term indicators
Market prices versus long-term worth                                     • Given behavioural factors, market prices can, and often do,
• Following more than nine years of robust growth, pricing in real         deviate from fundamental value for indefinite periods. We aim to
  estate markets is understandably stretched and is ahead of our           monitor market behaviour via our global performance
  expectations for long-term worth. In line with last quarter,             indicators. These help us understand the drivers of prevailing
  core assets in Asia-Pacific look to be the most overpriced               market prices (see Table 1).
  globally, particularly in the Hong Kong and Japanese markets.          • Global investment activity fell year-on-year, with activity
• In terms of sectors, our pricing indicators suggest that global          subdued in most regions. Global uncertainty and a lack of
  residential and industrial markets offer the greatest potential for      suitable products are holding back activity, despite there still
  risk-adjusted returns at this point in the cycle. The office sector      being a high level of ‘dry powder’ on the sidelines. The lack of
  continues to be the most overpriced, particularly in the                 entity-level (merger and acquisition) activity continues to subdue
  Hong Kong and Japanese office markets.                                   the comparative statistics with previous periods where there
                                                                           was a high level of entity-level activity.
• Long-term worth remains hard to find in global core real
  estate markets. For existing owners, opportunities exist for           • The key trends in volumes have not changed significantly.
  profit-taking in overpriced markets as investor demand remains           Pessimism and negative sentiment towards the retail sector
  favourable. We maintain our overweight position in the                   remain high as a result of the ongoing problems in the sector.
  North American real estate market. We also favour certain                Investment activity is subdued and sentiment towards the
  sectors and segments in the continental European markets from            sector’s prospects is gloomy. The unrest in Hong Kong and the
  a global allocation perspective, given regional pricing versus           ongoing Brexit uncertainty have suppressed activity levels in
  long-term worth.                                                         Hong Kong and the UK. Investment activity remained firm in
                                                                           the US, France and Australia.
04                  Global Real Estate Market Outlook                            For professional investors only, in Switzerland for qualified
                                                                                  investors only – not for use by retail investors or advisers

“The global performance signals remain relatively positive. Apart from the UK,
 where Brexit related uncertainty and the ongoing problems in the retail
 sector continue to affect the region, the indications are encouraging in all
 the other regions. This suggests that the current positive performance
 will continue.”
• Apart from Hong Kong and the UK, investor sentiment remains             conditions over the quarter. Lending terms tightened in Austria,
  favourable on a global basis. The most positive sentiment               the US and South Korea, and terms were looser in Ireland and Italy.
  continues to be in the European region, particularly for Hungary,
                                                                        • In line with last quarter, we continue to expect relatively robust
  Germany and Austria.
                                                                          rental growth across most regions over the next three years on
• Global share prices rose by 0.5% in the fourth quarter, which is a      an annualised basis. The strongest rental growth is expected to
  modest deterioration on the 8.1% increase in the third quarter.         be in the Americas region followed by Europe. We anticipate
  Most markets ended up in positive territory for the quarter,            modest rental growth in the UK market as it continues to be held
  despite the slowdown in returns. The US and Canada declined             back by political uncertainty and also by the ongoing problems in
  over the quarter, while Japan and Australia inched into negative        the retail sector. We expect the polarisation between retail and
  territory. The UK rebounded following the election result and,          industrials to continue. Retail rents are likely to continue
  similarly, Hong Kong recorded positive gains as tensions in the         declining, while industrial rents should remain robust as
  region moderated.                                                       long-term structural changes in shopping habits continue to play
                                                                          out. With bond yields continuing to moderate in most regions,
• Lending terms have continued on the recent loosening trend,
                                                                          the global spread to real estate remains compelling.
  although some countries witnessed a tightening in lending

Table 1: Aberdeen Standard Investments’ Global Performance Signals

               Performance signals             UK           Europe              APAC                 North America         Global
               Economic fundamentals                                                                                   
 Macro

               Margin over bonds                                                                                       
               Monetary Policy                                                                                         
               Supply                                                                                                  
 Real estate

               Flows of capital                                                                                        
               Lending                                                                                                 
               Fund flows                                                                                              
               360º view                                                                                               
Source: Aberdeen Standard Investments, December 2019.

Key
Performance Signal:         Trend:
Supportive                   Stable
Neutral                      Upward trend
Unsupportive                 Downward trend

Global overview                                                         • In the occupier markets, supply pipelines continue to be subdued
• Global investment volumes remain subdued and continue to                and well below the peaks of the last cycle across most core
  be affected by uncertainty and a lack of suitable product.              developed markets. The risk of a supply induced correction
  With a pause in trade tensions between China and the US,                remains relatively low. At a local level, some supply risks are
  more certainty around the Brexit process and an easing of the           materialising. This means that local knowledge and bottom-up
  confrontation in Hong Kong, global uncertainty has moderated.           asset selection are as critical as ever for strategy implementation.
  It is likely that there could be a slight pick-up in investment         Positive global growth should continue to support occupier
  activity over the year ahead. There continues to be a significant       demand as the real estate cycle moves to a period of lower
  amount of ‘dry powder’ on the sidelines, which is targeting real        total returns. Net income growth, rather than falling yields, will be
  estate, with the expectation that interest rates are likely to stay     the main driver of future return expectations.
  at low levels for some time yet. On a relative basis, the yield on
                                                                        • At this point in the cycle, core prices appear stretched relative to
  real estate continues to look attractive. In line with previous
                                                                          estimates of long-term worth. Where market prices are above
  quarters, we don’t anticipate there being a near-term catalyst in
                                                                          long-term worth, this implies that investors are not being
  the absence of a global recession that will lead to global real
                                                                          adequately compensated for risk. In turn, this suggests investors
  estate pricing weakening significantly at present. Signs of price
                                                                          may want to adopt a lower-risk profile at this stage and make
  declines continue to be limited, apart from the UK market and
                                                                          selective sales to re-position portfolios accordingly. In this
  specifically the UK retail sector.
                                                                          environment, seeking out value opportunities has become
                                                                          more challenging.
For professional investors only, in Switzerland for qualified                                  Global Real Estate Market Outlook              05
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“Although global uncertainty has moderated, it still remains at relatively
 elevated levels. With this in mind, we advocate a relatively low risk approach
 to seeking out value opportunities. We remain focused on an asset
 fundamentals and our conviction in an asset’s ability to deliver positive
 performance will be key for success.”
Regional outlooks                                                          estate demand. This has led to the tightest vacancies and rental
North America                                                              growth in North America for apartment, industrial and office
• Gross Domestic Product (GDP) growth in both the US and                   property types. However, the Calgary office market continues to
  Canada slowed in 2019. The services sector has continued to              suffer from the beleaguered energy sector.
  expand; however, the trade war with China has disrupted global
                                                                         • Healthy occupier fundamentals have continued to attract strong
  supply chains, which has negatively impacted the manufacturing
                                                                           investor demand. Transaction volumes moderated in the final
  sector. The manufacturing index from the Institute for Supply
                                                                           half of 2019, but remained well above historical levels. Industrials
  Management (ISM) in the US dropped sharply in 2019, signalling
                                                                           continued to experience rapid growth in sales and pricing during
  the sector’s deepest contraction since the global financial crisis.
                                                                           this period. Institutional capital is flowing into the industrial
  Canadian sector trends were more positive, but Purchasing
                                                                           sector as a result of robust performance and a positive outlook.
  Managers’ Index (PMI) readings suggest that activity remains
                                                                           However, retail annual transaction volumes fell by nearly
  sluggish. Activity is expected to decrease further next year, with
                                                                           one-third and pricing remained below 2015–16 levels.
  GDP forecasts of less than 2%. That said, reduced trade tensions
                                                                           Sales trends were stable among apartments and offices,
  offers some upside potential. The phase-one trade deal with
                                                                           but pricing continued to rise at a moderate pace.
  China includes cuts in certain tariffs on Chinese imports and
  increased Chinese purchases of US goods and services.                  • With the significant appreciation in prices over the past few years,
  The services segment of the US economy has strengthened                  overpricing risks remain evident in the North American market.
  recently, with the non-manufacturing ISM index rebounding in             This is particularly the case in the office sector where yields have
  the final quarter of last year. Private-services sectors continued       fallen to low levels and an increase in construction levels is likely
  to produce solid job gains. The unemployment rate fell to a new          to dampen rental demand in the future. Market pricing suggests
  50-year low, supporting broad-based wage and consumption                 that the US residential and industrial sectors continue to be more
  growth. Hiring in Canada accelerated last year, outpacing the US,        attractively priced than the office and retail sectors, and are likely
  particularly among office-using sectors Weaker global growth,            to offer better prospects for locating value opportunities.
  disruptive trade policies and muted inflationary pressures led to        The retail sector, particularly secondary malls, continues to
  an additional 25 basis point (bps) rate cut by the US Federal            experience issues with structural demand that are unlikely to
  Reserve (the Fed) in October. The Fed has signalled a pause,             abate. In Canada, our indicators suggest that the office sector is
  suggesting stable policy rates in the near term.                         not as overpriced as some of the other global office sectors.
                                                                           We remain positive on the forecast outlook for the
• Vacancies across all sectors remain tight relative to history, but
                                                                           North American markets. We continue to expect the market to
  we have also seen decelerating demand and rental growth.
                                                                           deliver an income-type return in the medium term, although the
  In 2019, industrial vacancies rose for the first time since the last
                                                                           downside risks have risen with yields hovering around new lows.
  recession. This was due to a slowdown in demand and
  accelerating supply. Leasing activity has likely been restrained by    UK
  weak industrial production and imports, coupled with a tight           • While there is low conviction in its base case, the ASI Research
  labour market that has limited hiring. Rental growth has                 Institute (ASIRI) expects a sluggish, but positive growth outlook
  moderated, but the sector continues to strongly outperform               to persist. It has revised upwards its expectations for GDP
  from very low vacancy rates. Although the national office                growth in 2020 to 1.4% although risks remain of a “cliff edge”
  vacancy rate is stable, it is at its lowest level since 2001.            Brexit at the end of the transition period in December 2020.
  Net absorption persisted at a steady pace, while supply was
                                                                         • A notable development in the December 2019 election was the
  measured. Rental growth was tepid but secondary and tech
                                                                           demolition of the so-called “red wall” of Labour seats across the
  markets with outsized job growth, such as Charlotte and Seattle,
                                                                           Midlands and the north of England. With Conservatives
  posted robust gains. The retail sector is still under significant
                                                                           representing some constituencies for the first time in decades
  pressure. Demand growth reached its lowest level since the last
                                                                           the focus of increased fiscal spending and capital could be tilted
  recession, as store-closure announcements rose to a record level
                                                                           more towards the regions. We expect fiscal stimulus to come
  in 2019 (according to Coresight Research). Neighbourhood
                                                                           through and steadily feed into growth, with a boost to consumer
  centres are performing relatively well – buoyed by
                                                                           spending. However, as the UK looks set to drift further from EU
  grocery-anchored centres – as they have been resilient to
                                                                           economic and regulatory alignment, we do not envisage a
  e-commerce. Vacancies have steadily improved in the apartment
                                                                           material pick-up in investment.
  sector. Development activity remains high, but supply has
  begun to moderate. This has led to a drop in concession rates,         • Occupational markets have, so far, largely been unfazed by
  supporting effective rental growth. Canadian real estate markets         prevailing uncertainty and a lack of clarity on the UK’s future
  are benefiting from attractive demand drivers and subdued                trading relationships. Take-up in the office sector remains
  supply. Outsized population and job growth have buoyed real              strong, with Central London leasing volumes now marginally
06          Global Real Estate Market Outlook                                     For professional investors only, in Switzerland for qualified
                                                                                   investors only – not for use by retail investors or advisers

  above the five-year quarterly average. Regionally, headline rents        speaking with one voice. Measures of industrial activity, business
  have been steadily rising and vacancy rates falling across the big       confidence and trade volumes are extremely depressed, but
  six office markets, boosted by large corporate occupier                  may have stopped getting worse. On the other hand, measures
  consolidation programmes. With supply pipelines generally                of consumer confidence, spending and the labour market are
  modest, the economic backdrop will be the key determinant of             more elevated, but starting to turn lower.
  demand and the rental tone in these markets. Meanwhile,
                                                                         • Helpfully, the policy environment is set to turn slightly
  industrials continue to report healthy take-up, especially for
                                                                           more supportive. European fiscal policy is loosening–
  well-connected areas in core markets and supply-constrained
                                                                           the change in the Eurozone structural budget deficit is likely to
  urban areas. Retail, however, continues to suffer severe
                                                                           add up to 0.5% to GDP in 2020. We therefore think that the bulk
  structural headwinds.
                                                                           of the Eurozone growth slowdown is in the past, and expect a
• The fourth quarter saw the highest quarterly volume of                   relatively flat profile for GDP growth over our forecast horizon.
  transactions in 2019, with the office and alternative sectors            However, even with growth stabilising, the economy is set to
  together contributing to over two-thirds of the £12.7bn total            expand around or just below trend – which means that inflation
  quarterly volume. A number of large portfolio deals in                   pressures should remain subdued. We therefore expect modest
  alternative property types underscored the very healthy                  additional easing from the ECB, and have pencilled in a single 10
  demand for secure income and repeatable cash flows. Despite a            basis point rate cut in each of 2020 and 2021.There are two-way
  number of large Central London office deals towards the end of           risks to our forecasts. Additional fiscal expansion represents a
  the quarter, the pool of overseas buyers has been shrinking.             rare upside risk. But given the low starting point for growth, and
  Some confidence may return in the short -term with a Labour              the uncertain global trade policy environment, most risks are to
  government avoided and, in the listed space, share prices have           the downside.
  moved very aggressively in response to October’s value rotation
                                                                         • Occupational Market Trends Modest economic conditions
  and an encouraging December 2019 election result for real
                                                                           provide a level of support across occupier markets in Europe. In
  estate. We are concerned this may be short-lived, however, if
                                                                           addition, over the last few years we have not seen an
  there is negative news flow regarding the UK’s negotiations with
                                                                           over-exuberant supply reaction across sectors. Indeed, we
  the EU.
                                                                           continue to believe that structural disruption through
• ASIRI has revised up its GDP growth forecasts for the UK                 demographic shifts, technology, governance and threats to the
  economy and, as such, we have made some modest upward                    environment will be equally as influential as cyclical trends from
  revisions to our numbers. Nonetheless, our real estate forecasts         this point forwards.
  still sit towards the lower end of the market consensus. For the
                                                                         • In office markets, leasing tension remains positive as stubbornly
  calendar years 2020-2022, annualised returns are expected to be
                                                                           low supply extends the rental cycle and we have upgraded our
  marginally positive at just under 2% p.a. Retail expectations
                                                                           forecasts in this sector accordingly. 2019 saw the highest level of
  remain negative over the forecast period, given the challenging
                                                                           take up recorded at almost 14 million square metres. New
  operating environment for retailers in the UK, and continue to
                                                                           development remains constrained and only 2 of the top 30 major
  pull down our all property total return expectations. The notable
                                                                           European office markets experienced a rise in vacancy in 2019.
  exception is the supermarket segment where we expect long-let
                                                                           The unweighted average vacancy has fallen to a new record low
  assets, let off affordable rents to outperform.
                                                                           of 6.6%. In Paris’s central business district, vacancy is only 1.7%
• The election result does not materially alter our outlook for UK         of total stock. In Berlin, it is 1.9%, and in Amsterdam Zuidas it has
  real estate and we maintain our approach to risk. As we enter a          also fallen to 2%.
  critical period for Brexit negotiations, there are a number of
                                                                         • Office rents across the major European markets increased by
  potential outcomes which hinge on the UK’s transition period
                                                                           1.2% in Q4 and by 4.1% year-on-year to Q4 2019, but we
  and future trading arrangements with the EU. Given this
                                                                           anticipate this rate will continue slowing as we approach peak
  backdrop we see very little justification to be taking on additional
                                                                           levels. Rome (12%), Berlin (10%), Oslo (10%), Amsterdam (8%),
  risk at this stage in the UK real estate cycle, with pricing of the
                                                                           Hamburg (7%), Barcelona (6%), Prague (6%) and Stockholm (5%)
  market well ahead of its long-term worth.
                                                                           have been the best performers over the last 12 months.
Continental Europe
                                                                         • The retail market is now seeing risk to income translate into
• Economic Outlook Eurozone economic activity remains weak,
                                                                           capital value declines on the continent. With roughly 10% of
  but may be finding a trough. Indeed, with Germany and the
                                                                           retail sales now sourced through ecommerce in continental
  Netherlands set to use some of their fiscal headroom, we made
                                                                           Europe, and with a growth rate of 9% per annum, pressures are
  modest upward revisions to our growth forecasts. Nevertheless,
                                                                           mounting. Prime high street rents have topped out and are now
  the outlook is still for weak growth and sub-target inflation,
                                                                           falling in most markets. The rate of decline has reached -0.4%
  which means that the ECB will probably have to ease policy again
                                                                           over the 12 months to Q3 2019. The strongest falls have been in
  in 2020. The cyclical growth data in the Eurozone are not
                                                                           Benelux (-3.9%), the Nordics (-3.3%) and Germany (-1.5%).
For professional investors only, in Switzerland for qualified                                    Global Real Estate Market Outlook              07
investors only – not for use by retail investors or advisers

  With exception of the very best shopping centres, this retail              to expect large differences in sector performance, with retail
  segment is considered to be experiencing more pain than other              significantly underperforming. In 2019, prices generally
  retail formats.                                                            continued to rise and economic risks increased. As such, we are
                                                                             gradually decreasing the risk in our portfolios by limiting
• Logistics remains the star sector, with annual take-up volumes
                                                                             leverage and by selling riskier assets and locations. In the future,
  roughly 50% above the long-term average. Demand remains
                                                                             we are focused on durable income streams for new acquisitions
  broad-based, but e-commerce fulfilment now represents
                                                                             and risk strategies should be carefully considered in the context
  roughly 20% of total take-up per annum. Logistics vacancy rates
                                                                             of the target sectors. While the cost of debt is low on the
  remain around 5% on an aggregate level. Rental growth is now
                                                                             continent – in many cases the ‘all in’ cost can be less than 100
  becoming more broadly evident, with build costs rising and
                                                                             basis points (bps) – it is important to resist the temptation to
  tenants forced to compete for what new space there is coming
                                                                             increase leverage. If leverage is implemented, target
  through in the best locations. Prime logistics rents increased by
                                                                             loan-to-value (LTV) ratios should be low to avoid adding
  3.5% over the year to Q3 2019, but when a reduction in
                                                                             too much volatility and downside risk.
  incentives is taken into account, net effective rents have
  increased by 4.5% over this period.                                      • There are a few areas where we have been willing to take
                                                                             greater risks. One is asset management risk (short leases and
• Capital Market Trends Investment in Continental European
                                                                             vacancies) in well-located office and logistics properties in cities
  commercial real estate reached €70 billion in the fourth quarter
                                                                             with low vacancy and strong rental markets. The other is
  of 2019, taking the annual total to €208 billion – down 2%
                                                                             value-added activities that are less linked to the economic cycle.
  year-on-year. The volume invested in retail property has fallen
                                                                             These include conversions from commercial use to residential,
  sharply in recent quarters, with the total down roughly 18% in
                                                                             or investment in diversifying alternatives where leases can also
  2019. By contrast, offices have seen a 14% increase in
                                                                             be longer.
  investment. Investment in residential property increased to
  €40 billion in 2019, rising by 18% to become the second most             Asia-Pacific
  active sector behind offices. Alternative sectors continue to            • The economic slowdown in Asia during 2019 was worse than
  receive an increasing share of total investment. Hotel investment          initially expected. The Asia-Pacific region is on track to register an
  increased by 30% in 2019, in part reflecting strong appetite for           average real gross domestic product (GDP) growth of just 4.4%
  long term cash flows in a sector less exposed to domestic                  in 2019. This compares with 5.2% the year before and the
  economic growth. Industrial investment increased by 7% in 2019             forecasted 5% at the start of the year. This would mark the
  to €25 billion and we believe this number would have been                  slowest growth since 2010. A sharper-than-expected fall in
  higher if there was sufficient product to meet demand.                     exports and manufacturing was the key drag on economic
                                                                             growth last year, largely as a result of the trade dispute between
• According to the latest CBRE valuation monitor in Q3 2019,
                                                                             the US and China.
  12-month all property values in continental Europe increased by
  4.0%, logistics by 10.1% and offices by 6.3%. Retail values fell by      • Social unrest in Hong Kong was a negative surprise in 2019.
  2.1%. By country, Germany (5.6%) and the Netherlands (5.7%)                Coupled with the negative impact from the US-China trade war,
  saw values continue to increase at the fastest rates. Caution              which had already weighed on exports prior to the social unrest,
  towards the future of physical retail is leading to an increase in         Hong Kong is now on track to report a full year real GDP
  yields in this sector as investors pull back. Office yields                contraction of 1.1% for 2019 (from +3.8% in 2018). We believe
  compressed further in the latter stages of 2019 to stand at 4.3%           political uncertainty will likely remain an overhang on investment
  on average. Logistics yields continue to fall and stand at 5.6%,           in 2020, considering the legislative council election is scheduled to
  having fallen by 30 basis points over the year. Prime levels are at        be held in September this year.
  3.9% in Germany, 4.3% in France and 4.7% in the Netherlands.
                                                                           • In our base case, we expect growth to stabilise at a low rate in
  Supporting the liquidity in the market, lending to real estate
                                                                             2020. We expect the slowdown in manufacturing to stabilise with
  remains abundant and very cost effective for borrowers. On
                                                                             a small rebound in exports in 2020. Coupled with the delayed
  good quality institutional-grade assets, the all in cost of debt can
                                                                             impact from tax and interest rate cuts in Australia and India, we
  be below 100 basis points in some jurisdictions.
                                                                             expect real GDP in Asia-Pacific to grow an average of 4.5% in 2020
• Performance Outlook and Risk In the short-to-medium term,                  (from 4.4% in 2019). The upside risks to this forecast include a
  we have slightly upgraded our forecasts and continue to expect             faster-than-expected turnaround in the global tech cycle,
  Europe will perform well in a global context. The cycle has                which will likely benefit markets such as Taiwan, Korea and
  become more advanced, implying that less upside is expected                Singapore. The downside risks include ramifications from
  from falling yields, but low interest rates support our notion that        potential geopolitical conflicts, a faster-than-expected pick-up in
  yields will be as low, or lower, in 5 years’ time than they are today.     inflation (and by extension, the implication for monetary policy),
  Stable income returns and modest income growth are expected                and a significant deterioration in the situation in Hong Kong.
  to be the key components of performance. Critically, we continue
08          Global Real Estate Market Outlook                                       For professional investors only, in Switzerland for qualified
                                                                                     investors only – not for use by retail investors or advisers

• Net rents in Asia-Pacific are on track to register an average            • Recent data suggests Asia-Pacific real estate’s access to credit
  growth of 0.8% in 2019, compared with 2.5% in 2018. The slower             has improved on the margin, but we expect lenders to remain
  growth in 2019 was principally on account of weaker office rental          selective in 2020. While high yield spreads in Asia were lower by
  growth (1.1% versus 3.7% in 2018), with Hong Kong (prime rents             an average 141 bps last year, the gap between investment grade
  -2.5% versus +5.9% in 2018) and China’s tier 1 cities (-6.2% versus        and high yield spreads remains at a high of 372 bps (versus the
  +1.1% in 2018) being the main drag. In spite of slower growth in           average 312 bps in the last three years). The lending attitude of
  net rents, vacancies remain relatively tight overall with the              banks towards real estate in Japan is also still relatively cautious
  exception of office properties in emerging Asia. As at the end of          compared with two years ago.
  the third quarter of 2019, vacancy rates in developed Asia for
                                                                           • The slide in 10-year yields during the second half of 2019 has
  office, retail, industrial and residential properties are all narrower
                                                                             widened the gap between cap rates/yields and 10-year sovereign
  than their respective mean over the past 10 years.
                                                                             yields/risk-free rates in Asia-Pacific, especially in the case of
• Overall, our near-term rental Asia-Pacific forecasts are:                  office properties in developed Asia. Taking into account the still
                                                                             conducive environment for listed real estate to raise new equity
  –– Offices: net rents are likely to be flat overall in the near term
                                                                             for acquisitions and the slightly improved access to credit,
     (+0.4% per annum (p.a.) over the next three years, with any
                                                                             we believe the wider yield gap is likely to attract more capital to
     potential upside in Australia (+3.2% p.a.), Japan (+2.7% p.a.) and
                                                                             be deployed into Asia-Pacific real estate in 2020, despite slower
     Singapore (+2.4% p.a.) mainly offset by downside in Hong Kong
                                                                             rental growth.
     (-3.8% p.a.).
                                                                           • We expect core returns for Asia-Pacific to trend lower,
  –– Retail: net rents are expected to fall by an average 2.5% p.a.
                                                                             given increased challenges in retail assets and in Hong Kong.
     over the next three years. We expect structural challenges to
                                                                             We forecast an average total return of just 2.8% p.a. over the
     continue for retail properties in Asia-Pacific. There is pressure
                                                                             next three years for core assets in Asia-Pacific, compared with an
     on rents to be sustained as a result of a further loss in market
                                                                             average 8.7% p.a. over the past two years. We expect the biggest
     share from offline shopping to online shopping, a greater
                                                                             drag on returns to come from retail assets and we forecast total
     supply of new retail space, and lower retailer margins.
                                                                             returns to be essentially flat over the next three years (from an
  –– Industrial: net rents are expected to grow by a slower 1.1% p.a.        average 5.4% p.a. over the last two years). In addition to negative
     over the next three years as we expect growth in China to               rental growth of 2.5% p.a. over the next three years, we expect
     decelerate from its current pace. But rental growth in                  yields to expand by an average 37 bps to reflect both structural
     Singapore could pick up pace as new supply moderates amid a             challenges and heightened investors’ aversion towards the
     mild recovery in exports.                                               asset class.

• According to data from Real Capital Analytics, transaction               • In Hong Kong, we forecast an average total return of just
  volumes for investment properties (excluding development sites)            1.8% p.a. over the next three years (from 6.2% p.a. over the last
  in Asia-Pacific are on track to register at least a 10% fall in 2019,      two years) and we are especially cautious about prime office
  compared with an increase of 5.3% the year before. This would              returns (-3.5% p.a. over the next three years). We expect leasing
  represent the lowest level of investment activity in the region            demand from Chinese firms and financial institutions to remain
  since 2013. It appears investors adopted a more defensive                  weak and we forecast prime office rents to fall an average
  stance in 2019. Transactions for residential properties                    6.1% p.a. in 2020-22. As a cross-check, this would narrow the
  (including rental apartments and senior housing) saw the biggest           discount between prime office rents in Singapore and
  gain during the year (+37.4% to USD5.8 billion). Singapore also            Hong Kong to 12% by the end of 2022 (from 34% as at the third
  saw the biggest gain in investment activity last year among                quarter of 2019), in line with the +one standard deviation
  major Asia-Pacific markets, with transactions for investment               discount between the two markets since 2000.
  properties up 27.5% in 2019 to USD9.5 billion.
                                                                           • In terms of downside risks, apart from a slower-than-expected
• Listed real estate investment trusts (REITs) in Japan, Australia           stabilisation in economic activity, recent events since the start of
  and Singapore raised a combined USD17 billion in new equity in             2020 have also raised the risk of geo-political conflicts and the
  2019. This represents a jump of 55.2% from the year before and             potential implication on energy prices. More relevant to the real
  the highest amount since 2013. Despite the marked jump in the              estate market would be the implications for inflation and
  supply of new securities, valuations remains robust with these             monetary policy. While it is unlikely interest rates would be
  three REIT markets trading at an average 1.4x book as at the end           raised to counter cost-push inflation, we think higher headline
  of 2019 – from 1.2x at the start of the year and above the +one            inflation numbers could restrict the room for policy makers to
  standard deviation level of 1.3x since 2009. This suggests                 introduce further monetary easing.
  investors’ demand for listed real estate remains strong and we
  believe the environment to raise funds for acquisitions remains
  conducive in 2020.
For professional investors only, in Switzerland for qualified                                 Global Real Estate Market Outlook            09
investors only – not for use by retail investors or advisers

• Our preferred long-term investment theme remains                      Summary
  urbanisation and population growth in the major cities of Asia.       Encouragingly, the global economic backdrop that provides the
  We continue to believe skilled labour will be drawn to cities that    underlying support for the real estate occupier and investment
  are ranked highly in terms of quality of living, infrastructure,      markets looks to have stabilised this quarter. Global uncertainty
  education and healthcare. We believe this will underpin               has reduced with the pause in the US-China trade war and central
  long-term housing demand in these cities, which should in turn        bank easing measures have loosened financial conditions.
  translate into above-average long-term returns for residential        However, global growth remains lacklustre and our expectations
  properties in these markets. We remain positive on residential        are for growth to be below the consensus of economic
  properties in Japan, specifically rental apartments in Tokyo and      expectations. Furthermore, the real estate cycle is at a late stage
  senior housing.                                                       and pricing remains stretched compared with earlier in the cycle.
                                                                        Despite this, the fundamentals for the asset class are encouraging
• We think there are still value-add opportunities to be found in
                                                                        with future supply significantly below the level it reached at similar
  office and industrial properties, but we would avoid Hong Kong
                                                                        points in previous cycles. Occupier markets remain well supported
  for now. Markets where we still see value-add opportunities
                                                                        and vacancy rates are below average in a range of different
  include office and industrial properties in Australia and Japan;
                                                                        markets. Additionally, there is an expectation in the current
  office properties in Singapore, India, Seoul and Taipei; and
                                                                        environment that interest rates are likely to remain at historically
  logistic properties in China’s tier 1 cities.
                                                                        low levels for a significant period of time yet. The margin that real
• On the other hand, distressed opportunities could start to            estate provides over the risk-free rate is at elevated levels.
  emerge for retail properties, especially in Australia. While we are   Investors do need to be cautious with this metric as the risk
  cautious on the overall structural challenges faced by retail         premium associated with real estate should arguably be higher
  properties, we think there could be an investment case for            now as lease lengths get shorter and as the propensity to break
  selected properties as the fall in capital values accelerates,        leases is higher than it was in the past. In the current and forecast
  especially in Australia. These include retail properties with         low-yielding environment, we expect demand for real estate to
  defensive characteristics (location with good catchment and           continue to be robust and we think that pricing will remain
  traffic; relatively low occupancy cost) as well as those with the     resilient. In terms of our sector and structural preferences, we
  potential for repositioning.                                          continue to like specific sectors and segments in our favoured
                                                                        markets that are continuing to benefit from long-term structural
• Above all, we believe investors need to stay nimble. All else being
                                                                        trends. These include industrial assets that are benefiting from
  equal, we prefer an investment that could be turned around and
                                                                        changes in shopping habits. The private rented sector is also
  sold within 36 months, as we approach what looks likely to be
                                                                        expanding on the back of the growing propensity to rent and a lack
  the latter part of this real estate upcycle.
                                                                        of future supply to meet projected population growth. We also like
                                                                        long-duration income, which has seen significant demand, offering
                                                                        investors a safe haven amid wider market volatility. With the cycle
                                                                        being elongated and in the context of the heightened geo-political
                                                                        and economic uncertainty at present, we remain risk averse and
                                                                        continue to pursue ‘sustainable’ income in our target markets
                                                                        and we maintain a forensic approach to seeking value in our
                                                                        favoured markets.
                                                                        Simon Kinnie
                                                                        Head of Real Estate Pricing
The value of investments and the income from them can go down as well as up and your investor may get back less than the amount
invested. Real estate is a relatively illiquid asset class, the valuation of which is a matter of opinion. There is no recognised market
for real estate and there can be delays in realising the value of real estate assets

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