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Real Estate Summary
Edition 4, 2018
Caution mounts despite real estate's firm underlying fundamentals.
We look closely at the industrial boom.
04 Global overview
16 European summary
10 APAC summary
22 US summary
UBS Asset Management
Content
04 Global overview
10 APAC summary
Our research team
Adeline Chan Amy Holmes Brice Hoffer Christopher DeBerry Fergus Hicks Gunnar Herm Joshua Rome Kurt Edwards Melanie Brown
16 European summary
Nicola Franceschini Paul M. Guest Samantha Hartwell Sean Rymell Shaowei Toh Tiffany Gherlone William Hughes Zachary Gauge
22 US summary
Global overview
Real estate capitalization rates and yields are leveling off and rents are growing in most markets. There are multiple risks, including the steady escalation of the US-China trade war. We expect advanced economies to slow in 2019 but still remain in growth mode. New government policies increase the risk of error as central banks withdraw stimulus.
Real Estate Summary Edition 4, 2018
Page 6 of 28
Macroeconomic overview At the start of 2018 we were broadly optimistic about the outlook, but still aware of the current risks. As we enter the
closing months of the year some of those risks have
materialized while new ones have emerged. Notably we have seen another pull-back in equity markets, with the S&P 500
suffering a 10%+ correction from its September peak to late
November. This is the same scale of drop that occurred in February and reflects nervousness on the part of investors. A
stock market re-pricing from elevated levels is healthy if it
stops excessive valuations, but more worrying if it becomes
larger with the potential to spill over to the broader economy.
At the current juncture we can cite a number of other risks as being present. Donald Trump's trade war with China has
escalated steadily and tariffs have been ratcheted up on both
sides; there is nervousness over emerging markets and crises in several; while a populist government in Italy is sparring with
the EU over its budget proposals. Inflation is also a risk given
tight labor markets in many countries and firming wage growth, now above 3% in the US for the first time since
2009. On the positive side, and showing that the Trump
administration can do deals if the terms are right, a successor to the North American Free Trade Agreement (NAFTA) has
been agreed. This would be subject to ratification, in the form
of the United States-Mexico-Canada Agreement (USMCA).
Despite these risks economies have held up reasonably well,
but did slow in 3Q. The US has been strongest, benefitting from a fiscal boost this year, with growth slowing to 3.5%
annualized in 3Q from 4.2% in 2Q. The Eurozone has been
weaker, registering 0.2% quarter on quarter (QoQ) growth in 3Q, the slowest in five years and down from 0.4% QoQ in 2Q.
It's worth noting that the initial estimate for 2Q Eurozone
growth was revised higher, which may yet happen to the 3Q figure. However, survey data has also weakened, implying the
slowdown is real rather than imagined. In China growth
slowed to 6.5% year over year (YoY) in 3Q, in line with the government's target for the year and expectations of slower
growth in the years ahead.
World trade growth has slowed slightly but not fallen
precipitously. It has received support from some exporters
expediting sales prior to tariffs coming into force. The
escalation of the trade war between the US and China poses a
significant risk. To date the US is imposing additional tariffs on
washing machines, solar panels, steel, aluminum and USD 250 billion of its annual USD 506 billion of imports from China (see
Figure 1). China is imposing tariffs on USD 110 billion of its
annual USD130 billion of imports from the US. President Trump has warned that the 10% tariff announced in
September on USD 200 billion of Chinese imports will rise to
25% in January if no agreement is reached, and threatened tariffs on another USD 267 billion of goods.
With China nearly out of runway in terms of additional goods
to tariff, it would need to look to other options for retaliation,
such as withholding supplies of essential rare earth materials on which it has a monopoly, or curbing the number of
Chinese tourists and students heading to the US. The IMF has
estimated that an escalation of the conflict which saw tariffs extended to cover all US-Chinese trade, all US car imports with
retaliation by trade partners, along with confidence and
market effects, could knock nearly 1% off US Gross Domestic Product (GDP) in 2019, around 1.6% off Chinese GDP and
0.8% off world GDP. However, some commentators suggest a
much larger impact on global GDP of perhaps 2-3%.
Figure 1: US-Chinese mutual goods tariffs (annual, USD
billions)
Sources: UBS Asset Management, Real Estate & Private Markets (REPM), November 2018
Against this backdrop the job of central bankers has arguably
become harder. So far the Fed has tried to discourage the notion of a "Powell put" and is expected to press ahead with
a rate increase in December given the strong economy.
However, a further knock to equity markets or the unfolding of another risk could see the Fed mimic its actions under Alan
Greenspan of easing policy in times of crisis, and hold back on
a December rise. Meanwhile, the European Central Bank (ECB) has tentatively announced that it will finish its asset purchases
at the end of the year, while the Bank of Japan continues with
asset purchases and rates at zero.
Moving into 2019 we expect growth to slow in the advanced
economies. The fiscal boost the US received in 2018 will fade while the Eurozone, already slowing, will face capacity
constraints in some countries due to low unemployment rates.
In general economic expansions do not die of old age, but longer expansions can encourage risk taking. Moreover, as we
exit an unprecedented period of new and unconventional
monetary policies there is scope for error by central banks. Even with supportive government policies, navigating these
waters successfully will prove tricky. Unhelpful government
policies could make the challenge harder still.
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Real Estate Summary Edition 4, 2018
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Capital markets Real estate investment activity has been healthy in 2018 as investors look to further build their real estate allocations. At
the global level investment volumes for income producing
assets were up 2.6% in the first nine months of the year compared to 2017 (in dollar terms). However, activity remains
below the peak levels reached in 2015, partly due to a
mismatch between buyer and seller price expectations in some markets, and partly due to a lack of available product. Indeed,
to counter this investors are increasingly turning to forward
funding and building to core as a means of deploying capital.
Figure 2: Global investment volumes (12 month, USD
billions)
Sources: RCA; UBS Asset Management, Real Estate & Private Markets (REPM), October 2018
Underlying activity in the office sector has been pretty stable, while retail and industrial have mirrored one another.
Industrial volumes showed strong growth in 2017, while from
the second half of 2015 retail volumes trended downwards. More recent data show a tentative recovery in retail volumes,
while industrial volumes have levelled off. Indeed, on a trailing
12 month basis global industrial investment volumes have
reached near parity with retail, having been nearly 40% below
them as recently as mid-2017 (see Figure 2).
Of the markets reporting performance on a higher frequency
basis, figures relating to 2018 so far have been positive. For
example, National Council of Real Estate Investment Fiduciaries (NCREIF) reported direct, all property, unleveraged
returns in the US of 7.1% for the year to 3Q, while MSCI-IPD
reported UK All Property returns of 8.2% over the same period. Meanwhile in the Netherlands, for which the latest
MSCI-IPD data available relates to 2Q, annual returns were a
punchy 14.9%. We think returns will slow in most markets moving into 2019 as capital growth fades.
Strategy viewpoint For the past couple of years we have been upbeat on the industrial sector and it has consistently topped our table of
performance expectations in most countries. This expectation
has been broadly met as the well-reported expansion in e-commerce has seen supply chains re-purposed and demand
for logistics facilities surge, pushing rents higher. If anything
our expectations proved too cautious and performance has been even higher than we were expecting.
For example industrial property recorded returns 20% in the
UK in 2017, 13% in the US and 12% in the Eurozone.
Moreover, even now we are expecting all these markets to
deliver double-digit returns in 2018. Over the next couple of years we expect industrial to continue outperforming, before
converging with the other sectors in 2021. In particular, we
think there is room for catch-up in some continental European markets where on-line sales are less developed than in the UK
and US, and Australia where Amazon arrived in 2017.
However, strong outperformance of any asset class can be a
worry and lead to fears of a correction. For example, the
industrial equivalent yield in the UK in 3Q 2017 was 5.9%, the highest of the three main commercial sectors. By 3Q 2018,
however, it had fallen to 5.3% and become the lowest
yielding sector, not previously seen in data going back to 1980. For the time being we expect the outperformance of
industrial to continue as strong demand drives rental growth.
Moreover, rents are coming off low levels and are a relatively low share of logistics companies' costs, whereas tight labor
markets mean staff availability and labor costs are becoming
more of an issue for them.
We would certainly be wary of transaction prices which are a
long way ahead of valuations. In particular, in a period of strong demand purchasers must do thorough due diligence on
assets they are considering purchasing and ensure they do not
factor in excessive rental growth expectations. We have previously discussed in this publication some of the things
which could derail the industrial story. They include any
disruption to the online distribution model, be that changing consumer preferences, or regulatory intervention on the basis
of environmental protection, traffic congestion or protecting
traditional retailers. Indeed, we have already seen some moves
in this area, including online retailers in the US being forced to
collect sales tax and granting business rates relief to small
retailers in the UK. Calls for such moves to level the playing field look set to only get louder.
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Real Estate Summary Edition 4, 2018
Page 8 of 28
Any hit to global trade volumes also presents a threat. Conceptually though, we think some types of industrial property are more at risk from a trade war than others. By definition, we think any reduction in trade volumes would likely have a disproportionate impact on real estate around key international transport modes such as ports and airports. With fewer goods flowing through these facilities demand for industrial space around them would likely weaken.
However, logistics facilities used to distribute goods to final consumers, particularly for online sales, look less exposed. Hence last mile, urban logistics facilities used by parcel companies and those used by retailers to fulfil online orders would seem more resilient. A caveat would be if the trade war triggered a broader downturn in the economy which impacted consumer spending. Under this scenario logistics focused on fulfilling consumer demand would likely suffer too.
Real estate investment performance outlook 2017 performance and outlook are measured against the sector's long-term average performance, with a margin of 100bps around the average described as "on trend" or "stable".
Asia Pacific
Office Retail Industrial Multifamily
Australia
Japan
Europe
France
Germany
Switzerland
UK
North America
Canada
United States
Icon color: 2017 performance Icon style: Outlook (2018-2020)
Above trend
Positive
On trend
Stable
Below trend
Negative
Source: UBS Asset Management, Real Estate & Private Markets (REPM), November 2018
Real Estate Summary Edition 1, 2018
APAC summary
Real Estate Summary Edition 4, 2018
Economic sentiment is likely to trend lower amidst uncertainty over trade tensions. Commercial property leasing demand is mixed but generally robust. Capital markets are buoyant although activity is centered on a few key cities. The industrial sector still sees value in general but the immediate winners and losers are unclear.
Real Estate Summary Edition 4, 2018
Page 12 of 28
APAC summary Demand and supply Trade seems to have gone from hero to zero these days, not due to its diminished importance to GDP growth, but because
the factor which has provided the uplift for much of APAC's economic recovery over late 2017 and early 2018 threatens to
become the very element which may hasten the growth
slowdown in the coming quarters. This is especially so given the recent escalation in the US-China trade conflict.
At a glance, it is not immediately clear what the eventual effect of the trade measures will be. Trade linkages are vast
and complex, and direct exposure to trade can only tell part of
the story. Take Singapore for example – export of goods to China and the US make up a combined ~17% of GDP, which
is dwarfed by Hong Kong's export exposure to both countries,
making it appear like Singapore would be relatively more insulated from the trade tariffs than Hong Kong (Figure 3). But
the final impact of trade is obscured by other factors such as
indirect trade linkages, the composition of exports and the diversity of the economy; given that Association of Southeast
Asian Nations (ASEAN) economies, which are among
Singapore's largest export partners, are also expected to take
a hit from the tariffs. Singapore would thus experience the
impact of the US-China tariffs via other channels as well. Thus,
it may serve us better to gauge the effect of the trade tariffs using the more general indicator of trade openness instead.
The countries more likely to be affected by an overall waning
of trade momentum in the near term are probably small and highly open economies, namely Singapore and Hong Kong
(Figure 4). In the longer term, each country has built up its
respective competitive advantage which is unlikely to be substituted and replaced so easily.
The common refrain across APAC economies in 3Q 2018 is that growth is slowing – China and Singapore both saw GDP
growth moderate while early indicators are signaling that the
same can be expected for Hong Kong and Australia.
The traditional sectors that used to fuel China's rapid rise have
slid in 3Q – industrial production growth cooled, credit growth slipped, and fixed asset investment (FAI) growth rate fell to
5.3% YoY for 8M 2018, a record low. Services sector growth
was the bright spot, outpacing GDP (6.5% YoY as at 3Q 2018) with a ~8% YoY expansion.
Australia's economy is holding up well as the country logs its 107th straight quarter of growth in 2Q 2018. Growth drivers
have broadened out from exports in 1Q to household
consumption and government expenditure in 2Q. Nevertheless, there are several factors that would keep us
from getting carried away on Australia's outlook, such as
potential negative wealth effect from falling home prices, lack of wage growth from the continued slack in the labor market,
and the fact that over a third of Australia's merchandise
exports go to China.
Hong Kong has seen its economy supported by consumer
spending in 1H 2018 but that looks to be less of a certainty
given that both home prices and the stock market have started to turn south. Singapore's economy has largely been
lifted by the external and manufacturing sectors but the latest
3Q 2018 GDP growth figures have slipped as it approaches late-stage expansion.
In Japan, GDP rebounded to an expansion of 0.7% QoQ in 2Q 2018 from a contraction of 0.2% in 2Q 2018. Business
investment and private consumption were the main
contributors to growth. Household spending is expected to pick up in the coming quarters given the tight labor market
and a possible frontloading of spending from the planned
consumption tax hike in 2019. Nevertheless, a trade slowdown remains a risk given its impact on sentiment.
Figure 3: Export of goods to US and China (% of GDP, 2017)
Figure 4: Export of goods and services (% of GDP, 2017)
Source: IMF, October 2018
Industrial
The sector most likely to bear the immediate brunt of a trade slowdown is ostensibly the logistics space. Hong Kong in
particular, being an open economy where almost all of its
exports are re-exports from China, is the prime candidate to take the strongest hit. Recent rental performance betrays any
sign of trepidation.
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According to CBRE data, overall warehouse rents rose 1.5%
QoQ, the strongest quarterly increase since 4Q 2014. This
comes amid a drop in warehouse vacancy rate to 2.9%, the lowest since 4Q 2015. Leasing activity was robust, although
this was partly due to frontloaded trading activity. The
buoyancy of demand for warehouse space may eventually soften when the impact of the tariffs trickle through, but
Hong Kong's industrial and logistics space will still be buffered
by demand from other high value-added occupiers as well as limited space availability.
Tier 1 cities in China are similarly facing tight supply, particularly in the high quality logistics space – vacancy rates in
cities like Beijing, Suzhou and Wuxi are below 1%, and new
supply in 3Q 2018 was readily absorbed with the net take-up in Tier 1 cities rising to a record high of 0.7 million sqm.
Notwithstanding a trade slowdown, the Chinese domestic
market is already sizable and a shortage of quality logistics space in Tier 1 cities will likely keep the rental outlook positive.
The rest of the APAC markets are similarly seeing strong performance in the industrial sector. Major infrastructure
projects are supporting the construction sector and
corresponding demand for industrial space. Melbourne, Australia is an outperformer with a 6% YoY increase in rents
in 3Q 2018. Rental growth in Sydney is more muted at 1.9%
YoY but demand is still strong, with vacancy across the major submarkets already at cyclical lows. Tokyo's logistics market is
facing a wave of major new supply but demand is similarly
robust. For example, 1Q 2019 is expected to see the highest
ever quarterly new supply, but some properties are already
reported to be fully let. The rise in vacancy rate from
upcoming supply is thus expected to be limited, although there is still a sharp distinction between the inland and the Bay
area, the latter of which has a tighter vacancy rate.
In Singapore, business park rents appear to be approaching
late-cycle expansion with growth starting to slow.
Nevertheless, the broader industrial market is expected to bottom in the near term given the tapering off of pipeline
supply. Retail
The performance of the retail market in APAC in 3Q 2018 was
largely shaped by two broad forces – growing inbound tourists and disruption due to e-commerce.
The markets which have been benefitting from inbound tourists are Hong Kong, Singapore and Tokyo. Tourism-
oriented retailers such as personal care companies, cosmetic
brands and watch and jewelry shops have been driving leasing activity in Hong Kong's high street. In Singapore, demand was
boosted by new entrants, while landlords have also been fine-
tuning their store offerings by bringing in more activity-based retailers like gyms, arcades and cooking studios.
Tokyo's prime retail market has also been a beneficiary of the rise in visitor arrivals, although that dipped in September in
part due to a recent spate of natural disasters. Leasing
demand was still healthy in 3Q 2018, led by luxury brands and
F&B operators. The outlook is positive in the near term given
the expected front-loading of consumer spending ahead of
the planned consumption tax hike.
Australia, on the other hand, has still been dealing with the
effects of the online disruption. Despite the rise in household consumption, major retailers such as David Jones are still
consolidating stores and regional centers are bearing the
brunt of the structural challenges posed by e-commerce. Prime Central Business District (CBD) retail, however, still
benefits from locational advantages and is still seeing rental
growth.
The Tier 1 cities of Beijing and Shanghai saw average ground
floor shopping center rents rise 0.9% and 0.2% QoQ respectively in 3Q 2018. The retail market is still driven by the
structural growth of the middle class and rising income levels.
Some new projects had pre-commitment rates of over 90% and it is reported that several others have secured full
occupancy ahead of completion. While the long-term
prospects for retail in China's Tier 1 cities remain positive, the near-term outlook will be impacted by substantial pipeline
supply.
Office
Strong demand and a lack of supply continued to drive
positive rental performance for most APAC markets in 3Q 2018 (Figure 5). Aside from the Tier 1 cities in China, vacancy
rates in most cities in APAC continued to tighten.
Figure 5: APAC CBD office vacancy rates (%of existing stock)
Source: CBRE, 3Q 2018
Nowhere is this more evident than in Tokyo, where the Grade
A vacancy rate fell below 1% for the first time since 2007.
Strong corporate profitability and a tight labor market are driving companies to increase their footprint. New builds in
2Q were almost fully let, and upcoming completions in 2019
are almost fully let. This resulted in a 2.2% YoY rise in rents in 3Q 2018, accelerating from the 1.2% increase in 2Q 2018.
Prime rents in Sydney grew by an enviable 6.8% YoY in 3Q 2018 as stock withdrawals continue in an already tight office
market (Figure 6).
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Real Estate Summary Edition 4, 2018
Page 14 of 28
Prime rents in close rival Melbourne also rose by a similarly
robust 6.8%, driven by strong economic performance and
white collar employment. Demand is expected to remain strong but substantial pipeline supply is expected to result in
rental growth slowing over the next 12 months.
Hong Kong's prime submarket is similarly tight, with rents in
central rising to a historical peak in 3Q 2018. There are,
however, signs that the market euphoria should start to cool soon. Leasing momentum slowed and the rental growth in
central has moderated from 3.1% QoQ in 2Q 2018 to 2.0%
in 3Q 2018. In general, leasing demand in Tier 1 cities in China seem to have been weighed down by concerns over the
US-China trade conflict as well as the regulatory clampdown
in the peer-to-peer lending sector. Average asking rents in Beijing was flat on a YoY basis while rents fell 1.2% YoY in
Shanghai. Singapore's office market was the outperformer in
3Q 2018, with a 15.6% YoY increase in CBD prime office rents, partly due to a low base effect. Demand was broad-
based and with pipeline supply tightening, further rental
growth is expected in the near-term.
Figure 6: APAC CBD prime office rent growth (% p.a.)
Source: CBRE, 3Q 2018
Capital markets Investment interest in APAC commercial property lost some
momentum in 3Q 2018 relative to 2Q 2018 but nevertheless
remains robust (Figure 7). Data from Real Capital Analytics
(RCA) shows that the rolling 12-month transaction volume in commercial property (excluding sales of development sites) in
APAC in 3Q 2018 was worth USD 165 billion, slightly lower
than the USD 176 billion recorded in 2Q 2018 but 3% higher than the total value for 2017. Transaction volumes received a
whopping 57% YoY boost from Hong Kong in 9M 2018,
followed by a 23% growth in transaction volumes in South Korea. Australia, Singapore and Japan also saw low single
digit contractions (1.3%, 3.2% and 4.4% YoY respectively),
with China being the only market with a more severe 15.9% YoY contraction, reflecting dampened sentiment due to the
government's deleveraging efforts.
Despite the dip in transaction volume, China still holds the
biggest share of investments in 3Q 2018 with 20% of total
transaction volumes in APAC, down from 25% a year ago. While the bulk of investment interest has centered on Tier 1
cities, capital has increasingly found its way into Tier 2 cities,
which likely reflects a search for yield and value.
Hong Kong, in the meantime, has been the most visible
recipient of abundant capital spilling over from the Mainland as it sees its share of total APAC investment volumes rise from
about 12% in 3Q 2017 to about 17% in 3Q 2018,
representing an almost doubling of the absolute value of transactions. Office properties traded hands most often, and
in a reflection of how the stratospheric rise in capital values
has forced investors to purchase smaller and smaller parcels of space, all but one of the office transactions in 3Q 2018 were
of strata floors and units, according to RCA data. The sole en
bloc transaction in 3Q 2018 was for Lever Tech Centre for USD 159 million (USD 1,390 psf), but the biggest office deal
worth goes to the sale of the 58th and half of the 21st floor of
The Center at USD 229m (USD 6,202 psf), which only made headlines about a year ago for being the largest single office
building transaction in history. Just a year on, the building is
already being sliced and diced up for sale and at values that are almost 50% higher than its original sale price of USD
4,198 psf. This is emblematic of the trend that has been going
on in Hong Kong for years – huge amounts of capital looking for assets, driving capital values to ever higher values and Cap
Rate to ever lower levels.
Total value of deals in Japan has largely held steady from a
year ago, and transaction activity remained anchored by J-
REITs in the office sector. Australia has experienced a rise in transaction volumes in 9M 2018 with investors drawn to its
relatively higher yields while owners are increasingly open to
taking profit on their holdings.
While strong investor interest has presided over a multi-year
Cap Rate compression in APAC, we think the yield compression story is starting to lose momentum. Most
markets are already experiencing a squeeze in the yield
spreads, and investors would be well-advised not to underwrite significant capital growth in their investments.
Figure 7: Commercial real estate transaction volumes (USD billion)
Source: RCA, 3Q 2018
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Real Estate Summary Edition 4, 2018
Page 15 of 28
Viewpoint Trade wars – you can't win, Darth
In several meetings with investors and associates over the past
months, we have often been asked to 'pick sides' and predict whether China or the US will emerge triumphant in this
protracted trade scuffle. There has to be a loser, no? Adam
Smith, in his book "The Wealth of Nations" puts forth trade (mercantilism) as a zero-sum game, which obviously is no
longer valid in our increasingly interlinked global production
networks. It is also not true that the side that exports more
(i.e. China) stands to lose more relative to the net importing
party (i.e. US), given the globalized nature of intermediate
inputs in manufacturing. Many of the imports from China, on which the US is slapping tariffs are vital inputs in the
production chains of companies producing in the US itself.
Suffice to say, it is near impossible to pick a winner (or loser) from the ongoing trade fracas. When the dust settles, if it
does, both the US and China will feel the pain inflicted
mutually. At the same time, some real estate markets will benefit more, albeit serendipitously, while many others will
become collateral damage.
While many market watchers have commented on the arsenal
of tools that China has at its disposal, it will not come away
unscathed. Our ground checks have surfaced anecdotal feedback that some manufacturers in China are starting to
feel the stress on their profit margins, as major US customers
start to pass through part of the tariffs to these exporters. In response, the Chinese government has relaxed its financing
guidelines and directed more funding towards the small and
mid-sized firms in China in a bid to tide these manufacturers over this rough period. The State Council has also recently
announced tax cuts that will provide more than USD 6bn of
tax relief in 2018 alone. In early October, China further slashed the reserve requirements on banks to inject an
estimated USD 100 billion into the economy. For sure, these
are just the tip of the iceberg in terms of the supportive measures China can engage in.
What is worrying is that this trade issue may distract China from its ongoing deleveraging efforts, as it takes two steps
back and potentially starts to ease up on its monetary policy.
There are many 'what-ifs' here. Any excessive credit that is not directed at productive sectors may end up spurring greater
indebtedness and sow the seeds of financial woes in the
future. If this does get out of hand, we can expect domestic investments into commercial real estate to further increase,
pushing up already frothy capital values. In the residential
sector, inventory destocking is still underway, especially in the lower tier cities, and if Beijing allows residential construction
and investment to grow, the current destocking efforts will be
partly derailed after years of strong progress. Furthermore, if China embarks on the devaluation of the currency to offset
the tariffs, it will risk capital flight and imply a willingness to
retreat from financial liberalization goals. So even if China wins the trade war, it still loses.
From a regional perspective, the trade tensions have spillover
effects on regional commercial real estate markets that extend
beyond China. Generally there are two main channels of transmission; one, through a slowdown in economic growth
and business sentiments, and two, via the re-routing of real
estate locations in the supply chain. It is also likely that weakened business confidence, if persistent, will have a
significant impact on growth, and consequently the demand
for commercial real estate such as industrial space.
More than half of China’s exports to the US are produced at
facilities owned by foreign companies. Tariffs directed at China exports in reality affects many American and European
companies that have production facilities in China. For a while
now, many manufacturers, foreign or domestic, have already started to diversify their production bases, partly as a result of
rising labor costs in China. The beneficiaries of the re-direction
of manufacturing locations have been the likes of emerging Southeast Asian countries such as Vietnam, Indonesia and
Malaysia. While the trade issue has increased the urgency for
manufacturers to explore alternative options, it would be naïve for anyone to believe there will be a mass exodus of
manufacturing from China to Southeast Asia overnight.
Companies cannot immediately respond to tariffs by hastily moving their operations out of China, and there is significant
capital expenditure yet to be amortized. Our view is that
emerging Asia continues to be a hotspot for industrial property, but there is no reason why the trade skirmish has
accelerated or enhanced the investment appeal of these
emerging markets. There are huge risks associated with
investing in an emerging economy, and much of the
institutional logistics stock is not available for sale or
investment yet. Manufacturers who do enter the likes of Indonesia or Vietnam often struggle with identifying industrial
facilities of good specifications if they do not have local
partners. On the other hand, there is also market mention of Japanese and Korean manufacturers shifting production in
China back home. Again, this will likely not happen on a
massive scale, and we should not expect industrial property prices in Japan or Korea to surge in the near term.
In the mid to long term, the regionalization of APAC through greater multilateral cooperation and trade linkages, such as
the ASEAN bloc or the Regional Comprehensive Economic
Partnership, is likely to offer fortification against trade and economic shocks. Can these regional partnerships shield Asia
from the stray bullets of the trade war? No. Should it even be
desirable for Asia to move towards insularity? Again, the answer is a resounding no. What a solid trade and economic
bloc can do for Asia, is to create an enlarged hinterland of
demand and supply for goods and services, and that is likely to be positive for commercial real estate prospects.
In conclusion, this is going to be a long game. The fundamental growth drivers are intact but there will be losers
and some fringe winners. To that end, we do not believe
opportunistic investing in industrial real estate will bring about attractive risk adjusted returns.
16
European summary
17
Take-up and rents continue to rise despite softening fundamentals, while the development pipeline remains muted in most locations. Investment volumes continued to fall in 3Q as caution persists. Yields remain stable in almost all locations.
Real Estate Summary Edition 4, 2018
Page 18 of 28
European summary Demand The 'Euroboom' expected at the start of 2018 appears to have lost more momentum in the third quarter as soft economic
fundamentals and political uncertainty appear to be weighing on demand (see Figure 8). GDP growth in 3Q was highly
disappointing at just 0.2%, its lowest level in five years. While
part of this can be explained by transitory factors, sentiment has declined over the year hinting we may not see a stellar
rebound in 4Q. Manufacturing appears to have also had a
slow start in 4Q with PMIs sinking below 50, indicating contraction. As a result, European equity markets have
tumbled in line with a global sell-off in recent months; the
Stoxx Europe 600 is currently trading at around 7% below its level at the start of the year.
A large factor is the political situation in Italy, where the populist government is at loggerheads with the European
Commission over its high spending budget, despite already
high levels of government debt. As a result, the spread on Italian bond yields over German bunds has reached record
highs. Economic activity has also reduced in the third quarter,
as the situation shows no sign of resolving itself soon.
It is perhaps unfair to single out Italy, as other countries have
not had a great quarter either. Germany saw almost flat GDP growth, although part of this can be explained by disruptions
to the auto industry as well as problems with shipping on the
Rhine. On a brighter note, Spain continues to expand at a healthy pace and France has performed reasonably well too,
benefitting from growth in both consumption and fixed
investment.
In spite of softening economic indicators, office take-up
remains strong and 3Q18 saw a rise of 2.1% YoY as rolling annual volumes continued to trend upwards. Take up in UK
regional cities has been stronger than in London with Glasgow
and Liverpool both seeing strong leasing compared with the previous year. London has actually been fairly resilient with
most of the new supply in the pipeline pre-leasing at a decent
rate. Take-up in the City actually increased by 14%, although a growing share of the market is accounted for by serviced
office providers such as WeWork. Since much of the take-up is
also relocations of tenants already in situ, there are also concerns about older more secondary stock which will likely
be released in the near future. Elsewhere, Munich (+32%) and
Frankfurt (+19%) had a strong 3Q, while Paris (+13%) and Lyon (+22%) also saw high levels of tenant demand as the
economy continues to improve. Utrecht in the Netherlands has
become popular with occupiers as availability in Amsterdam continued to decline; leasing here grew by 167% when
compared with the same point in the previous year (on a four
quarter cumulative basis). Porto also had a stellar four quarters up to 3Q, with volumes rising by 347%.
There were not too many poor performers this quarter;
Aberdeen saw take-up fall by 3% most likely due to concerns
about its ongoing reliance on the oil market. The West End of London also saw take-up decline by 21%, however this has
more to do with low levels of supply than demand. We are
hearing anecdotally that occupiers will still pay top rents for modern offices as and when they become available.
Pan-European rental growth remains strong with prime rents increasing by 3.2% when compared with the same period last
year. Utrecht and Porto both saw stellar growth following
surging levels of take-up with rents rising by 21% and 18% respectively. Stockholm saw yet another good quarter with
rents rising by 17%; the Swedish capital has been a
consistently strong performer of late, with rents seeing double digit growth for the past 13 quarters. Also showing
persistently strong performance was Berlin, with rents
growing by a further 12%. There were relatively few cities seeing prime rental decline: the City of London has seen rents
decline fractionally, with values falling by 2% despite high
levels of leasing activity, while rents in Vienna also fell by 2%.
Figure 8: Aggregate European office take-up volumes
(000s sqm, select key centers)
Source: JLL, 3Q18
The retail sector has had a rough year, especially in the UK where values have finally started to fall. There have been
numerous administrations and company voluntary
arrangements (CVA), while a private equity-owned shopping
center in Maidenhead entered into administration. The picture
in Europe is somewhat less severe, due at least in part to
lower levels of online shopping. JLL estimate the current share of online sales in Europe will reach 11.9% in 2022, compared
with 22% in the UK. Nonetheless, prime remains more
resilient than average with pan-European rents growing by 1.3% YoY. We are hearing anecdotally that tenants have
become much more aggressive when negotiating rental levels
which is limiting further income growth for landlords. Nonetheless, Italian cities performed well with Rome (+16%),
Milan (+14%) and Verona (+14%) all seeing strong levels of
growth. At the other end of the spectrum, rents are now falling in several locations including Hamburg (-2%), Antwerp
(-6%) and Brussels (-7.5%).
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Real Estate Summary Edition 4, 2018
Page 19 of 28
Figure 9: Consumer confidence - outlook next 12 months
(Balance - SA)
Sources: Datastream; DG ECFIN, August 2018
As is now very well known, logistics is very much the 'in'
sector having become mainstream thanks to the growth of
online shopping. Demand from operators such as Amazon remain very strong, as they compete with retailers and
traditional manufacturers for space (see Figure 9). This
ensured rents continued to tick-up in 3Q; on a pan-European basis with prime rents growing by 1.6% YoY.
There is, however a big discrepancy between urban rents and warehouses in out of town locations. Larger format sheds
tend to see lower rental growth due to the predominance of
design and build in this market and cheaper land value. In cities, however there are many other uses jostling for space
which makes logistics schemes hard to zone due to the
relatively low capital values and high land usage. For this reason, industrial supply in key cities remains
incredibly scarce and rental growth on existing sites has been
double-digit the past few years. Rents in Berlin grew by 8% to 3Q18, while the Schiphol area in Amsterdam saw values jump
by 15%. In the UK the story has very much been about
London and the South East, however the regions are likely to catch up. In 3Q rents in the South East still grew by 5.4%,
however the highest growth was in the South West of the
country at 11.6%. By way of caveat, values here are almost half the levels currently on offer in London and the South East.
Supply Supply continues to be very restricted as most European cities
are seeing relatively low levels of development (see Figure 10). Speculative space under construction as a proportion of total
stock remains under 5% in most European cities. The
standout exception is Warsaw, where there is currently 11.5% of additional speculative stock under development, although
this has moderated from 15% during the previous quarter.
The City of London continues to see high levels of development although speculative volumes have been pared
back to just 5.6% of total stock. La Defense in Paris now
actually has more speculative space underway at 6%. The 'big 7' German cities by contrast (Frankfurt, Munich, Berlin,
Hamburg, Dusseldorf, Stuttgart, Cologne) all have less than
2% of speculative space under construction.
Unsurprisingly office vacancy continues to trend down, falling
from 7.3% in 2Q to 7.1% in 3Q. As ever, there are significant
regional differences. Berlin and Munich remain the German cities with lowest availability with respective vacancy rates of
just 2.5% and 3.1%, though Frankfurt (8.3%) and Dusseldorf
(7.6%) are somewhat higher. London remains low despite high levels of development and wavering demand, with the
City at just 5.5% and the West End at 3.7%. However, as
alluded to above, this is due to effective pre-leasing on the new schemes and we could see the release of more
secondhand space going forward. Paris has seen its vacancy
fall over the past couple of years from above 7% in 2015 to just 5.1% in 3Q 2018. The only recorded areas with vacancy
above 10% in this quarter were Rome and the Schiphol area
of Amsterdam.
Retail continues to be blighted by the issues discussed above
and has subsequently seen very low levels of development in all segments. It is likely that there is now too much retail space
in Europe, although the situation is not nearly as bad as in the
US. The UK has the highest per capita supply and as such is facing the greatest challenges. Secondary shopping centers
are particularly vulnerable, although retail warehouses are
showing some distress following recent administrations. Going forward, the question will not be so much where to build
retail space, but which locations to convert to other uses.
There is a lack of supply data available for logistics, however in
most areas monitored by CBRE there has been a decline in
availability particularly for prime stock. It is increasingly
challenging to secure zoning for use by logistics development
as facilities are unpopular with residents and local authorities.
The former are generally hostile to increased Heavy Goods Vehicle (HGV) traffic while the latter gets much lower tax
revenue compared with other uses. For this reason, industrial
land is particularly constrained in urban areas, which has fueled strong rental growth for existing sites. In more remote
locations, development is easier but this tends to command
lower capital values. For these reasons, there is a lack of speculative development across Europe and occupiers are
increasingly turning to pre-lease deals with landlords to meet
their specifications.
Figure 10: Prime rent index (3Q08 = 100)
Source: CBRE, 3Q18
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Real Estate Summary Edition 4, 2018
Page 20 of 28
Capital markets Capital markets continued to slow in the third quarter with volumes down around -30% when compared with the same
period the previous year. While the third quarter is often a
quieter one, it cannot be denied this represents a notable lull in market activity. It is hard to pin down what has spooked
investors; there does not appear to be a huge fall in sentiment
and pricing has remained solid. One explanation is general concerns about geopolitical issues, such as the Italian budget
and Brexit. Additionally the prospect of a trade war will be a
worry for what is ultimately an exporting continent (see viewpoint). However, it could just be a brief pause as the
early indications are that 4Q has got off to a dynamic start.
The slowdown was reflected across all sources of capital,
although the biggest fall was among buyers from China (-
54%) and Hong Kong (-61%). Other Asian investors appear to have picked up the slack to some extent and it is likely it will
be a record year for South Korean investment into Europe
with around EUR 7 billion either completed or under contract. Overall, US investors remain strong net sellers and 2018 has
not been able to maintain the momentum of the previous
years in terms of foreign capital shoring up the market. Interestingly, there has been an increase in European money
coming into the UK indicating continental investors may not
be as concerned about Brexit as initially thought.
The fall in volumes seemed to weigh heavily on the office and
retail sectors, though even logistics fell slightly when compared with the previous year. The most resilient sectors
were accommodation services, as investors look to add
diversification through assets less exposed to the business cycle. Apartments only saw a slight decline YoY, while senior
housing and care homes actually saw volumes increase
fractionally.
Activity varied significantly by country as Germany, Sweden
and Spain all saw more money spent than in the previous
quarter, while the French market slowed by around -60% following a year of strong spending. Italy continues to be
plagued by political uncertainty and saw its slowest three
months since the Euro crisis in 2012.
In line with the general market, there have been few cities
where volumes have increased. Lisbon is an exception, where nearly EUR 2 billion of assets were traded in 2018 as
international investors look to take advantage of Portugal's
slightly delayed recovery. Frankfurt also saw volumes jump as several of the large towers traded, possibly related to
anticipated benefits from Brexit. London remains in demand
with volumes only declining fractionally, despite the number of deals coming off significantly. This reflects ongoing demand
for prime assets even as the UK prepares to withdraw from
the EU. At the other end of the spectrum volumes into regional centers were not as buoyant with Manchester and
Birmingham both seeing a fall in transactions, while Berlin saw
volumes decline by a third possibly reflecting the very stretched yields now on offer there.
As alluded to above, pricing remains strong; pan-European yields declined by a further 3 bps to reach 3.8%. Most of this
compression came from the industrial sector which came
down by a further 15 bps, while office yields and retail remained largely flat. Office yields were flat in most locations,
although increased investment in Portuguese real estate saw
the relatively high-yielding Porto compress by 50 bps,
although Lisbon surprisingly remained flat. Multiple logistics
centers across Europe continued to see compression of around
30-50 bps. Selective well-performing retail assets continued to compress, although spreads between prime and secondary
assets remain at elevated levels.
Figure 11: EU-15 Yield Index Figure 12: European Investment volumes (EUR billion)
Sources: CBRE; RCA, 3Q18
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Real Estate Summary Edition 4, 2018
Page 21 of 28
Overall, it is likely most investors are adopting a wait and see
approach. Rising bond yields will be on their minds as the
Federal Reserve and Bank of England (BoE) continue to tighten and the ECB prepares to phase out its quantitative easing
program. This led to October being one of the worst months
for equities since the financial crisis as rising bond yields led to a global sell-off. Real estate is similarly vulnerable to a higher
interest rate environment, and while there is as yet no
discernible upward pressure on yields investors will likely be feeling more apprehensive about the current levels of pricing
in the European market. A slight mitigation of this is that the
ECB (and to a lesser extent the BOE) are well behind the Federal Reserve in terms of monetary tightening. Also, factors
such as rental growth (real or anticipated) are driving property
returns and occupier markets are reasonably strong at present.
Nonetheless, considering prime office yields are now below
3% in some major cities, it would not take much of a shift to see some impact.
Viewpoint Trade Wars: the view from Europe
As detailed above (see Figure 1), 2018 has been the year
Donald Trump's rhetoric about tariffs has been ramped up and begun to impact supply chains. The acrimony between
the two countries is about more than tariffs; the resentment
has to do with alleged intellectual property theft, forced technology transfers and a good old fashioned rivalry between
the current world hegemon and the rising one. This topic is
too lengthy to discuss here, but escalating tensions will have some immediate consequences for real estate.
Europe, as an exporting continent, is likely to suffer from any impediments to free trade. UK car manufacturer Jaguar Land
Rover's recent production freeze was touted as a response to
Brexit, but in reality the cause was a fall in sales to China. Meanwhile, the disappointing outturn in Germany's GDP data
is heavily linked to a soft demand for its exports in China with
many producers complaining of weaker Chinese sales. It could be argued these issues relate more to an inevitable slowdown
in breakneck economic growth in China; however the trade
war will most definitely exacerbate this decline.
The capital account is also likely to take a hit. Chinese and
Hong Kong investors have been strong net buyers of European real estate, having invested over EUR 21.5 billion in
2017 alone. Chinese capital has shored up the London office
market since the EU referendum, accounting for a large share of some of the trophy office purchases and keeping volumes
at elevated levels. As detailed above (see Figure 12), 3Q has
seen a -54% decline in capital coming from China and a -61% decline in capital coming from Hong Kong, indicating
this important source of capital may be starting to dry up.
Again, in the instance of escalating tensions over trade, it is likely Chinese companies will be more nervous about foreign
assets or the Chinese government may look to restrict
outward investment.
The asset class likely to be most affected by this is logistics.
Domestic demand (especially e-commerce) has become a big
driver, however this still only accounts for a negligible share of warehousing overall (see Figure 13). To this end, occupier
demand will still be driven by external trade factors, especially
in Germany where car manufacturers account for a large share of the market. This raises several red flags for landlords
who have export-oriented tenants, as those covenants could
well be weakened by a protracted trade war.
This could also pose issues for industrial real estate from a
portfolio allocation perspective. Traditionally, the higher income return in logistics was compensation for the fact that
rental growth tended to be moderate and has consistently
underperformed inflation. As shown by the charts in the previous section, yields for logistics are at record lows. And
while rental growth has been higher than its historical average
it is not expected to surge significantly over the next five years. Should there also be a weaker demand environment, this
could put further downward pressure on rents.
Strategy
Notwithstanding the above, we are not recommending a sell-
off just yet. While a trade war is bad for everyone in the long term, Europe could perversely benefit from tariffs imposed on
US companies. This is already apparent in Asia where
Vietnamese companies are filling gaps left in the market by their Chinese counterparts. Real estate investors should simply
be more mindful of the risks surrounding manufacturing
tenants and assessing how reliant an asset's location is on a particular industry. Careful underwriting is more important
than ever (considering the already stretched valuations in the
logistics sector) as a dip in demand for exports may just be the straw that breaks the industrial camel's back.
Figure 13: Share of industrial floorspace by occupier
type (%)
Source: Prologis, 2017
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Packaging/Plastics
Construction
Healthcare/Pharma
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Diversified Retailer
Apparel
Food & Beverage
Auto & Parts
Consumer Products
Electronics/Appliances
Real Estate Summary Edition 4, 2018
US summary
Major US property sectors are more than two years into a period of income-driven returns with one exception. The industrial sector claimed the highest returns of the major US property sectors in 2018 with more than half of the return coming from capital appreciation. With capital market pressures building, it is likely that returns will settle down somewhat in 2019. Demand is still strong, reflecting positive economic and labor market conditions and should continue to drive income growth in excess of inflation.
Real Estate Summary Edition 4, 2018
Page 24 of 28
US Summary Real estate fundamentals Overall, US commercial real estate performance remains true to our expectation for steady, income-driven returns. The
industrial sector is the only sector experiencing meaningful
Cap Rate compression, leading to outsized appreciation, (see Figure 14). Office and multifamily appreciation is in-line with
inflationary levels, which results in a total return reflective of a
long-term expectation. Retail depreciated recently, meaning that retail return is positive but below its income return. The
mall segment, which comprises approximately half of the
value of the retail component of the NCREIF Property Index, is responsible for most of the weakness.
Pressure is building in the capital markets as interest rates are increasing, pushing up the cost of debt and pushing down the
spread available on real estate investments. Commercial real
estate can and has operated in a reduced spread environment, as long as income and economic growth remain supportive of
strong cash flows. Real estate performance responds to the
fundamentals and expectations for fundamental growth.
Currently, income growth is strong, and we expect positive conditions in the economy and labor markets to continue to
support fundamentals.
As the Fed raises short-term rates, the market is putting
upward pressure on long-term rates, leading to a flatter yield
curve. Even after seven years of a flattening yield curve in the 1990s and three years of a flat yield curve in the mid-2000s,
US real estate generated positive quarterly total returns until
the recession of 2008, as real estate investors continued to benefit from income-driven performance
US equity market volatility increased in late 2018, including
periods of correction. There is no immediate implication for
the private US real estate sector from the public market
volatility, however, as investors we should be mindful of changes in the investment environment.
When looking at real estate revenue in relation to occupancy and rents, occupancy rates are high relative to the past 10
years. With the exception of the industrial sector, occupancy
faces a small degree of downward pressure with supply growth matching or exceeding demand. As there is little room
to increase occupancy, rent growth (see Figure 15), is the
driving force behind income gains. Economic conditions create some optimism that growth will continue to reflect positive
momentum for the US.
Figure 14: US real estate returns across property types - Rolling four-quarter total return (%)
Source: NCREIF Property Index, September 2018
Figure 15: Property sector rent growth - Year-over-year change (%)
Sources: Axiometrics; CBRE-Econometric Advisors, September 2018
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Real Estate Summary Edition 4, 2018
Page 25 of 28
Apartments
Apartment vacancy rates have trended lower over the past
three quarters, even as new construction reached a peak point. At 4.2%, vacancy remains below the 20-year average
of 5.4%. Rent growth is above inflation at 4.3% in the year
ended September 2018 per Axiometrics.
US homeownership was fairly flat near 64.4% during the first
three-quarters of 2018, representing an anticipated pause in a two-year trend of increasing homeownership. Strength in the
labor market and steady household formation help offset a
renewed consumer preference for homeownership, leading to sustained demand for institutional multifamily rentals.
Industrial
Growth in net rents is strong but decelerating as supply
increases. Rents grew by 5.4% in the year ended September
2018 compared to 7.5% growth in the year ended September 2017.
Industrial availability was 7.1% in 3Q18, down a total of 30 bps from year-end 2017, as low as it has been since 1Q01.
We anticipate 2018 will be another good year for US
industrial. As we progress into 2019, the sector will have to contend with higher construction levels, (see Figure 16), which
could bring strong rent growth figures down toward
inflationary levels.
Office
Three quarters into 2018, deliveries of new office buildings
remain elevated, especially in technology related sectors and secondary markets. At 1.9%, office rent growth
underperformed inflation during the year ended September
2018 with downtown rents growing at half the pace of suburban office's 3.1% rent growth.
Average office vacancy decreased 10 bps over the year ended September 2018. The gap between downtown office vacancy
at 10.5% and suburban vacancy at 14.1% remains wide.
Downtown locations are likely sacrificing some rent growth to keep space occupied.
Retail
Consumer spending is up due to increased disposable income
and low unemployment, which should support retail sales in
2018. Sales in brick and mortar stores increased by 4.9% during the year ended August 2018.
The mall/lifestyle and power center segments are facing higher availability of 5.8% and 6.8%, respectively. Rent growth is
volatile as landlords compete for tenants. Stability in high-
quality properties is likely offset by deterioration in others. At 9.1%, availability in Neighborhood, Community and Strip
(NCS) retail is down 40 bps since the end of 2017. Rent
growth was just above inflation at 2.8% in the year ending September 2018.
Figure 16: Supply trends - Year-over-year completion rate (%)
Sources: Axiometrics; CBRE-Econometric Advisors, September 2018. Supply is shown as a completion rate (i.e. completions as a percent of existing inventory). Shaded area indicates forecast data.
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Real Estate Summary Edition 4, 2018
Page 26 of 28
Capital markets US commercial real estate is now nearly three years into a period of sustainable, income-driven returns. Historically, the
income return component generated 70% to 90% of
property-level total return in the US. Unlevered property returns have been between 1.5% and 2.0% per quarter since
mid-2016. 3Q18 saw the NCREIF Property Index rise by 1.7%,
(see Figure 17), with more than 60% of that return coming from income.
US transaction markets remain liquid in aggregate with the
absolute volume of sales at USD 473 billion for the year ended
September 2018, (see Figure 18). After slowing a bit in 2016 and 2017, sales volume showed signs of leveling off during
the first three-quarters of 2018 with total volume up by USD
18 billion compared to the first three-quarters of 2017. Broad trends remain similar to 2017 with sales of retail and office
properties decreasing over the year and sales of apartments,
industrial and hotels increasing.
Figure 17: US property returns (%) Figure 18: US transactions - Transaction volume (USD
billions)
Source: NCREIF Property Index, September 2018 Source: Real Capital Analytics, September 2018
One reason transaction volume is lower for retail and office is that lenders have a higher debt appetite for industrial and
apartment assets. Real estate debt capital is low cost and
generally available but not free-flowing, a situation that arose prior to the last downturn. Increasing interest rates compress
spreads available to lenders in a competitive marketplace. The
spread between property yields and the cost of debt further compressed in early 2018. On the whole, US debt markets can
be described as operational, but not excessive, which
encourages development but not an abundance of supply.
Long-term interest rates remain low relative to US history even
as those rates moved higher in 2018. The 10-year US Treasury
rate was 2.4% at the end of 2017 but rose 50 bps over the
first two months of 2018. As of early November 2018, the 10-
year US Treasury remains above 3.0%.
With little movement in Cap Rates, the upward move in
Treasury rates condensed spreads available in US real estate (see Figure 19). Recent spreads offered by real estate
investments are below long-term expectations, representing a
change from the wide spreads that drew capital so quickly in the wake of the last recession. This in turn relieved one of the
pressures that had been pushing Cap Rates lower.
While the real estate spread is well-above historic lows, it is already low enough to be putting upward pressure on Cap
Rates, even though Cap Rates appear to be holding flat near
historic lows. There is no noticeable distress in the market that might put stronger upward pressure on Cap Rates. Income is
growing, while potential sellers can afford to be patient. Debt
is available, and capital expenditures are increasing.
Figure 19: Commercial real estate spread (basis points)
Sources: NCREIF Fund Index, Open-end Diversified Core Equity; Moody's Analytics, September 2018.
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Real Estate Summary Edition 4, 2018
Page 27 of 28
A growing economy and tight labor market should continue
to generate the demand for real estate, further supporting
income growth. Realized and expected growth in real estate income has directly offset the upward pressure on real estate
Cap Rates from the tight spread. Current economic expansion
is considered to be self-sustaining at or above the long-term average, with US GDP increasing by 3.5% during 3Q18 (see
Figure 20).
Figure 20: US real GDP growth - Real GDP growth (%)
Source: Moody's Analytics, September 2018
In September 2018, the unemployment rate was 3.7%,
continuing downward movement. A tight labor market
generally makes it tougher to fill open positions and has put slow, upward pressure on wage inflation. Job growth has
been bumpy but strong (see Figure 21). Over the past year,
average monthly job gains exceeded 200,000 per month.
The tight labor market is one reason wage growth is expected
to continue to accelerate in the US. Higher wages and consumer spending should reinforce expectations for more
inflation. Over the year ended September 2018, consumer
price inflation was 2.3% in the US. A strong labor market implies that consumers should continue to spend on retail
purchases and afford increases in rental rates.
Figure 21: US job growth and unemployment rate (%)
Change in employment (thousands of jobs)
Source: Moody's Analytics, 2 November 2018
The labor market is strong enough, and inflation is just high
enough to justify expectations for continuing the Fed's
monetary tightening through the balance of the year. In September 2018, the Fed increased the target range for the
short-term Federal Funds Rate (2% to 2.25%). Another 25
bps increase in the short-term rate is expected in December 2018 and is already priced into the market.
Even as capital markets face some pressure on spreads and the cost of debt, fundamental strength in the US economy,
labor market and confidence measures support relatively good
occupancy rates and continued rent growth in the real estate sector.
Strategy viewpoint US properties are appreciating at about the pace of inflation.
Appreciation now relates back to the positive rent growth
generated by properties, as opposed to the outsized influence of capital flows the US experienced in 2014 and 2015.
Beginning in early 2016, US real estate entered a widely-
anticipated period of income-driven performance.
Looking more closely at the drivers of income, rent growth is
the true powerhouse behind the gains. A continued positive outlook for economic growth reinforces our view that
property-level income growth should outpace inflation even as
the pace of growth moderated in recent years. Income-generated performance is consistent with a long-term
expectation for private commercial real estate.
As anticipated, interest rates rose in 2018 condensing the
spread available on real estate. Cap Rates are not currently
increasing in most property sectors; however, we expect a small upward movement over the coming year.
Capital investment into stabilized assets is increasing, an expected outcome in a long expansion. Debt and equity
capital is seeking growth strategies, and existing assets are
under some pressure to compete with new construction.
Investors should pay careful attention to the risk-return
expectations for incremental capital. A low return environment with excess capital competing for a small number
of value-add deals can quickly become hostile.
We expect markets to continue on a stabilized path, which
will likely result in a continued convergence of expected
performance and, relative to past years, limit the investment opportunities that seem obvious. In light of this, diversification
will grow in importance.
-4
-2
0
2
4
6
3Q09 1Q11 3Q12 1Q14 3Q15 1Q17 3Q18
Quarterly annualized Annual growth
4.0
5.0
6.0
7.0
8.0
0
100
200
300
400
May-14 Mar-15 Jan-16 Nov-16 Sep-17 Oct-18
Job growth (L) Unemployment rate (R)
Page 28 of 28
For more information please contact UBS Asset Management
Real Estate & Private Markets (REPM)
Research & Strategy
Paul Guest
+44-20-7901 5302 [email protected]
Follow us on LinkedIn
www.ubs.com/repm-research
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