Outlook 2017: Real estate themes to watch

Outlook 2017: Real estate themes to watch

Outlook 2017: Real estate themes to watch

by Timothy Bellman & Joe Rodriguez, Managing Director, Head of Global Real Estate, Managing Director, Head of Global Securities, Invesco Real Estate, Invesco Canada

Investors have been drawn to real assets in general and to real estate in particular due to the comparative stability and attractiveness of their income returns and the prospects for growth.

A recent heightening of capital market, political and geopolitical risk levels has resulted in a less certain outlook for investment assets broadly, including real assets. This may reinforce the attractiveness of real assets’ income potential, which is largely based on long-term contractual cash flows.

Three themes to watch in 2017

Presently, three themes dominate investors’ concerns about real assets for 2017: current prices, future performance and predictability in the light of political developments.

  • Prices. In many markets, the real estate yields/cap-rate spread over local long-term government bond yields are close to the long-term average spread. In Europe and parts of Asia Pacific, spreads as of mid-November were more than one standard deviation above the long-term average. This gives some comfort that, relative to other asset classes at least, real estate prices are not out of line. It also suggests that in a macro environment of modest inflation and low interest rates, there is little reason to anticipate an imminent or sharp upward movement in real estate yields/cap rates. Indeed in much of the world, yields/cap rates seem at least as likely to remain stable or even to fall further first, which could result in upward pressure on prices.
  • Performance. In many ways, the outlook for future performance depends on the potential for growth in real estate net operating income. The outlook for market fundamentals gives some reassurance. Commercial real estate fundamentals remain robust in the U.S. and are strengthening in Australia, much of Continental Europe and a number of other countries. Demand has softened slightly in some developed markets recently, but supply remains broadly in line with demand and rents continue to trend upward. This should provide support to real estate returns, in our view.
  • Predictability. The future is inherently uncertain. This simple point has been brought home by the rising tide of populism that has swept across the world and poses a challenge to the established world economic and political order. Consequently, levels of political and geopolitical risk are elevated. The surprising result of the U.S. presidential election has created an uncertainty about key aspects of U.S. economic policy and international relations that will only become clear over the next few years. The surprising result of the U.K.’s referendum on membership in the EU has created an uncertainty at the heart of the world’s largest economic group that is expected to last several years. In Asia Pacific, uncertainty lingers over the next stage for Abenomics in Japan or China’s political transition in 2017. This level of uncertainty has implications for real estate markets and for investment strategy.

Where we see opportunity

What does this mean for real estate opportunities in 2017? First and foremost, it is important to emphasize that despite the elevated levels of uncertainty, we at Invesco Real Estate do not expect to change our general approach to investing in the United States, the United Kingdom or elsewhere: