The Federal Reserve’s unexpected monetary policy shift last month back towards renewed patience in light of moderating global economic growth and inflation, will give some extra comfort to real estate investors dreading the inevitable climb in rates around the world.
But there are other risks which continue to dominate thinking about the year ahead and the returns which are achievable. These include: sourcing quality assets, structural shifts affecting offices and retail, construction costs as well as macro and financial considerations such as, economic growth, currency volatility and cost of debt.
Allocating capital in late-stage cycles can be tricky. Of course, this is not the same market as cycle mid-2007, rather we could be headed for a plateau in prices which will affect achievable returns.
Tom Leahy, Senior Director, EMEA Analytics at Real Capital Analytics, explained:
“There are signs, though, that commercial property investors are modifying their strategies in view of the challenges. Investors reoriented themselves towards the major metros last year which speaks to two drivers: firstly, an attempt to exploit an ongoing trend for urbanization; secondly, these larger metros are more liquid and maintained liquidity better during the last downturn than smaller markets.”
“Another sign that investors aren’t chasing higher returns at this stage of the cycle is that the volume of value-add deals across Europe has fallen every year since 2015. This partly confirms the narrative that investment managers are following a ‘same risk, lower return’ strategy as they try not to overstretch.”
Further evidence of this pragmatic investor view can be seen in this year’s Emerging Trends in Real Estate report by PricewaterhouseCoopers and ULI.
More than three-quarters (77%) of investors surveyed are targeting the same returns (47%) or somewhat lower (30%). Almost half of survey respondents (48%) were seeking between 5-10% in 2019, while a further one-fifth (21%) were targeting 5% or under. Another 19% were gunning for 10-15%.
The repeated theme in the survey interviews chimes with the themes regularly discussed at industry conferences: income is king, it is all about sustainable cash-flows. However, as return expectations continue to moderate down, and interest rates begin their scent, the relative value of real estate will inevitably begin to lose its decade-long shine. The optimists will counter that we are not there yet.