UBS: has the capital cycle peaked?

With investment volumes on a downward trajectory, yields showing no sign of moving out and reportedly record amounts of dry powder targeting real estate, the signals are truly mixed for investors assessing where we are in the capital cycle, argues UBS.

To start with the fundraising environment, UBS says the picture is fairly optimistic. As PERE reported in April, the first quarter of 2019 saw $39bn raised, a total representing the best outturn in a single quarter since the global financial crisis, according to UBS analysis. This followed on from a full year in which 20% more capital targeting Europe was raised.

However, this robust capital raising total masks more than it reveals. Much of this $39bn is explained by the launch of two mega funds: Brookfield raised $15bn for its Strategic Real Estate Partners III fund, while the Lone Star Fund XI raised $8bn. This accounts for over half of the capital raised, which if stripped out would mean the first quarter of 2019 was a comparatively weak quarter, according to UBS analysis.

“This indicates that, while total fundraising has been resilient, it appears investors are being more selective about which managers they allocate capital to. This should have an impact of the dynamism of the market, as there will be fewer bidders on transactions.”

Furthermore, UBS says the hard numbers indicate the money just isn’t being spent, which may be indicative of restricted suitable assets, which aligns with the 2019 ULI emerging trends report, which stated the number one reason investors reported not investing more in real estate was a shortage of quality product and land.

UBS continued:

“RCA have reported a surge in forward sales suggesting investors are finding new means to achieve target returns. This is arguably borne out by the recent survey of investor intentions conducted by PMA which suggested that − while the net balance of investor buying intentions fell away − the appetite for development rose. With investors looking to riskier deals in fewer geographies and sectors it is no surprise that the aggregate investment volume has reduced somewhat.

“Nonetheless, there is one other big tailwind for European real estate capital markets − the almost eternally low interest rate environment. With the market pricing in even more delayed rate hikes, European government bonds have fallen again with bunds hitting a 0% yields once more in 1Q19.

“Investors tend to substitute real estate and government bonds, and generally demand a 150-200 bps risk premium for holding real estate over government bonds. In the current environment, that criterion is satisfied even with real estate yields at rock-bottom levels. This environment also means North American and Asian Investors are able to hedge cheaply when investing into Europe.

“The first quarter of the year can be a slightly odd one for investment markets. While there are signs investment is running out of steam, there are plenty of reasons investors will stay with the asset class, not least due to the unattractive returns elsewhere. The second quarter should provide more clarity, but those expecting a market collapse may be waiting for some time yet.”

james.wallace@realassetmedia.com