Global finance experts speaking at the 2016 ULI Fall Meeting in late October said that institutional investors were preparing for an extended period of low interest rates and global volatility. However, U.S. presidential election results soon added another layer of complexity to the forecasts.
“The prevailing view is everything is fully priced and nothing is particularly cheap,” said Jack Chandler, managing director of global real estate firm BlackRock, during a panel on the future of global capitalization.
Jon Zehner, cohead of LaSalle Investment Management’s client capital group, told the group that most investors were assuming that interest rates would rise slowly, if at all, over the next few years. He revised those remarks after the election.
“The unanticipated U.S. election results have clearly changed the markets’ expectations around U.S. government spending and tax policy, with many investors anticipating that a President Trump will dramatically increase infrastructure spending and request significant tax cuts,” Zehner said.
“The combination seems likely to produce wider government deficits and consequently, over time, inflation above current levels. This should prompt a rise in interest rates, which we are already beginning to see in the bond markets and changes the intermediate-term view that interest rates will stay low for longer. Although it is too early to tell what the impact will be on real estate asset pricing, it may well alter the value of asset income streams and dividend yields, as I had articulated on the ULI Dallas capital markets panel discussion.”
Balancing risk with the demand for yield is becoming an increasingly difficult equation, the panel of high-level investment executives emphasized in the discussion moderated by Ngee Huat Seek, chairman of Global Logistics Properties and chairman of ULI Asia Pacific. Uncertainty about central bank policies on interest rates continues to affect the value of risk assets and the amount of liquidity, Chandler said.
Investors are “spending as much time trying to handicap [central banks] as property markets,” he said.
Three things are guiding the current market, Zehner said at the Fall Meeting: leverage levels are coming down, lenders are demanding more control, and the pace of international capital investing around the world has gone up “dramatically.”
In turbulent times, with investors hunting for yield, “clearly, real estate is in favor these days,” said Peter Ballon, head of real estate investments for CPP Investment Board. “Large pools of capital continue to exert buying power” around the globe, he said, with the appetite for property still strong from Asia and the Middle East.
“These pools of capital are not going to be very spooked by interest rate movement,” Ballon said. “This is permanent capital committed to real estate, and they will provide some stabilization to pricing that will be good for real estate in the long run.”
More investors are looking at real estate as a long-term commitment, not a short-term trade, said Michael Spies, senior managing director, Tishman Speyer. A recent ULI study of institutional investors found that 20 percent of assets were held for more than 20 years, he said. “I suspect that number will grow.”
Recent data show that the international flow of capital into real estate is still growing, with alternative investments offering few rewards with similar risks, panelists said. Global investors still need a place to put their money, even when rates are low.
Geopolitical risk is driving investors to real estate, not slowing them down, Zehner said. “A lot of capital flowing into real estate is just looking for a safe haven,” he said. Despite high valuations, many of the global funds will continue to focus on top-quality locations, not secondary markets, he said. “People still remember [the crash],” he said.
Funds around the world are adjusting their allocations toward real estate, even though projected returns may be lower than in the past, panelists said. “Astonishingly, making 4 or 5 percent income yield, having some inflation hedge and some prospect for capitalization preservation and maybe some growth, actually ends up being fairly attractive,” Chandler said. “The whole metrics are being challenged by these low rates.”
These days, “in true core,” 6 percent is an acceptable total return,” Spies said. The real risk is “people stretching the definition of core to chase yield,” he said.
Developing markets are “where the growth is,” Spies said. His fund is looking more to emerging markets that have been hammered in recent years, including Brazil. “Brazil looks like a pretty opportune time,” he said. After an era of turmoil, there is the “beginning of a shift in sentiment, so now is the right time to be investing cyclically in Brazil,” he said.
CPP Investment Board is also looking for higher yields in noncore markets, Ballon said. The company is “pulling back from trophy real estate,” he said. In top-property markets like midtown Manhattan, “the pricing in our mind is very expensive,” he said.
Instead, CPP is focusing more on markets with “dislocations,” where there are higher risks but more opportunity for higher returns. Recent investments include office buildings in Calgary, Canada, which has been hit by the oil downturn; China; the United Kingdom; and Brazil.
“We’re trying to work around the edges,” Ballon said. “We’re going into new sectors.” But this is a playing field requiring expertise and “feet on the ground” to succeed, he emphasized. “Anybody who invests without that will get what they deserve,” he said.
Many geopolitical factors—including instability in China and continued turmoil in Europe—loom on the horizon. The fallout from Brexit is still largely unknown. In the short term, there has been little impact, said Zehner, who is based in London.
“If you talk to real estate owners in London, in terms of their rental experience, it has been largely a nonevent,” Zehner said. Prices are pretty much unchanged, though a little softer, he said.
But the long-term impact is much more difficult to predict. “What is in the background is we still have no idea what Brexit will mean, and the level of uncertainty.”
The Brexit story is only starting to play out, panelists agreed. “The fact is, two years from today we will not know anything more,” Spies said. “The whole way this thing unfolds unfortunately just creates uncertainty.”
Whatever the outcome “it will be expensive” for the United Kingdom, he added.