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Despite rising concerns in some sectors, analysts with the real estate arm of Dutch bank ING see real estate remaining a competitive investment in many regions of the world over the next one to two years.
The following are extracts from ING Real Estate's Global Vision report:
After several years of unprecedented performance, real estate has emerged as a widely accepted asset class globally. Investors have increased their exposure to commercial property, heightening competition for available real estate. With commercial property yields at record lows and pricing at record highs, is the golden era of performance over? What can investors expect in the years ahead? Will real estate remain competitive in a changing landscape?
Several important short-term trends suggest that over the next 12-24 months, real estate will indeed remain competitive. First, despite a forecast cooling of the global economy from a record pace of expansion, growth rates are expected to remain above trend thus supporting demand for commercial real estate. Second, the flow of capital to real estate remains strong and preliminary estimates suggest that capital flows in 2006 exceeded those in 2005. Third, real estate is becoming a less risky asset class given its improved liquidity and transparency across the world.
Paradoxically, even as real estate generally becomes less risky, investors have become more creative in their search and riskier in their strategies to sustain higher returns. Finally, with real estate fundamentals generally healthy and improving, earnings growth should continue to support steady income returns. Despite the heightened competition for assets, there are still a number of excellent opportunities for investors of different styles and with different risk/return thresholds.
Global Economic Outlook
The global economy finishes its fifth year of expansion on several high notes, which bodes well for real estate investment in 2007. This has been the strongest period of expansion since the early 1970s, with the global economy expected to have grown by around 4% in 2006. Although expected to slow in 2007, global GDP should remain above its long-term average through 2010. Emerging economies, especially those in Asia, are expected to grow strongly in 2007. Japan’s expansion, which in November became the longest sustained period of monthly economic growth since World War II, should also bring some balance to the world economy.
Europe, too, after several years of sub-par growth, is expecting a steady and significant improvement in output growth. Figure 1 shows current and forecasted economic growth for key countries and regions relative to a blended 10 year average (calculated as a five year historic and five year forecast average). Headline inflationary pressures continue to subside in most countries as oil prices stabilize and some excess demand is removed via the slowing global economy. Interest rates appear to be at a turning point in several advanced economies, including the US and the UK where they are close to a peak.
In Japan, Australia and the Eurozone, some further monetary tightening may be expected. Unemployment rates, currently at historic lows in most advanced economies, are likely to stay stable in the coming year according to Consensus Forecasts. In the Eurozone, employment levels continue to improve.
The key economic trends by region are:
• Asia Pacific (excluding Japan) is expected to be the fastest growing region in 2007, with a forecast aggregate growth rate of 6.5%. Increasingly, domestic demand and intra-regional trade are complementing inter-regional exports as the principal drivers of growth. China, still growing faster than any other economy, is expected to cool slightly in 2007, while India’s growth should remain strong. Signs point to another year of growth for the Japanese economy in 2007. The smaller regional economies (Australia, South Korea, Hong Kong and most ASEAN nations) are expected to experience stable growth.
• Economic growth forecasts have been revised upwards in both the UK and the Eurozone. Higher growth is expected in the less mature countries outside the Eurozone such as Russia, and in the Central and Eastern European countries. Within the mature economies, Germany stands out for its improved economic prospects, although problems persist in Italy and Portugal. Nevertheless, economic growth in the Eurozone in 2007 should reach its highest rate in six years.
• In North America, the US economy continues to defy the pessimistic predictions of a “hard landing” following the housing slowdown. The US economy has in recent years been ‘housing-influenced’ and the slowdown in the housing market is raising questions about the resilience of the wider economy. The Canadian and Mexican economies have enjoyed high commodity prices, which have helped drive their recent growth. Overall, the outlook for North America remains stable for 2007.
Real Estate Capital Flows
To a significant degree real estate’s strong performance in recent years has been driven by the inflow of capital, which has pushed down yields worldwide. As 2006 began, investors questioned whether the strength of capital flows could be sustained, evidence towards the end of the year suggests that capital flows into real estate have remained very strong.
From 2004 to 2005, capital flows to Asia Pacific increased 38% to US$ 264 billion, flows to Europe increased 34% to US$ 262 billion, and finally, in the US, capital flows increased 9% to reach US$ 480 billion in 2005. Though capital flow figures for 2006 have not yet been released, preliminary estimates suggest that they are on track to surpass those of 2005.
The increased allocation of capital to real estate has impacted pricing across the world. Competition for real estate assets has increased, pushing down yields to historically low levels. In some markets, finding high-quality real estate has become problematic, and investors have been prepared to bid very aggressively for well-located real estate with stable cash flows and creditworthy tenants. At such historically low levels, room for further yield compression appears limited.
Though further yield compression is not ruled out for select markets and property types, higher earnings growth will probably be the key driver of total returns over the next 12 to 24 months. Investors will need to pay much more attention to the demand-side in order to continue to generate strong performance in the years ahead.
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