UBS Asset Management’s Real Estate & Private Markets (REPM) business has been investing in real estate for 75 years, having launched its first real estate fund as early as 1943. Since then, the business has grown steadily, expanding the universe and scope of its real estate investments and adopting a truly diversified business model. On an assets under management basis, the business is one of the leading global real estate investment managers today.
REPM’s capabilities include core, value add and increasingly opportunistic strategies on a global, regional and country basis. These are offered through open- and closed-end private (unlisted) funds, fund of funds, individually managed (separate) accounts, REITs and publicly traded real estate securities globally. The business actively manages direct investments in the hotel, industrial, multi-family/residential, office and retail real estate sectors, as well as in farmland in the US – a business that specialises in the acquisition, management and disposition of agricultural real estate investments.
Industrial: E-retailing has been a major factor in European logistics in recent years. However, a major part of Europe’s logistic industry is manufacturing related and thus business-to-business (BtoB) and not business to- consumer (BtoC). The current issues affecting the German automotive industry and manufacturing in general, may act as a drag on the BtoB logistics sector, with occupier demand likely to weaken in line with the fundamentals. This may increase further the appeal of distribution, which is still experiencing record low yields. Investors are mostly focused on distribution assets located close to major agglomerations, as these function best for ecommerce fulfilment and due to intense competition have seen the greatest levels of rental growth. Nonetheless, with interest rates set to remain low for the foreseeable future, we are still anticipating healthy returns which will outperform the European all property average.
Office: Despite a weakening of the European economy in 2019, fundamentals for the main office markets remain relatively robust. The deterioration of the economy has been almost exclusively driven by challenges within the manufacturing and export sector, whilst the services sector has thus far been fairly resilient. This has continued to deliver solid levels of office-based jobs creation across most markets. Despite the positive demand fundamentals, we still see few signs of a meaningful supply response emerging. Although construction levels have risen in a number of markets over the past few years, much of this is driven by pre-let schemes. Vacancy rates are at historical lows across many markets, and in core central locations there are very few options available to occupiers. This continues to drive positive prime rental growth which will generally exceed inflation levels for 2019. On the investment side, there is still healthy appetite, particularly for core office buildings, however volumes have fallen back in 2019. This is partly because of a limited number of buildings coming to the market, and also the level of pricing which has been reached which has made underwriting increasingly challenging.
Retail: The retail sector in Europe is experiencing a structural adjustment through the growth of online retailing, although the impact of this is unevenly distributed amongst the different countries. The UK is the most advanced, while on the mainland northern Europe has been more affected than Southern Europe. Central and Eastern Europe by contrast has seen much lower growth in ecommerce and is still seeing growth in traditional retail sales. In general, however there has been a rise in vacancy rates and rental growth is generally flat, if not negative. While this is affecting all segments of retail, secondary shopping centres are currently the worst affected while outlet centres, foodstores and high street in dominant towns and cities are more resilient. This has been reflected in investor sentiment, with yields on secondary, more tertiary assets seeing the sharpest outward movement. We believe the market has yet to find its nadir in Europe; however when that time comes there will most likely be buying opportunities for brave investors.
Global: The resilient appeal of global real estate is driven by a number of factors: low, albeit rising bond yields; the hunt for steady income; the importance of asset diversification; and a need for stability. Unconventional monetary policies in the form of quantitative easing and ultra-low interest rates have, in recent years, boosted the relative appeal of the asset class, while the consequential increase in capital flows has caused a surge in transactions. Volumes are now down from their peak but remain in line with long-run averages. This continued strength reflects a reluctance to let go of assets given uncertainty as to how to re-allocate capital attractively. Many markets present a price gap between buyers and sellers, with owners of real estate, even with leverage, generally under no pressure to sell while buyers are not willing to pay ever higher prices given the interest rate outlook.
Total returns globally continue to reduce as a result of reduced yield compression and capital value growth. Construction is starting to pick up, but broadly the supply side response has been muted this cycle, particularly in Europe. In the best locations, this has meant good levels of rental growth, meaning returns are not driven primarily by income. Differentiation in projected total return between markets and sectors is narrowing as the cycle extends. Income returns tend to be quite stable over time both within and across markets, while capital growth can vary tremendously depending on a market’s stage in the cycle.
Historically, rising interest rates have coincided with strengthening property returns, thanks to an improving economy and rising rents. This time is different: property returns are slowing as rates rise because a period of exceptional capital value growth driven by ultra-low interest rates and excess liquidity has come to an end. Nevertheless, global real estate remains attractive relative to other asset classes and provides the income and low volatility many investors desire. Lower leverage and less exuberant pricing for lower quality real estate also means the asset class is less at risk than in the last cycle. Returns have certainly reduced but remain in line with the long-term returns one should expect from institutional property.
Source: UBS Asset Management, Real Estate & Private Markets; September 2019. Past performance is not a guide to future performance.
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