GLOBAL REAL ESTATE PERFORMANCE IN 2017

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1 RESEARCH INSIGHT GLOBAL REAL ESTATE PERFORMANCE IN 2017 Trends and Insights from MSCI s IPD Global Annual Property Index Bryan Reid May 2018 MAY 2018

2 CONTENTS Overview... 3 Summary... 3 About the Data... 3 The Year in Review... 5 Global Total Return Edges Up in Southern Europe Bookends Performance Rankings... 6 Convergence of National Performance Results... 7 Momentum Reverses as Most Markets Improve... 8 Yields Still at Record Lows in Many Markets... 9 Industrial and Non-Core Sectors Lead Returns Currency Movements Could Have Had a Substantial Impact European Cities Performed Well, Especially Versus Recent History MSCI.COM PAGE 2 OF 1515

3 OVERVIEW SUMMARY Global asset-level real estate delivered a total return of 7.9% in 2017, up from 7.4% in 2016 and marking the eighth consecutive year of positive performance since the global financial crisis. In 2017, capital growth increased 68 basis points to 3.1%, but this was still down on the recent peak of 5.4% in 2015 and the pre-financial crisis peak of 8.4% achieved in Income returns continued to compress and reached a record low 4.7% in 2017, more than 140 basis points lower than in 2010 and over 300 basis points lower than in Spain was the best performing market in 2017, with a total return of 14.5%. After Spain, the next best performers were Hungary (13.2%) and the Netherlands (12.4%). Last year s best performing market, Sweden, saw its total return decline from 13.9% to 10.8%, only the 10 th best return in The worst performer in 2017 was Italy, with a 4.7% total return. ABOUT THE DATA In generating the IPD Global Annual Property Index, MSCI processes full investment performance details from a large dataset of almost 54,000 individual assets. These assets were valued at US$1.7 trillion in 2017 and were appraised at least once each year. This dataset provides insights across geographies and property types, and is the basis of a series of analytical tools for portfolio managers, strategists and risk managers. The key datasets covered in the report are available through MSCI s Global Intel product. The IPD Global Annual Property Index weights real estate investment returns across 25 countries. MSCI produces national real estate indexes in 24 of these 25 countries. Finland is included in the IPD Global Annual Property Index through a partnership with KTI. While MSCI s national indexes for Japan and Korea are included in the IPD Global Annual Property Index, our market data for seven other Asian countries China, Hong Kong, Indonesia, Malaysia, Singapore, Taiwan and Thailand are currently excluded. For each country where MSCI produces an index, the size of the professionally managed universe is estimated annually so that appropriate weights can be applied to each country s performance when creating aggregated indexes such as the IPD Global Annual Property Index. Each year the estimates improve as more information becomes available and more opaque markets achieve greater transparency. In 2017, North America and EMEA respectively comprised 44% and 40% of the weighted total, with the remaining 16% in Asia Pacific. MSCI.COM PAGE 3 OF 1515

4 Exhibit 1: 25 Countries in the Global Annual Property Index NOT YET IN THE GLOBAL INDEX AMERICAS 44% EMEA 40% ASIA PACIFIC 16% Source: MSCI MSCI.COM PAGE 4 OF 1515

5 RETURN THE YEAR IN REVIEW GLOBAL TOTAL RETURN EDGES UP IN 2017 The MSCI IPD Global Annual Property Index registered a total return of 7.9% in 2017, the eighth consecutive year of positive returns since the global financial crisis and 50 basis points higher than in However, the return was lower than its recent peak of 10.7% in 2015 and also below the returns in 2010, 2011, 2013 and Following the recovery from the financial crisis, real estate benefited from loose monetary policy and plentiful capital chasing yields, which helped to boost returns and support performance, primarily through yield compression. After the slowdown in 2016, when the global index total return fell 330 basis points and most countries recorded lower returns, there were fears that global property might have reached a turning point. Worries about the growth of e-commerce, political populism and rising interest rates all weighed on expectations. With 2017 s total return edging up again and most countries reporting higher returns, fears that the year might continue the downward trend proved unfounded. Exhibit 2: MSCI IPD Global Annual Property Index Returns All property returns in local currency 20% 15% 5% % -5% - -15% ANNUALIZED INCOME RETURN CAPITAL GROWTH TOTAL RETURN Source: MSCI, KTI MSCI.COM PAGE 5 OF 1515

6 2017 RETURN SOUTHERN EUROPE BOOKENDS PERFORMANCE RANKINGS The best total return of 2017, 14.5%, was achieved in Spain, where several years of robust economic growth have helped to drive stronger real estate performance. Spain also had the second highest return in Last year s best performing market, Sweden, saw its total return drop from 13.9% to 10.8%, only the 10 th best return in At the other end of the spectrum, Italy recorded the weakest 2017 total return of 4.7%. Italy has endured relatively weak performance recently, posting the lowest total return in three out of the last four years and ranking as one of the bottom five countries every year since Having been the weakest performer in 2016, the U.K. rebounded strongly in 2017 with a return of 9.6%,, outperforming the global index by 170 basis points. Between 2013 and 2015, the U.K. had been one of the strongest performing markets globally, thanks to strong demand for assets in international gateways such as London. But in 2016, U.K. performance deteriorated significantly after the surprise result of the Brexit referendum, leaving it with the lowest total return in the global index. Uncertainty around the U.K. s impending departure from the EU continued in 2017, but investor confidence returned sufficiently to drive returns back above the global average. Exhibit 3: 2017 Returns by Country All property returns in local currency 16% 14% 12% 8% 6% 4% 2% 0% -2% INCOME RETURN CAPITAL GROWTH TOTAL RETURN Source: MSCI, KTI MSCI.COM PAGE 6 OF 1515

7 ANNUAL TOTAL RETURN CONVERGENCE OF NATIONAL PERFORMANCE RESULTS With the best performing country achieving a 14.5% total return in 2017 and the worst 4.7%, the spread was less than 10 percentage points. This gap was the smallest for the MSCI IPD Global Annual Property Index since 2001, when there were only 17 countries in the index. Even if we exclude the most volatile markets such as Ireland (which went from a 27.7% return in 2006, to -34.8% in 2008 and back up to 39.7% return in 2014) and South Africa, the spread is still smaller than at any point since This convergence of returns can potentially be explained, at least in part, by the fact that real estate is becoming an increasingly global asset class and that cross border capital flows have been growing. Several years of expansion driven primarily by yield compression globally and the fact that debt has not played as big a role in this cycle as the last have also probably contributed to this outcome. Exhibit 4: The Global Index Versus National Markets All property annual returns in local currency 50% 40% 30% 20% 0% % -30% -40% INDIVIDUAL COUNTRIES GLOBAL Source: MSCI, KTI MSCI.COM PAGE 7 OF 1515

8 TOTAL RETURN MOMENTUM REVERSES AS MOST MARKETS IMPROVE The improvement in the global index reflected a general acceleration across national markets. Seventeen of the 25 national markets recorded a higher total return in 2017 than in This contrasted with last year, when all but four of the 25 countries saw total returns decline. Of the four countries which improved in 2016, three (the Netherlands, Austria and Italy) continued to improve (although the acceleration in both Austria and Italy was marginal in both years) while South Korea s performance deteriorated slightly in Returns for Ireland, Sweden, the U.S., New Zealand, Japan, Denmark and Switzerland all declined in 2016, and continued to do so in The most notable deceleration was in Ireland, where performance had been exceptionally high in 2014 and 2015 but then fell below the global index, leaving it the fifth-worst performing country in The remaining 14 countries in the global index experienced a slowdown in 2016 but an acceleration in This reversal was most pronounced for the U.K., where a capital market shock followed the surprise Brexit referendum result in 2016 and severely impacted performance that year. Exhibit 5: Performance Momentum Across National Markets All property annual returns in local currency 25% 20% 15% 5% 0% (UP) 2016 (DOWN) 2017 (UP) 2017 (DOWN) Source: MSCI, KTI MSCI.COM PAGE 8 OF 1515

9 NET OPERATING INCOME YIELD YIELDS STILL AT RECORD LOWS IN MANY MARKETS Since 2008, low interest rates have helped boost real estate prices by lowering both borrowing costs and discount rates on future operating income, while also reducing yields for other asset classes. As real estate asset values have grown, yields have compressed. In 2016, the income return on the MSCI IPD Global Annual Property Index fell below 5% for the first time since its inception, and it continued to compress in Yields are now at the low end of their historical ranges across many of the world s real estate markets. In the short term, low yields could be considered a risk factor for investors with higher totalreturn expectations. Historically, income returns have been relatively stable and have made up a sizeable portion of the long-term return from direct investment in private real estate. Faced with falling yields, investors wanting to maintain higher total-return targets will be more reliant on capital growth. Longer term, it is not clear whether the shift toward lower real estate yields is sustainable. With the Federal Reserve raising U.S. interest rates again, there are concerns about a repricing of real assets. Rising rates could be bad for bond values, due to a discount-rate effect, but the prognosis is not as clear for real estate. Unlike bonds, cash flows from real estate are not fixed. Lower vacancies, higher rents and lower operating expenses can all help to boost net operating income (NOI), and thus values. Exhibit 6: National Market NOI Yields Against Historical Ranges All property net operating income yields in local currency 9% 8% 7% 6% 5% 4% 3% 2% HISTORICAL RANGE TO 2015 DEC 2016 DEC 2017 Source: MSCI, KTI MSCI.COM PAGE 9 OF 1515

10 2017 TOTAL RETURN INDUSTRIAL AND NON-CORE SECTORS LEAD RETURNS At the sector level, two clear trends stood out in The first was that non-core sectors (hotel and other) recorded relatively strong returns in a number of countries. As yields have firmed and access to core sectors stock has become more challenging in certain markets, non-core investments such as hotels and healthcare have attracted increasing interest, boosting their performance. The second trend has been the continuing outperformance of industrial among the core (retail, office, industrial and residential) sectors. Residential did well in a few countries including the Netherlands, Germany and Canada, but industrial generally offered the highest core sector returns. This outperformance was most notable in the U.S., the U.K. and Italy, where industrial returns were well above those for all property. Only in the Netherlands, Australia, Portugal, Finland and Poland did industrial underperform the all-property measure. Over recent years, the industrial sector has benefited from changing consumption patterns and the growth in e-commerce and logistics. Demand for warehousing and distribution solutions has helped drive industrial performance. By contrast, retail performance has been more subdued, only outperforming industrial in Portugal and Poland last year. Exhibit 7: 2017 Sector Performance by Country Global returns in local currency 25% 20% 15% 5% 0% RETAIL OFFICE INDUSTRIAL RESIDENTIAL HOTEL OTHER ALL PROPERTY Source: MSCI, KTI MSCI.COM PAGE 10 OF 1515

11 2017 TOTAL RETURN CURRENCY MOVEMENTS COULD HAVE HAD A SUBSTANTIAL IMPACT Local currency returns enable us to focus on performance without any currency impact. However, movements in exchange rates can have a big impact on unhedged foreign currency exposures. For example, the 2017 global index return would have increased from 7.9% in local currency terms to 13.8% in terms of U.S. dollars, but decrease to 0% in euros. The weakening of the U.S. dollar in 2017 boosted unhedged foreign returns for U.S. based investors and, in particular, the depreciation against the Euro had a notable impact. For instance, Spain s 14.5% total return would have more than doubled in U.S. dollar terms to 30.3% and even Italy s 4.7% local currency return, the worst in 2017, would have been 19.2% in U.S. dollars. In fact, measured in US dollars, the U.S. total return of 7.0% would have been the weakest of the 25 countries in the global index. For euro-denominated investors, currency appreciation had the opposite impact in For instance, measured in euros, the 7.0% local currency total return for the U.S. would have fallen to -6.0%, while Italy s 4.7% return would have outperformed Norway, Canada, New Zealand, Japan, Switzerland and the U.S. Exhibit 8: 2017 Sector Performance by Country Global returns in local currency 35% 30% Spain, % 20% 15% 5% 0% -5% - Source: MSCI, KTI Spain, US, 7.0 Italy, Global Index, 0.0 US, -6.0 EUR Local Currency USD Italy, 19.2 Global Index, 13.8 MSCI.COM PAGE 11 OF 1515

12 EUROPEAN CITIES PERFORMED WELL, ESPECIALLY VERSUS RECENT HISTORY At the city level, there had been only two markets which recorded total returns over 15% in 2016, Amsterdam (16.4%) and Munich (16.1%). Stronger city performance in 2017 was mostly to be found in EMEA particularly in the Iberian Peninsula and Scandinavia. Of the 85 cities tracked by MSCI, only Calgary experienced a negative return at -0.3%. Like Edmonton, Houston and Perth, Calgary s performance suffered in the wake of the collapse in commodity prices of late Across these commodity cities, capital growth has remained either negative or very weak, but showed some signs of improvement in Exhibit 9: 2017 Total Return Performance by City All property annual total returns in local currency Source: MSCI In addition to stronger returns, European cities generally also showed signs of growing momentum. Most European cities recorded a 2017 total return above their 5-year annualized performance, whereas North American cities generally showed the opposite trend. Most global gateway cities also saw total returns slip. Tokyo, New York and London all underperformed their 5-year annualized return, though Paris did slightly better than over the medium term. Judged on their 2017 total return and 5-year annualized performance, the world s major cities do not stand out, for all their popularity with offshore investors. MSCI.COM PAGE 12 OF 1515

13 2017 TOTAL RETURN Exhibit 10: City 2017 Return vs 5-Year Annualized Return All property total returns in local currency 20% IMPROVING 15% PARIS LONDON 5% TOKYO NEW YORK SLIPPING 0% -5% 0% 2% 4% 6% 8% 12% 14% 16% 18% 20% 5 YEAR ANNUALIZED TOTAL RETURN ASIA OCEANIA CONT. EUROPE NORTH AMERICA AFRICA UK & IRELAND Source: MSCI MSCI.COM PAGE 13 OF 1515

14 CONTACT US AMERICAS Americas * Atlanta Boston Chicago Monterrey New York San Francisco Sao Paulo Toronto EUROPE, MIDDLE EAST & AFRICA Cape Town Frankfurt Geneva London Milan Paris * ABOUT MSCI For more than 40 years, MSCI s researchbased indexes and analytics have helped the world s leading investors build and manage better portfolios. Clients rely on our offerings for deeper insights into the drivers of performance and risk in their portfolios, broad asset class coverage and innovative research. Our line of products and services includes indexes, analytical models, data, real estate benchmarks and ESG research. MSCI serves 99 of the top 100 largest money managers, according to the most recent P&I ranking. For more information, visit us at ASIA PACIFIC China North * China South * Hong Kong Mumbai Seoul * Singapore * Sydney Taipei * Thailand * Tokyo * = toll free MSCI.COM PAGE 14 OF 1515

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