Property Markets: The Quarter in Review

Transcription

1 January 11, 2013 Investment Team Update August 15, 2016 PERSPECTIVE FROM FRANKLIN REAL ASSET ADVISORS With global property markets in different stages of the real estate cycle, various economic forces are impacting regions and sectors in distinct ways. In this market review, Franklin Real Asset Advisors explores the macroeconomic environment and notable real estate sectors in the United States, Europe and Asia over the second quarter of 2016, identifying where they see opportunities across the landscape. US Property Markets Expectations for economic growth in the United States moderated in the first quarter of Global uncertainty increased at the end of the second quarter when the United Kingdom voted to leave the European Union, prompting the US Federal Reserve to refrain from raising interest rates during the reporting period. Within the multifamily sector, net absorption began to slow as new supply came online. The national vacancy rate remained stable over the first quarter of 2016, as rental rate growth also slowed over the period. approximately 670,000 new jobs during the quarter, bringing the unemployment rate to 4.9% according to the US Bureau of Labor Statistics. The recovering job market bolstered the confidence of the US consumer, and spending began to pick up during the quarter. Yet, global uncertainty remained and was further underscored by the Brexit vote that occurred on June 23, While the markets have begun to settle, they have remained sensitive and volatile. It is against this backdrop of uncertainty that the US Federal Reserve chose not to raise interest rates in June, yet indicated that the strengthening US economy may warrant modest and measured increases in the remaining months of the year. Chart 1: US Unemployment Continues to Decline January 2000 June % 10% 8% Overall vacancy rates in the industrial sector continued to decline over the quarter with millennial-favored technology oriented markets such as New York and Washington, DC showing particular strength. Retail real estate continued to improve in the second quarter as consumer spending in the United States increased over the period, especially in the food service and online retail sectors. 6% 4% 2% 4.90% Tepid economic growth in the United States of 1.2% gross domestic product (GDP) for the second quarter of 2016 set the tone for modest growth expectations the rest of the year. Consensus estimates called for a range between 2.0% and 2.5% of GDP growth for the remainder of 2016, likely coming in at just under 2.0% for the year overall. The labor market added 0% US Unemployment Rate Source: FactSet, US Department of Labor. Important data provider notices and terms available at The above chart is for illustrative and discussion purposes only.

2 Multifamily real estate continued to moderate relative to prior quarters, but remains healthy overall. During the first quarter of 2016, the national multifamily vacancy rate remained at 4.7%, according to CBRE. In addition, the first quarter of 2016 marked a 4% year-over-year (yoy) rent appreciation, above the historical average but moderating from peaks in recent years. Despite the modest cool down in the sector, investor demand has remained strong with approximately US$45 billion of investment activity for the first quarter of the year with portfolio sales likely driving the totals for the quarter. Net absorption reached approximately 29,300 units marking one of the highest first quarters of the year since 2010 also noted by CBRE. Further supply deliveries are expected throughout 2016 and into For the calendar year 2016, approximately 293,000 new units are expected to come online. Some of these units may be pushed into 2017 for delivery, yet 2016 is on pace to set the high-water mark for multifamily completions. These units coupled with the estimated 225,000 slated for delivery in 2017, bring the estimated total for the two years to roughly 518,000 new units according to CBRE. Not surprisingly, New York, Dallas/Fort Worth, Houston and Seattle led the nation for new supply deliveries over the past year. This trend mirrors some of the tightest markets in the United States (those with vacancy rates of 4% or less), which also include the New York City metropolitan area including Long Island and Newark, NJ as well as Miami, Los Angeles, Oakland and Providence, RI, according to CBRE. The national vacancy rate for office property across the United States declined during the second quarter of 2016, bringing the rate to 16.0%, a 10 basis point decrease over the first quarter of the year, according to REIS. For the first quarter, office investment remained healthy, with US$31 billion of transactions, albeit 14.8% below the prior year s level for the first quarter transaction volume according to CBRE. Not surprisingly millennial-favored technology oriented markets hold six of the top 10 rankings nationally, with New York and Washington, DC being tied for the tightest markets in the country, both with 9.1% vacancy rates, according to REIS. San Francisco is not far off with a 10.1% vacancy rate as of the second quarter of Absorption slowed during the quarter to 6.9 million square feet, the slowest quarter for absorption since the first quarter of During the same time period, less than nine million square feet of new office space came online, bringing total additions to new supply for the first half of the year to just over 16 million square feet. New office supply may have reached its highest point in the current cycle, with approximately 65% of it concentrated in 10 markets. These supply constraints have been boosting Class B properties where vacancy is low and/or demand is high, according to Jones Lang LaSalle. Asking and effective rents grew by 0.6% in the second quarter, the 22nd quarter for rising rents, according to REIS. The industrial real estate market continued to grow in the second quarter of 2016, with vacancy declining in warehouse and distribution space as well as flex/research and development space as net absorption exceeded new construction in both property types, according to REIS. Overall vacancy for industrial real estate in the United States declined by 10 basis points to 5.6%, its lowest rate since 2002 according to CBRE. The 40.7 million square feet of new supply added during the first quarter of 2016 was short of the 60.9 million square feet that was absorbed by the market. According to CBRE, demand for supply had outpaced deliveries for the past 23 consecutive quarters, one of the longest streaks in the market s history. Due to tight supply, rents increased in many core markets, with growth rates of 1.7% for the first quarter of 2015 and 6.0% yoy, according to CBRE. Every metro across the United States cited positive rent growth for the quarter, as noted by REIS. Acquisitions for US industrial real estate slowed slightly during the first quarter of the year to US$13 billion. Individual asset purchases represented the majority of the transactions as compared to multifamily real estate which was largely driven by portfolio sales, as cited by CBRE. The US consumer picked up the pace in spending during the second quarter of Retail and food service sales grew by 0.6% in June 2016, as compared to the month prior and the industry overall posted a 2.7% rise in revenue when compared to the same period in Online retailers and those with a combined physical and online presence continued to garner the most attention from US consumers, grabbing a 14.2% gain over the same month one year ago according to the US Census Bureau. This divided attention from consumers between online and physical retailers continued to drive the divergence in performance for retail property types. At the one end of the spectrum, neighborhood and community shopping centers cited a decline of 10 basis points to an overall vacancy rate of 9.9% while the other end, malls, increased by 10 basis points to 7.9% overall, generally moving in opposite directions according to REIS. While the mixed-bag of overall demand for retail property continued in the quarter, a review of asking rents shows that for the eighth consecutive quarter, retail net asking rents grew by 2.3% yoy. Retailers in San Francisco, Denver and Atlanta, markets with strong population, job and income growth, rank the highest in projected rent growth through 2018, as noted by CBRE. Despite the positive rent growth, supply continues to impact the overall dynamics of the sector. While total completions for the first quarter of 2016 came in at 9.4 million square feet, below the average firstquarter completions when compared to , it was nearly double the amount delivered during the first quarter of 2015, according to CBRE. This demand was reflected in the increased level of investment activity during the first quarter of 2016, but slowed when compared to prior quarter and year-earlier levels. Investment volume marked US$18 billion in transactions, most 2

3 notably including the US$2.3 billion acquisition of Inland Real Estate Corp. by DRA Advisors and Prudential Real Estate Investors, according to CBRE. This decrease in volume represented a yoy decline of approximately 31%. European Property Markets The unexpected result of the Brexit vote in late June triggered financial market and currency volatility, and a substantial increase in investor uncertainty. Effects were felt most acutely in the UK commercial real estate market while investment volumes in continental Europe remained strong. Against this backdrop, prime office yields in London expanded, while yields in the largest German markets of Frankfurt, Berlin and Munich contracted slightly. Yields remained stable in the Paris central business district, but contracted in the wider Paris area. Within the office sector, take-up declined slightly year-over-year due primarily to the result of the Brexit vote and its resulting effects on the London office market. More broadly, office vacancies decreased across continental Europe to the lowest level since The UK referendum for continued European Union (EU) membership dominated the news during most of the quarter. The vote by the British electorate on June 23 to leave the EU ( Brexit ) triggered financial market and currency volatility, and a substantial increase in investor uncertainty. These developments and the resulting protracted exit process are expected to not only affect the United Kingdom but also the rest of the EU economy in various ways, including trade, investments and migration. While uncertainty is expected to diminish over time, the consequences on the growth outlook for the United Kingdom as well as for the rest of the EU in 2016 and 2017 are expected to be negative. Brexit is expected to slow private consumption and investment, and impact foreign trade. In the short term, the UK referendum outcome triggered significant safe haven flows with rising risk premiums across market segments and falling sovereign bond yields. All benchmark 10-year sovereign yields declined significantly, including the German Bund, which turned negative. While uncertainty dampened appetite for the UK commercial real estate investment market, activity remained strong across most of Europe. European investment volumes were slightly up in the first quarter of 2016 and up nearly 30% versus the 10-year quarterly average though down around 19% on the second quarter of Low levels of investment in Europe s two largest markets the United Kingdom (referendum) and Germany (primarily inadequate supply of properties) stood in contrast to France and Sweden, the third and fourth largest markets, which had a strong second quarter with investment volumes up significantly on same time last year. Looking ahead, it is expected that some demand that had previously targeted the UK market may be diverted into other European markets with similar safe haven characteristics. Germany is seen as the biggest overall winner providing most liquidity and secure alternatives. Chart 2: European Investment Turnover ( m) Investment Turnover (EUR Millions) Q Q ,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10, Q '08 2Q '09 2Q '10 2Q '11 2Q '12 2Q '13 2Q '14 2Q '15 2Q '16 EUR Millions Source: CB Richard Ellis. The above chart is for illustrative and discussion purposes only. Prime office yields contracted further in Germany as a result of strong investor demand and a shortage of supply above all for large properties in the core segment. A particularly dynamic example was provided by Berlin, where the net initial yield for office buildings has eased to 3.70%, only just 10 basis points higher than in Munich (3.60%), Germany s key market. In Frankfurt, the top yield has also slid below the 4% mark, and now stands at 3.95%. Prime yields remained stable in the Paris central business district (CBD), but posted a 25 basis points contraction in most other submarkets in the greater Paris region over the second quarter of In contrast, prime London West End yields increased by 25 basis points to 3.50%, which is not surprising given the uncertainty in the run up to the UK referendum. The office leasing market across Europe was down 4% yoy, although heavily impacted by a drop in the London leasing market (-56% yoy) where occupiers took a wait-and-see approach ahead of the referendum. Excluding the United Kingdom, European takeup in the second quarter grew by 3% yoy. Some of the strongest yoy increases in Europe where reported in Luxembourg (+39%), Amsterdam (+29%), Munich (+59%) and Paris (+16%) and point to a further and more broadly-based improvement in corporate sentiment. Office vacancy has continued to decrease with the European aggregate dropping by 10 basis points to 8.5%, the 3

4 lowest since the first quarter of As a result, rental levels stabilized across Europe. In Paris, limited new supply and stronger take-up increased prime rents for the fourth consecutive quarter (+3.4% quarter-over-quarter). In Spain, Barcelona (+3.7%) and Madrid (+0.9%) continued their strong run. Other office markets such as Stockholm (+9.4%), Berlin (+6.3%), Milan (+2.0%), Dusseldorf (+1.9%) and Munich (+1.5%) also recorded growth in the second quarter. Prime rents remained stable in London over the quarter. Looking ahead, while the longer-term impact of Brexit on Europe s real estate markets is difficult to predict at this point, the flight to safety is expected to continue. This, together with the quantitative easing still in place by the European Central Bank, will benefit real estate and put further pressure on prime yields for city center assets in the short to medium term. Asian Property Markets Japanese property markets have continued to strengthen, despite investor concerns regarding the overall performance of the Japanese economy. In the office sector, overall vacancies continued to fall while average rents continue to rise with many analysts predicting an increase in the rate of rent growth in the Tokyo office market. Negative interest rates in Japan have further supported the real estate sector with yields falling across all property types, and Japanese nationwide average land prices rose for the first time in eight years. China s Q GDP grew 6.7% year-over-year, due primarily to central bank stimulus. However, private real estate investment weakened over the period, especially in the residential sector. Retail sales increased year-over-year fueling investor optimism regarding the retail and logistics sectors. In Japan, the disconnect between the broader economy and the real estate market continued in the second quarter of Despite increasing investor concerns over the recent performance of the Japanese economy, as well as the overall effectiveness of Abenomics, fundamentals in the real estate sector have continued to improve. In the office sector, overall vacancies continued to fall while average rents continue to rise. The Miki Shoji office building vacancy rate survey of Tokyo s five main wards improved over the second quarter to 4.07% as of June 2016, from 4.34% as of March The average office asking rent per tsubo (equivalent to 3.3 square meters) for the five central wards of Tokyo increased by 1.1% quarter-over-quarter to 18,179, which equates to a 4.47% increase yoy. On average, Tokyo office rents have been growing by 4% to 5% yoy since As we mentioned previously, across the market as a whole, demand for office space remains firm while office supply for the remainder of 2016 and 2017 is rather low. As a result, some local market analysts are suggesting that the pace of Tokyo office rental growth may increase. The Bank of Japan s decision to adopt negative interest rates earlier in the year has been a boon to the real estate sector. The Japan Real Estate Institute announced that as of April average real estate market yields have fallen further. Tokyo CBD office market yields declined to 3.9%, while Tokyo non-cbd office market yields fell to 4.9%. Regional office yields slipped to 5.8%. In other sectors, Tokyo downtown retail yields fell to 3.8%, while Tokyo residential yields declined to 4.4%. In other positive news, Japan s nationwide average land prices (in general a lagging indicator for the real estate sector) rose for the first time in the eight years since the global financial crisis. While Tokyo commercial land prices turned positive in 2014, land prices in the rest of the country also started to improve over the second quarter of Chart 3: Vacancy Rates in Tokyo Continue to Decline Office Vacancy Rate (Tokyo Major 5 Wards Average) June 1998 June % 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 6/98 6/00 6/02 6/04 6/06 6/08 6/10 6/12 6/14 6/16 Source: Miki Shoji. The above chart is for illustrative and discussion purposes only. 4.07% China s second quarter 2016 GDP grew 6.7% yoy, the same rate as last quarter, on the back of a string of stimulus measures from the government and the central bank. While government-linked investment was strong, private investment continued to weaken. In particular, private real estate investment growth slowed across the country, especially in the residential sector, which increased by only 5.6% yoy in June. The bright spot has continued to be retail sales, up 10.6% yoy as of June 2016, which we believe bodes well for the retail and logistics sectors. China s efforts to reduce the country s reliance on manufacturing and encourage the service sector have continued apace but the transformation has been far from smooth-sailing. Industrial overcapacity in the cement and steel sectors, and soaring land prices, especially in urban centers, are some of the challenges that the government has to deal with. 4

5 WHAT ARE THE RISKS? All investments involve risks, including possible loss of principal. The risks associated with a private equity real estate strategy include, but are not limited to various risks inherent in the ownership of real estate property, such as fluctuations in lease occupancy rates and operating expenses, variations in rental schedules, which in turn may be adversely affected by general and local economic conditions, the supply and demand for real estate properties, zoning laws, rent control laws, real property taxes, the availability and costs of financing, environmental laws, and uninsured losses (generally from catastrophic events such as earthquakes, floods and wars). Real estate securities involve special risks, such as declines in the value of real estate and increased susceptibility to adverse economic or regulatory developments affecting the sector. Investments in REITs involve additional risks; since REITs typically are invested in a limited number of projects or in a particular market segment, they are more susceptible to adverse developments affecting a single project or market segment from more broadly diversified investments. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments; investments in emerging markets involve heightened risks related to the same factors. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. 5

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