Property Markets: The Quarter in Review

Transcription

1 Investment Team Update 26 February 2018 Property Markets: The Quarter in Review 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 fourth quarter of 2017, identifying where they see opportunities across the landscape. US Property Markets The US Federal Reserve (Fed) raised short-term interest rates by 25 basis points to 1.50% during the fourth quarter of 2017 in a widely expected response to a strengthening US economy. Chart 1: US Unemployment Continues to Decline January 2000 December % 10% 8% 6% 4% 2% 4.10% Within the multifamily sector, new supply entering the market has pressured rent growth, but we believe that demographics will continue to support the sector, overall. Overall vacancy rates in the office property sector marked their fifth consecutive quarterly increase in the fourth quarter of 2017 due to new supply coming online. Secondary markets such as Dallas and Atlanta remain a bright spot, however, and technology tenants have continued to drive a significant portion of overall demand. The retail sector continues to struggle as online retailers gain market share. However, transaction volume remains strong in New York, Los Angeles and Chicago and among retailers that provide experiences and services that cannot be replicated digitally. Not surprisingly, the Fed raised short-term rates by 25 basis points (bps) to 1.50% at their final meeting of the year. 1 The announcement was largely expected, due to the improving US economy, the gradual removal of monetary policy accommodation and an increasingly positive outlook for Despite hurricane-related fluctuations, the unemployment rate for the United States remained unchanged in December standing at 4.1%, citing an increase in total nonfarm payroll of 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. 148,000 jobs. Health care, construction and manufacturing were the largest contributors to these gains. 2 Further, the Fed s median projection for gross domestic product (GDP) is 2.5% for 2017, moderating to 2% by These projections are slightly above the prior quarter s and reflect positive changes regarding revised tax policy, the full effects of which remain uncertain. 2 Transaction volume for US commercial real estate typically surges in the final quarter of the year. While December 2017 posted strong overall transaction volume, it was the first December in eight years without the seasonal surge associated with year-end closings. 3 An exception to this trend was industrial real estate, which posted its second-most-active year in history for the sector. The suburban office and senior housing sectors also posted gains for the year. 3 This shift likely demonstrates nearly full pricing in other sectors, multifamily and urban office, as investors seek alternatives for their capital.

2 Multifamily rent growth remained muted, absorption rates moved slightly for new supply and volume declined, representing the first annual decline since 2009, during the third quarter of New supply entering the market has continued to pressure rent growth with rent growth decreasing by 10 bps quarter-overquarter to 2.4%. 4 Absorption for new inventory rose 30 bps from mid-year, increasing by 1.3%. Volumes year-to-date during the third quarter remain 11.9% lower than last year s record setting pace. 4 New supply will begin to moderate in 2018, with overall fundamentals strengthening during the year. Despite the setbacks due to new supply entering the market, demographics continue to support multifamily overall, in our view. In select major markets across the United States, new supply of office space has been outpacing demand, pressuring vacancy rates, which have increased during the third quarter of Relative to the third quarter of 2016, office vacancy rates for central business district (CBD) Class A and B space have increased by 40 and 50 bps, respectively, in the third quarter of Secondary markets are a bright spot for office investment in the United States, marking the largest share of overall investment since Dallas and Atlanta led this activity with US$3.0 billion and US$2.3 billion of investment, respectively. 4 Technology tenants have maintained an appetite for creative office space that is driving a significant portion of overall office demand. Regardless of the increasing vacancy rates in Class A and B office properties, investors continue to seek stability and cash flow from these investments and will likely help to mitigate the softening in this segment of the market. Demand for industrial real estate has driven new supply and net absorption is likely to surpass 200 million square feet by the end of During the third quarter of 2017, vacancy was flat at 5.2% nationally with a 54.2% pre-leasing rate for new deliveries. 4 Rents have continued to grow, reaching new all-time highs at US$5.40 per square foot nationally during the third quarter of 2017, with four of every five markets noting an increase in asking rents. 4 Total sales volumes through the third quarter of 2017 are already the third highest when compared to the full-year tally since Tertiary industrial markets in the United States are starting to feel spill-over demand, noting attractive rent growth opportunities and increasing scarcity in primary and secondary markets. 4 The changing landscape for retail real estate has fueled the demand for industrial properties in all segments of the market, including older buildings requiring re-purposing due to their urban location decreasing delivery times to customers driven by online retail. In the face of evolving customer needs, retail real estate is challenged, but has remained stable. 4 Rents rose 4.7% yearover-year (yoy) as of the third quarter of 2017, and vacancy remained steady at 4.8% nationally. 4 Retail transaction volume has continued to decline, dropping by 23.4% yoy. 4 While capitalization rates have compressed modestly in primary markets, driven by heighted competition for strong performing assets, secondary market capitalization rates have declined by 20 bps for the first time in six years. 4 Investors are narrowing their focus in retail real estate with the three most attractive markets for transactions year-to-date as of the third quarter of 2017, the same as 2016, New York, Chicago and Los Angeles. 4 Investors are willing to pay premiums to transact in these markets despite retailers announcing store closures. 4 Experiential retail- and necessity-based retailers have continued to perform well and will likely weather the changing landscape of retail real estate as consumers bifurcate their spending between online platforms and retail that cannot be replicated digitally. European Property Markets Overall, the European economy remained strong through the end of 2017, marking the highest GDP growth since Growth is expected to remain positive in 2018 although political uncertainty in many of the region s largest markets may dampen investor enthusiasm. In Germany, prime yield compression for commercial properties, especially in the office sector, has continued amid increasing activity from international buyers attracted by the country s relatively stable political environment and continued economic strength. Demand has remained strong in the United Kingdom as many investors appear to have shrugged off concerns relating to the 2016 European Union (EU) referendum. Office take-up was especially strong in the technology and media sectors. Investment activity has also remained strong in France, although volume has become increasingly dependent on large transactions in central Paris. The eurozone has continued to outperform forecasts and is expected to end the year of 2017 with the highest GDP growth since The region s economic activity has picked up steam with a strong labor market, high business and consumer sentiment, expansionary manufacturing activity and a healthy and dynamic global economic backdrop. Growth prospects for 2018 are expected to remain positive and largely in line with The bloc s ability to dodge further political hurdles, however, will become crucial in maintaining the positive momentum. Germany remains in political uncertainty, with coalition negotiations expected to be lengthy and complex, while political tension persists in Spain following the Catalonia independency referendum in October. In addition, the growing support for populism and the corresponding Five Star Movement party remains a risk in Italy where general elections will take place in March In December, the United Kingdom and EU eventually reached an agreement on separation terms allowing negotiations to move on to a second phase. Agreeing on a transition period will be vital for providing certainty to domestic and international corporations and safeguarding investment in the United Kingdom. The economic outlook for the United Property Markets: The Quarter in Review 2

3 Kingdom meanwhile remains mixed. On the positive side, the rebound in the manufacturing sector signals an acceleration in the expansion of output, and a healthy labor market propelled the unemployment rate to yet another multi-decade low. On the downside, the private consumption and services industry sentiment dropped, while the housing market cooled further. The overall UK economy is likely to slow in 2018 as rising inflation erodes consumers purchasing power, while the prolonged Brexit uncertainties may keep investors on the sideline. In Germany, the commercial real estate market saw a total investment volume of around 18.6 billion in the fourth quarter of 2017, bringing the total for 2017 to around 57.3 billion, according to property consultant Colliers. This represents a 10- year record high and the third consecutive year with a total volume greater than 50 billion. An increase in investment activity from international buyers has been recorded in Germany as a result of the country s stable political environment and continued economic strength. Foreign investors accounted for circa 45% of the transaction volume, with the majority coming from the United States and the United Kingdom as well as from France, China and Singapore. Increased investment demand has continued to outpace supply, leading to further yield compression for prime commercial properties, especially in the office sector. Yet, prime yields may be near a bottom as investors are now increasingly targeting secondary assets and locations given their lower valuations and higher return potential. Occupier demand for office space in the six largest cities in Germany has kept growing during the fourth quarter, leading to a record 11% increase in take-up compared to the already strong previous year. This rise in tenant demand has increasingly been driven by co-working space operators and serviced offices which have leased six times more space than in the previous year. In the United Kingdom, occupational demand has continued to be positive and robust across a number of sectors despite the substantial downgrade of rental growth forecast in the aftermath of the EU referendum in June In addition, investor appetite for UK real estate remains strong, albeit particularly concentrated on prime long income producing assets as well as on those properties with a strong rental growth outlook. As a result, the all-property UK prime yield has further sharpened, reaching an average of 4.50% by the end of 2017, according to property consultant Savills. Office take-up in London increased year-to-date through November 2017 by 20% as compared to this point in The majority of leasing transactions were recorded for space of Grade-A standard. Technology and media sector companies have remained the largest occupier of new space to-date with around 20% of the total take-up. Investor appetite for real estate in France has remained strong, with 2017 investment volume expected to amount to over 25 billion and in line with the achievement in 2016, according to the advisory firm CBRE. Compared to 2016, investment volume was less balanced in relation to transaction size, and more driven by Chart 2: Office Property Clock As of Q London City Paris CBD Cologne, Dusseldorf Dublin Hamburg, Stuttgart Frankfurt, Manchester Budapest, Copenhagen, Edinburgh, Munich, Prague, Stockholm Berlin, Luxembourg Amsterdam, Barcelona, Helsinki, Lisbon, Madrid, Rome, St. Petersburg Milan Brussels Rental growth slowing Rental growth accelerating Rents falling Rents bottoming out Lyon, Oslo Athens Istanbul London WE Geneva Bucharest, Kiev, Moscow, Warsaw, Zurich Source: JLL, January The clock diagram illustrates where JLL estimates each prime office market is within its individual rental cycle as of the end of December Markets can move around the clock at different speeds and directions. The diagram is a convenient method of comparing the relative position of markets in their rental cycle. Their position is not necessarily representative of investment or development market prospects. Their position refers to prime face rental values. Markets with a step pattern of rental growth do not tend to follow conventional cycles and are likely to move between the hours of 9 and 12 o clock only, with 9 o clock representing a jump in rental levels following a period of stability. The above chart is for illustrative and discussion purposes only. There is no assurance that any estimate will be realized. Property Markets: The Quarter in Review 3

4 large single transactions in Paris as well as by portfolio acquisitions. The market has been continuously dominated by domestic investors (around 65% of total volume), however the share of Asian buyers increased substantially in From an occupancy perspective, Paris recorded its best performance since 2007 with more than 2.6 million square meters office takeup in 2017 representing a more than 8% increase compared to the previous year and an over 15% growth compared to the long-term average between 2007 and The overall Paris vacancy rate dropped to 5.9%, while further upward pressure on prime rents has been recorded in the Paris CBD. Despite the scarcity of supply, the Paris CBD continues to be the preferred location for firms seeking to attract talent in a well-integrated urban environment. Other European markets also witnessed high activity, with substantial prime office rental growth witnessed in Amsterdam, Barcelona, Madrid, Stockholm, Athens, Lisbon and Milan, where improving economic conditions have resulted in increased occupier demand for the limited Grade-A space available. Asian Property Markets Japanese GDP grew for the seventh consecutive quarter due to overseas demand, stronger capital expenditure from the financial and services sector and an increase in private inventory investment in raw materials. Office fundamentals remain strong in downtown Tokyo and in other major cities such as Osaka, although factors such as a shortage of construction labor may present challenges to future growth. During China s 19th Congress of the Chinese Communist Party in October 2017, President Xi Jinping signaled that the government will continue to manage capital flow into the property market, and will clamp down speculation on properties. In India, housing demand is also expected to increase, especially in the Mumbai suburbs, owing to a 10% to 20% price decrease, upcoming infrastructure projects completion and greater transparency and accountability driven by the Real Estate Regulation Authority. The Asia-Pacific region (APAC) is expected to experience expansionary fiscal policies over the next several years, as governments ramp up on infrastructure spending and social programs with the intention to foster longer-term inclusive growth. Monetary policies in developed Asian countries are expected to remain accommodative given the relatively benign inflationary environments and tight labor markets. Although bank lending requirements are beginning to tighten into 2018 in some markets, such as in Australia and China, we expect the costs of borrowing will continue to remain moderately favorable for many countries in general. In terms of economic growth, we believe developed Asian countries such as Japan, South Korea, Hong Kong and Singapore are less likely to see the same levels of marginal gains that developing Asian economies are Chart 3: Vacancy Rates in Tokyo Continue to Decline Office Vacancy Rate (Tokyo Major Five Wards Average) December 1999 December % 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 12/99 12/02 12/05 12/08 12/11 12/14 12/17 Source: Miki Shoji. The above chart is for illustrative and discussion purposes only. 3.12% experiencing. On the backdrop of increasing e-commerce penetration, supply chain efficiency and labor shortages, there is a structural undersupply and significant pent up demand for modern industrial properties across the region. Third-party logistics providers and chain retailers continue to seek welllocated distribution space near major ports, railways and roads to facilitate the efficient delivery of goods. As a result of continued yield compression, APAC investors are also increasingly seeking opportunities in unconventional asset classes such as data centers, self-storage and senior living, where competition is currently limited and yields are relatively higher. The Japanese economy grew at an annualized rate of 2.5% in the quarter ending September 2017, representing seven consecutive quarters of growth. Exports grew by 1.5% from the previous quarter amid solid overseas demand as the global economy gains traction. Stronger private capital expenditure, particularly in the financial and services sectors and an increase in private inventory investment in raw materials, such as oil, also contributed to the growth in GDP for the quarter. The Miki Shoji office building vacancy rate survey of Tokyo s five main wards compressed to 3.12% in December 2017, from 3.17% a quarter ago. The average office asking rent per tsubo (approximately equal to 3.3 square meters) for the five central wards of Tokyo increased 0.9% over the quarter to 19,173, which equates to a 3.41% yoy increase. Office vacancy rates also remained tight in Osaka and other major cities, while average rents continued to experience moderate growth. Overall, leasing markets and real estate fundamentals have remained healthy in major cities in Japan. As the number of foreign visitors continues to increase, demand for hotel rooms remained strong and retail store sales have gradually improved. Condominium unit price and residential rents also rose in the Greater Tokyo area due to the knock-on effect from rising residential land prices. With respect Property Markets: The Quarter in Review 4

5 to the logistics sector, although a large supply that came into the Greater Tokyo market in the past few years has been absorbed given the robust occupier demand, a recent supply surge will continue to weigh on occupancy rates in some of the sub markets. According to Mitsubishi UFJ, October 2017 vacancy rates for logistic properties remained at circa 5% in the Greater Tokyo region. Despite the overall sound Japanese real estate market fundamentals, the widespread shortage of construction labor has been causing delays in office and commercial project completions, particularly in the Greater Tokyo area. The government is working with many private companies to combat this issue before it becomes a chronic problem. In the fourth quarter of 2017, China s economy grew at an annualized rate of 6.8% yoy based on official data, beating analyst expectations of 6.7%. The growth was led by the rebound in the industrial sector, a resilient property market and the strong export growth. Growth for the full year of 2017 was 6.9% yoy amid the Chinese government s intent to contain financial risks, and to curtail a rapid debt build-up. During the China National Congress in October 2017, President Xi Jinping signaled that the government will continue to manage capital flow into the property market, and will clamp down on property speculation. The central government also reminded the provincial governments that more lending restrictions should be enforced and building-related regulations should be strictly followed. The ultimate goal of the government is to balance capital flows between the real estate industry and other industries such as services, manufacturing, technology and biotechnology. In Shanghai, tertiary industries such as information transmission, software and information technology services sectors have enjoyed strong growth of 13.7% yoy in the first three quarters of 2017 according to Colliers research. This has resulted in solid demand in Shanghai s business park property market in According to Colliers, overall leasing demand was very strong in 2017, and net absorption increased 150% yoy to 780,000 square meters (8.4 million square feet), doubling 2016 s figure. In Beijing, in order to curb air pollution levels in the Beijing-Tianjin-Hebei region, the government has issued a strict order requiring Beijing s six urban districts and surrounding suburbs to suspend construction and demolition work, which contribute to the increase in dust pollution during the winter heating season. It is expected that these tight regulations will stimulate green building design in the future. Moreover, the focus on work-life balance will continue to drive the upgrade of traditional offices. Landlords will have to transform their projects to match the tenants changing needs. India s GDP posted a higher growth rate of 6.3% in the quarter ending September 2017, despite the interference caused by the goods and services tax (GST) and the hovering after-effects of demonetization. Manufacturing and mining activities resumed post GST and have contributed significantly to GDP growth. Meanwhile sentiment in the real estate sector continues to improve gradually. During the fourth quarter of 2017, new residential unit launches in the top seven cities in India were at 33,400 units, well above the six-quarter average of 26,100 units (a 51% increase yoy), largely driven by the Greater Mumbai, Chennai and Kolkata regions, based on Morgan Stanley research. Housing demand is also expected to pick up, especially in the Mumbai suburbs, owing to a 10% to 20% price decrease, upcoming infrastructure projects completion, and greater transparency and accountability driven by the Real Estate Regulation Authority (RERA). According to UBS research in January 2018, India has the potential to capitalize on favorable demographics over the coming decade as the nation s working age population ratio is expected to surpass other countries, including China. In the next five years, India s labor force addition will be 1.5 times that of the rest of the APAC region, the United States and EU combined, with the emergence of seven million new job seekers per year. This positive demographic trend will have a significant impact on the India real estate sector, in our view. 1. Source: US Federal Reserve. 2. Source: US Bureau of Labor Statistics. 3. Source: Real Capital Analytics, Costello, Jim, Where Was the Surge in Year-End Transactions for 2017? 18/1/ Source: Jones Lang LaSalle, Investment Quick Look, US, Q 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. 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6 IMPORTANT LEGAL INFORMATION The foregoing information reflects our analysis and opinions as at 31 December 2017 unless otherwise indicated. This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. Because market and economic conditions are subject to rapid change, opinions provided are valid only as at the date indicated. The portfolio managers analysis of issues, market sectors, and of the economic environment may have changed since the date of this commentary. Charts included are for illustrative and discussion purposes only and are subject to change. There is no assurance that any forecast, projection or estimate will be realized or that any investment strategy will be successful. 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