Our most and least favoured global real estate markets
As we approach Q4 2017, we believe commercial real estate should continue to see healthy operating fundamentals in most global markets amid solid economic growth, steady job creation, reasonable new supply levels, and monetary conditions that are likely to remain accommodative even as stimulus is gradually withdrawn. We have outlined where we see our greatest opportunities for the latter part of the year as well as those areas that we are approaching with caution:
Opportunities
US offices, residential and data centers appear attractive
In general, we anticipate that the demand for commercial real estate in the US will outstrip new supply across most sectors, driving rents and REIT cash flows in the coming months, although supply is accelerating in some areas. We also see the potential for positive earnings surprises as the year unfolds, given the generally conservative guidance companies have recently provided. In light of current valuations and expected growth rates, our US allocation is positioned in favour of sectors that we believe stand to benefit most from faster growth, such as urban apartments, single family homes, and manufactured homes. Data centers’ growth prospects remain solid, in our view, with secular demand from cloud computing and the growth of e-commerce as significant tailwinds.
Continental Europe set for further acceleration
We hold a constructive view of continental Europe’s property markets. Economic growth in the region is expected to remain strong, which should bolster real estate demand as supply lags in most markets. Favoured themes include German office and residential properties, predominantly in major cities like Berlin, where demand far exceeds supply. We also like Spanish offices, with demand returning amid some of the fastest economic growth on the continent. Office landlords in France appear attractive to us, as Paris is gradually recovering and we believe they may gather new tenants relocating from London as a result of Brexit.
Several U.K. sectors appear attractive – despite Brexit
Although the U.K. economy has been on a weakening trend since the country’s decision to leave the EU in 2016, we believe domestic-focused properties such as industrial, student housing and health care should be relatively insulated from Brexit fallout. For example, the industrial sector is benefiting from the decline in the pound due to the impact on exports, as well as growing demand for logistics services as retailers strive to improve product delivery times to customers. Despite the more defensive nature of these properties, many of these landlords are trading at compelling discounts to the value of their underlying assets. However, we remain mostly negative on the London office and residential sectors, as we expect supply will continue to be delivered to the market while demand weakens due to Brexit, which could pressure rents and capital values.
Japan awakens
We see a similar story to Europe is playing out in Japan, where a stronger macro backdrop and continued monetary stimulus are providing favorable conditions for real estate developers.
After a long slumber, Japan’s economy is seeing a meaningful improvement in growth. Real GDP grew at a 4% annualized rate in the second quarter of 2017, marking the sixth consecutive gain and the longest and strongest expansion in a decade. In July, the unemployment rate hit its lowest point since the mid-1990s at 2.8% as businesses benefited from a stronger global economy, a soft yen and—for the first time in years—a recovery in domestic consumption. This backdrop has created increasing demand for Tokyo office space, driving market rents and asset values higher.
Australia select areas of opportunity
In Australia, we are seeing the Sydney office market have continued to experience net demand growth in a tight environment for new supply, giving a substantial boost rental rates. However, retail spending trends at traditional shopping centers could weaken if Amazon disrupts the Australian retail market in the way it has in the US, potentially pressuring valuation premiums for mall companies over the next several years.
Approaching with Caution
US retail landlords and healthcare face continued headwinds
We remain underweight the overall US retail sector due to e-commerce retail growth and continued obsolescence of department stores that could drive a longer-term deterioration in net operating income. In retail, we are focused on companies with high-quality properties in desirable locations that should continue to attract tenants. We believe the health care sector is likely to remain challenged, with only modest growth prospects for the coming year.
Singapore appears challenged
We remain cautious towards Singapore despite the near-term improvement in the outlook for trade, as domestic conditions remain soft and new supply of real estate is still a challenge. In our view, REIT fundamentals remain subdued, with no major real estate sector likely to experience positive rental growth in the next 12 months.
Keeping a Watch
Neutral in Hong Kong, but more positive overall
Hong Kong could face headwinds from rising US interest rates, as its monetary policy is tied to that of the US. That aside, we believe leading Hong Kong landlords can still deliver solid dividend growth mainly supported by proactive asset management. Discretionary retail sales appear to have bottomed and office fundamentals have been supported by low vacancies and demand from Chinese companies. In general, we prefer property companies with active management teams that may support strong recurrent income and dividend growth.
Jon Cheigh, portfolio manager, Cohen & Steers Global Real Estate Securities fund
