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Q4 2021
Global Real Estate Market Outlook
02Global Real Estate Market Outlook
Global Economic Overview . The initial rebound in global economic growth has
reached its zenith, and the underlying pace of recovery will slow from here. A downshift was always to be expected, but the combination of the Delta-driven fourth Covid wave, a slowing Chinese economy, and the slightly earlier commencement of Fed normalisation leave the path ahead more challenging. The outlook is still for several years of above-trend global growth, but divergence and downside risks have become more prevalent.
. Meanwhile, with the growth scare superseding inflation fears as the focus of market attention, aRI re-iterates its expectation that the current bout of price pressures will prove transitory. Nevertheless, in some countries the
period of above-target inflation will stretch into 2022, and will be hard for central banks to look through.
. aRI has downgraded its 2021 (5.5%) and 2022 (4.4%) global GDP forecasts, while maintaining 2023 at 3.5%. These forecasts are below consensus, and aRI believes most forecasters are taking insufficient account of growth divergences and the extent of long-term global economic scarring. Nevertheless, aRI’s global growth forecasts are still very punchy by any historical comparison, and the world economy remains in the recovery stage of the cycle.
. Indeed, overall global monetary policy settings are moving in a less accommodative direction. In particular, aRI now expects the US Federal Reserve (Fed) to start tapering asset purchases in 2021 or very early in 2022,
Executive summary . The abrdn Research Institute (aRI) has
reduced its expectations for global growth in light of the Delta-driven fourth Covid wave, a slowing Chinese economy and the slightly earlier-than-expected commencement of Fed normalisation. aRI continues to expect that, although inflationary pressures will remain elevated, they are likely to be transitory.
. Furthermore, although aRI has revised down its forecasts for global growth, it expects the global economic upswing to continue. Indeed, it is forecasting well-above-average global growth over the next few years.
. aRI’s view is that downside risks have increased. These risks include waning vaccine protection against severe disease and the over-hasty withdrawal of policy support that would weigh on growth and inflation. However, aRI asserts there are still upsides to growth from a potential rapid savings rundown, or to inflation from longer-lived supply-chain disruptions. aRI’s overall view is that there remains an equal balance of risks between the upside and downside.
. Given that expectations are for above-average global growth, this is providing a solid foundation for our expectations for real estate returns. Moreover, as some of the capital decline we expected previously has now
passed, our forecasts for overall returns in all the regions are close to single-mid-digit over the next three years.
. The investment market is back almost to its pre-pandemic levels. That said, investors continue to target a small number of sectors that have been resilient in terms of income reliability. These include the industrial, residential and some alternative sectors. The improvement in prices for some retail assets that we highlighted last quarter continues. Investor interest is improving due to higher yields and the reduced risk to income as economies improve. The target assets are mainly on retail parks that are food-anchored with an absence of fashion retailers as tenants.
. We continue to prefer parts of the market that are benefitting from long-term structural trends: ageing demographics, changes in technology, a focus on sustainability and changes in the way we are shopping and living. These sectors include industrials, residential, and selected assets categorised as alternatives. These sectors remain more resilient than those parts of the market that are vulnerable to secular changes. In our view, some retail remains particularly exposed to the changes, with the current crisis accentuating structural transformation in the sector. We remain cautious given the ongoing market uncertainty, and continue to pursue ‘sustainable’ income in our target markets. Furthermore, we maintain a forensic approach to asset attributes to ensure assets are ‘future’ proof.
“Despite the abrdn Research Institute (aRI) having revised its global economic forecasts modestly downwards, the expectation is that the global economy will remain firmly in an upswing. And although inflation pressures will persist for some time, they are still likely to be transitory.”
03 Global Real Estate Market Outlook
and to hike rates three times in 2023. Among other developed market central banks, clearer timelines for removing support have emerged from the Reserve Bank of Australia, Reserve Bank of New Zealand and Bank of England. And among emerging markets, rate hikes have broadened out from Brazil and Russia to include Mexico, Czechia, Hungary, Chile and Peru.
. Fiscal policy support is also being withdrawn, with the global fiscal impulse (the change in the structural budget balance) very negative in both 2021 and 2022. While there are risks of a fiscal policy error in parts of Latin America, globally the fading fiscal impulse can probably be offset by the rebound in private-sector demand. And aRI is still incorporating a dual-track partisan and bipartisan $3 trillion US infrastructure package to pass in coming months, as well as systematically looser fiscal policy in Germany if the Green party joins the governing coalition later this year.
. There continue to be wide confidence intervals around the aRI forecasts, so focusing on ranges and scenarios is more useful than point forecasts. aRI has increased the probability it attaches to the downside scenario. This involves waning vaccine protection against severe disease and over-hasty withdrawal of policy support that would weigh on growth and inflation. But there are still upsides to growth from a potential rapid savings rundown, or to inflation from longer-lived supply-chain disruptions. On balance, aRI considers overall risk evenly distributed, although this is a shift from the upside balance of risks that it was previously signalling.
Market Behaviour Explained by Short-Term Indicators . Given behavioural factors, market prices can, and often
do, deviate from fundamental value for indefinite periods. We aim to monitor market behaviour via our global performance indicators. These help us understand the drivers of prevailing market prices (Table 1).
. Although some regions are re-imposing an element of restrictions as economic activity revives, real estate investment is also picking up, as investors are more able to visit assets, complete paperwork and so on. The latest investment transactions data suggests we are not far from the pre-pandemic levels of activity. Activity continues to be focused on areas with resilient income including industrials, apartments and some of the alternative sectors.
. Examining the global listed real estate sector’s recent performance as a forward-looking indicator for the direct markets, year-to-date performance remains encouraging, albeit performance has moderated
a bit recently. The sectors that have outperformed from the start of the year include US malls, US storage, US apartments and US strip centres. Paris offices, EU retail, Australian retail and US hotels are the biggest underperformers versus the wider sector from the start of the year.
. In the lending market, lending conditions continue to loosen further. Lenders remain tolerant of covenant breaches, and continue to exercise considerable forbearance. The emerging trend for ‘green’ lending that’s linked to future ESG (environmental, social & governance) outcomes continues to increase. Despite the easing in lending criteria, lenders broadly remain risk averse and there continues to be significant divergence across sectors. There is less lending capacity in sectors with higher perceived income risks – retail and some poorer-quality parts of the office sector.
Table 1: abrdn’s global performance signals
Performance signals UK Europe
North America APAC Global
Mac
ro
Economic fundamentals ↗ → ↗ → ↗Margin over bonds → → ↘ → →Monetary policy → → → → →
Real
Est
ate
Supply → → → ↘ →Flows of capital ↗ → ↗ ↗ ↗Lending ↗ → ↗ → ↗Fund Flows → ↗ ↗ ↗ ↗360° view ↗ → ↗ → ↗
Key Performance Signal Trend
Supportive
Neutral
Unsupportive
↗ Upward trend
→ Stable
↘ Downward trend
Sources: MSCI, PMA, RCA, CBRE, Refinitiv, abrdn, Q4 2021.
Global Overview . Investment activity bounced back in the second
quarter of 2021 because inspecting assets and carrying out due diligence became easier with less onerous travel restrictions. Overall investment levels are almost back to the same levels as 2019. The US region drove the recovery as activity here snapped back.
“Global investment activity has recovered sharply and is almost back to its pre-pandemic levels.”
04Global Real Estate Market Outlook
It was followed by a significant rebound in the European region. Activity didn’t rebound as much in Asian markets, partly because activity held up better in this region in 2020. The apartment and industrial sectors continue to attract a significant amount of investment as investors target these outperforming sectors. To illustrate the popularity of the apartment sector, more capital was invested in the apartment sector than the office sector this quarter. This is the first time apartment volumes have exceeded office volumes globally. The most liquid markets, i.e. the US, UK and Germany continue to attract a disproportionately large share of overall investment activity. Retail remains out of favour with investors, reflecting the structural pressures from changes in the way we shop and the effect on the sector’s returns. However, as indicated last quarter, investors are tentatively investing in specific parts of the retail market where they think prices have reached a floor. This includes retail parks where the occupiers are perceived to be more resilient than other retail occupiers – DIY operators or certain discount chains for example. We believe the heightened polarisation we’ve witnessed across sectors over the past few years has now peaked and the divergence in returns is likely to narrow from here.
. There have been a few distressed sales globally. However, these remain the exception rather than the rule. Banks are better capitalised in this cycle and are exercising more forbearance compared to the 2008 financial crisis. Sales from some of the sectors under pressure from declining income, e.g. the retail sector, are picking up where buyers may be able to convert the assets to other uses. The hotel sector continues to benefit from banks’ leniency in this cycle - occupancy is at very low levels and there has been widespread breaching of banking covenants. We reiterate that, inevitably, given the rising vacancies and reduced demand in some sectors, there will be a larger element of distressed selling further into the cycle.
. The longer-term structural trends that were already underway in certain sectors continue to increase owing to changes that have been accelerated by the coronavirus crisis. For example, more online activity is benefitting the industrial sector to the detriment of the retail sector. In the office sector, we are very selective in terms of asset attributes. The increase in home-working will lead to less demand in the sector and more occupier desire for value-add attributes such as flexible workspace solutions and asset-specific qualities such
as good connectivity, a core location and positive ESG factors. We remain very cautious towards poorly located older assets that are most vulnerable to the changing dynamics in the sector. Consequently polarisation will be a key feature of the office sector in the future cycle.
. Asset prices in most sectors are beginning to reach a floor and we expect reasonably strong returns from global real estate over the next few years. Given the ongoing above-normal uncertainty that is a consequence of new strains of Covid, we continue to adopt a conservative approach to risk in our positioning, and continue to focus on resilient income in our favoured sectors.
Regional outlooks
North America
Chart 1: Significant rental growth from multifamily in the SunbeltMultifamily Rent/SF
Atlanta Las Vegas Phoenix Tampa
0.00.20.40.60.81.01.21.41.61.82.0
2021
Q3
2021
Q2
2021
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2020
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2019
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2019
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Sources: Costar, abrdn, September 2021.
Occupier market trendsOffice leasing activity has improved and is now above pre-pandemic levels for the first time in the second quarter of 2012. Absorption has improved also. However, vacancies continued to rise to 12.4% and are expected to remain elevated for the quarter ahead. Retail demand prospects are improving, with all categories of in-store retail sales returning to, or surpassing pre-pandemic highs. This will aid a variety of retail centres including malls. However, mid-grade and lower-grade malls will continue to suffer. A few
“Our proprietary global performance signals have improved further and continue to point to reasonably strong returns from global real estate over the next few years.”
05 Global Real Estate Market Outlook
“Our latest forecasts are for reasonable mid-single-digit returns from global real estate over the medium term. The income yield is likely to be very attractive in what we continue to expect will be a low-income environment from other assets”.retailers such as Macy’s, Burlington and Target revealed growth plans that focus on opening smaller, formatted stores. The industrial sector continues to benefit from strong growth due to a variety of positive industrial demand drivers, including ecommerce sales, consumption, and industrial production. Meanwhile, tight supply has caused some distributors to look past the largest centres for additional space. A prime example of this is Las Vegas Industrial absorbing spill-over demand from Southern California.
Investment market trendsSales volume slowed earlier in the year. However, the three-month deal volume as of July was $144 billion, a 35% increase from first-quarter 2021, according to Real Capital Analytics data. Transaction-based cap rates compressed modestly for most sectors. However, Central Business District (CBD) office recorded a notable increase in cap rates, with a 59 basis point (bps) increase year-on-year (y/y). The industrial sector has continued to strongly outperform, with annual NCREIF returns reaching 23% as at the end of second-quarter 2021.
Performance outlook and risk toleranceThe industrial sector is expected to remain a clear outperformer. Vacancies remain well-below historical levels, which will continue to support strong rental growth. Residential sector performance prospects have improved significantly. This is being driven in part by the rebound in gateway markets and also by heavy demand within the Sunbelt area. Office sector returns will suffer from weakening fundamentals and increased uncertainty regarding workers returning to the office due to the Delta variant. Elevated vacancy rates will continue to weigh on rents over the next year, particularly in pricey gateway and supply-heavy markets. Retail performance will vary across segments. Retail sales dipped slightly in July but still displayed a strong recovery y/y. Data centres are expected to benefit from robust demand drivers and attractive yields.
UK
Occupier trendsThere is little indication that demand for industrial space is waning, with the sector continuing to record impressive take-up numbers. As a result, the vacancy rate for the sector is now below 3%, according to CoStar data. The industrial sector has experienced a supply response.
But with increased build-cost inflation presenting a major headwind, it’s widely anticipated that some of this supply pipeline will face delays in completion. This will benefit up-and-built assets.
Workers in the UK have been gradually returning to offices throughout the third quarter, after coronavirus restrictions were lifted. Levels of occupation remain significantly below pre-pandemic levels and it’s clear that there is no one-size-fits-all approach applied by employers. The long-term impact on the way that offices are utilised, and how much space businesses will require in the future, remains highly uncertain at present. Although vacancy rates are higher, they have shown tentative signs of stabilisation – particularly for Grade A offices in central London.
Investment trendsInvestment volumes picked up considerably during second-quarter 2021, reaching £15.8 billion. Despite a modest slowdown during the summer, the trend has continued into the third quarter; investment volumes were over £10 billion, according to property data. Sentiment towards UK real estate has improved markedly, and this is now feeding through into the investment market.
UK real estate performance has rebounded during the third quarter, as restrictions were lifted and the economy re-opened. During the 12 months to August 2021, all-property total returns reached 11.6%, with the industrial sector recording an exceptional 27.2% over that period. A recovery in retail warehouse performance is now evident, with a total return of 12.4% recorded over the 12 months to August. This helped lift overall retail total returns to 5.1%, ahead of those from the office sector (1.8%).
Performance outlook and risk toleranceStructural tailwinds are now acutely visible, within the industrial sector in particular. Driven predominantly by yield compression, total returns in the 12 months to August reached 27.2%, a figure not seen since December 1989. Moving forward, the occupational market is expected to be the key driver of performance, with prime industrial assets best placed to capture rental value growth.
06Global Real Estate Market Outlook
Chart 2: Margin between prime retail warehouses and distributionEquivalent Yield And Margin (%)
Margin Between Prime Retail Warehouses & Distribution
Prime Distribution Prime Open Retail Warehouse
-2-1
012345678
Aug-21Aug-20Aug-19Aug-18Aug-17Aug-16Aug-15Aug-14Aug-13-2-1
012345678
Source: CBRE, abrdn, October 2021
Polarisation within the retail sector is expected to continue, given recent performance within the retail warehouse sector. The sector rebounded strongly in the second half of 2021, with prime yields moving in by 75-100 bps. But this is narrowly focused on assets that are let on affordable rents, and anchored by grocery, discount and DIY occupiers. The outlook for fashion-oriented parks, high-street shops and shopping centres remains more challenging, given their vulnerability to online retail sales.
As is the case with the retail sector, the polarisation in performance will become more evident in the office sector, in our view. The best-quality space will continue to experience more robust demand, providing greater support for rents and pricing. However, for secondary office assets that fail to comply with increasingly stringent ESG requirements and that don’t possess the necessary amenity or flexibility credentials, the outlook is far more challenging. This is yet to be shown in performance, but we expect this to be more evident as we move into 2022.
Continental Europe
Occupier trendsGood-quality and well-located offices have held up remarkably well through the pandemic across most European markets. Take-up was subdued through rolling lockdowns but has started to see green shoots emerge as delayed requirements are now active again. Take-up in Paris during the second quarter of 2021 was more than double the level seen in the second quarter of 2020, with total supply stabilising as a result. The major regional office markets in Germany were more stable,
having not experienced a slowdown to the same extent as the rest of Europe through the pandemic. Headline rents are stable on average, but incentives are rising and tenants currently have more negotiating power than before the pandemic. We expect the office market to be polarised between the best in class energy efficient buildings and those not meeting good standards.
The European logistics market continues to move from strength to strength. The strong demand drivers established prior to the pandemic have been accelerated through increased ecommerce. Logistics take-up hit a new record during the first half of 2021, reaching 18 million square metres. At this rate, 2021 will set another full-year record for leasing. Rents are rising consistently across Europe as demand and build costs continue to increase.
Polarisation is increasingly evident within the retail sector itself. On average, supermarket values increased by 8.6% over the year to September 2021, while standalone retail warehouse and retail park values increased by 4.3% and 3% respectively. Shopping centre values continued to trend lower, with a fall of 4.9% for prime and 5% for secondary centres.
Rented residential real estate has continued to prove resilient during the pandemic. Private rented residential market values increased by 5.4% over the year to September 2021, as investor sentiment continued to rise and new investors entered the market. Alternative real estate sectors continue to attract a lot of attention from investors due to strong thematic tailwinds. The ability to positively influence the ESG agenda through care-related real estate, in particular, means investors are also increasingly interested in non-traditional areas of real estate. Our increasing demand for data and cloud services has pushed data centre demand and output to new highs.
Investment market trendsIn the context of rolling lockdowns and stringent rules on business travel, liquidity has held up remarkably well with €271 billion of deals completed over the year to September 2021. But this still represents a 10% fall compared with the previous 12-month period to the third quarter of 2020. Over €60 billion of deals were closed in the third quarter alone, a 21% increase on the 2020 third-quarter volume.
By sector, the polarisation depicted in our Houseview continues to be reflected in capital flows. Rented residential and senior living account for the lion’s share of investment at €90 billion over the first three quarters of 2021. Offices are now well into second place at €66 billion, while logistics is closing the gap rapidly with €43 billion.
07 Global Real Estate Market Outlook
Chart 3: Expectations for European Total Returns (%)
1 Year 3yr average 5yr average
-2
0
2
4
6
8
10
12
IndustrialResidentialAlternativesOfficeRetailAll property
Source: abrdn ungeared, not risk-adjusted, local currency total returns from September 2021, October 2021.
Performance outlook and risk toleranceOur current base case suggests All Property returns of 5.2% per annum (p.a.) over the first three years and 5.1% p.a. over five years. We have revised our numbers slightly higher as the resilience of the office markets, some retail formats and hotels has surprised us, given the extent of the impact of the crisis on demand drivers and rental cash flows.
Total return forecast spreads between sectors have therefore come down, but they do remain large. Residential and logistics assets are expected to demonstrate far stronger fundamentals under the current base case, with values continuing to rise sharply over the next 12 months. We prefer risk strategies to be focused on the parts of the market with the strongest fundamentals and to reduce risk where thematic impacts are having the greatest negative disruption to physical assets.
Asia Pacific (APAC)
Occupier market trendsThe overall rental decline across the major real estate sectors in APAC continued to slow during the second quarter of the year (-7.2% y/y, from -9.5% y/y the previous quarter), as vacancy trended lower, albeit marginally (9.6%, from 9.7%). All sectors contributed to the sequential improvement last quarter (Chart 4). Industrial rents registered an average growth of 1.1% y/y (from -0.7% in the first quarter) as Hong Kong logistics rental decline narrowed to 2.9% y/y (from 8%). Prime office rents in Seoul continued to outperform the rest of the region’s office markets, reporting an average gain of 3.2% y/y in net effective rents in the second quarter. Singapore’s prime office rents also beat our expectation during the quarter, with an average increase of 1.3% quarter-on-quarter (q/q) – the first sequential gain since end-2019.
In APAC’s retail sector, prime retail rents in Shanghai continued their outperformance during the quarter, with an average increase of 2.4% y/y – the first y/y gain since third-quarter 2019. Robust leasing in three projects completed in the second quarter propelled net take-up in Shanghai to a quarterly high, dominated by food & beverage operators.
Chart 4: Net rent change (% y/y)
APAC office APAC retail APAC industrial
-20
-15
-10
-5
0
5
10
15
20
25
1Q21
3Q20
1Q20
3Q19
1Q19
3Q18
1Q18
3Q17
1Q17
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1Q16
3Q15
1Q15
3Q14
1Q14
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Source: Jones Lang LaSalle, abrdn, September 2021.
Investment market trendsData from Real Capital Analytics (RCA) shows a 19.5% y/y jump in the total value of real estate investments (excluding development sites) to US$42.2 billion across APAC during the second quarter. This is 2.6% higher than the five-year, second-quarter average of US$ 41.2 billion, despite the pandemic. China represented the largest share of deals in APAC during the quarter (around 27% of the region’s total value), followed by Australia (around 22%). Investment activity in China in the second quarter was lifted by purchases of retail assets, including the US$1.4 billion acquisition of five Mosaic-branded malls by Brookfield in June. In terms of investment value by sector, industrials continued to dominate in the second quarter, with US$12.6 billion (+81.2% y/y) transacted across the region during the period. These included GLP’s US$942 million purchase of the Songjiang Internet Data Centre in Shanghai from Zhejiang Century Huatong Group. Investment demand for industrial assets is likely to remain robust, as allocation to the sector in APAC catches up with other regions.
Performance outlook and risk tolerance Despite the near-term challenges, such as the spread of the Delta Covid variant, a slowing Chinese economy and less accommodative monetary policies on the margin, we have raised our total return forecast for APAC
08Global Real Estate Market Outlook
real estate over the next three years. Retail properties outperformed our expectations during the first half of this year, especially in China’s Tier-1 cities, Hong Kong and Singapore. Given our base case remains for reopening to pick up from 2022 and markets such as Japan to experience higher spending, we have raised our near-term forecasts for the retail sector. In terms of risks, on the macro front, downside risks include waning vaccine protection against severe disease. Also, the over-hasty withdrawal of policy support that would weigh on growth and inflation. A steeper yield curve over the medium term could also be a concern, although sectors where rental growth is expected to outpace inflation are likely to see less impact. Finally, we believe capital expenditure needs are likely to rise, especially in the office sector.
SummaryWith the ongoing significant improvements in economic growth as economies re-open, the real estate market is also benefitting from the pick-up in overall activity. Occupier markets are stabilising, and requirements that were put on hold are now being revived. Occupier-controlled space that was put on the market is also being withdrawn. Investment activity is improving sharply and, globally, investment activity is almost back to the levels that prevailed in 2019 prior to the pandemic. Our expectations for the direct markets’ overall performance have improved again this quarter. We anticipate approximately mid-single-digit total returns on an annualised basis over the next three years for global real estate. Unfortunately, due to the increase in Covid-driven restrictions in some of the Asian markets, our expectations for the forthcoming quarter are likely to be pared back modestly for this region until the restrictions are eased. Income is likely to be a key component of returns in most markets as the potential for capital growth moderates. We anticipate that our expectations for
returns will continue to compare very favourably with the current and expected low level of interest rates. As we have alluded to before, there is still a significant amount of ‘dry powder’ yet to be deployed in the sector that is likely to further bolster current pricing.
We continue to expect the long-term structural trends that have been in place for some time to persist. Therefore, we expect polarised - albeit reducing - sectoral performance. As we said last quarter, we anticipate the large divergence in performance between sectors that has been a key component of market performance to slowly and steadily decline from here. We remain very selective in terms of asset attributes, however. The increase in home-working will lead to less demand in the office sector and more occupier desire for value-add attributes, such as flexible workspace solutions. Asset-specific qualities, such as good connectivity, a core location and positive ESG factors remain vitally important. Increasingly, we are seeing office fundamentals deteriorate globally and investors are becoming more discerning when it comes to the attributes associated with offices. They favour large, efficient and well-located buildings, with close proximity to public-transport nodes. We remain very cautious towards poorly located older assets that are most vulnerable to the changing dynamics in the sector.
Risks to the outlook remain, and the aRI view is that they are now balanced between the upside and downside. We therefore maintain our cautious view towards riskier assets. Our asset managers continue to adopt a forensic attitude towards sourcing assets that we think are likely to be future-proof. We remain focused on resilient income in our favoured sectors.
Simon KinnieHead of Real Estate Forecasting
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