Global real estate markets are experiencing significant change because of new economic cycles and strong thematic trends. It might pay to look beyond domestic markets.
Global real estate markets are experiencing significant change because of new economic cycles and strong thematic trends. We believe that global economies and how we use real estate are driving different outlooks from one corner of the globe to another. In this context, looking beyond domestic markets could provide investors with stronger diversification benefits.
Inflation pressures and economic change
High inflation has led to higher interest rates in most areas of the world, as central banks battle to keep prices in check. However, the drivers of inflation are quite different from one region to the next, resulting in a more disparate impact across real estate markets. It’s at times like these that portfolio diversification can deliver.
Inflation pressures in the US are coming from tight labour markets and strong demand-side drivers. In Europe, the pressures are from the supply side, with rising energy costs feeding through to higher core inflation. The response to this by policy makers will be influenced by the local drivers of inflation.
Current expectations are that interest rates could reach around 5% in the US, while they are likely to peak at lower levels in Europe – perhaps closer to 3%. A global easing cycle could be back on the cards later in 2023. But the European Central Bank policy makers could eventually push the base rate back to lower levels than the US Federal Reserve, given the differences in long-term inflation drivers.
Diversification during de-globalisation
So why does this matter? During periods of greater economic change or disparity, real estate markets behave quite differently, and this can increase the impact of diversification. Global total returns in 2008 (following the abrupt impact of the credit crunch), for example, ranged from between +12.7% (for South Africa) and -35.3% (for Ireland). That year, global real estate returned an average of -7.7%, compared with -21.8% for the UK market. Therefore, taking a global approach can offer downside protection by providing the benefits of diversification when risks rise.
We believe some of these economic disparities could continue to widen through long-term structural change. Deglobalisation could lead to further de-correlation in returns. After a strong 20-year period when trade, financial markets and energy supplies became ever-more entwined and global economies became ever-more reliant on each other, some of this is beginning to unwind. The pandemic accelerated this trend, although it was happening beforehand as evidenced by Donald Trump’s “America First” policies and other political surprises, such as Brexit. Domestic energy, food, information security, and a greater pharmaceutical and healthcare interdependence represent additional components of de-globalisation. A lower level of dependence on each other should reduce how similarly our economies behave.
Befriending the global trend
Diversification is not the only driver of global investment strategies, though. There are strong thematic trends entrenched in global economies that are changing the investment landscape for good. The key trends are behavioural changes in consumption, technological changes in the way we conduct business, and demographic changes that are influencing the way we live. They are all shaping how we use physical space and this is creating new investment opportunities for investors in all corners of the world.
These forces of change are ebbing and flowing at different speeds and to different degrees across the world. Ecommerce penetration rates in China and the UK, for example, are upwards of 25%. Yet in emerging economies, they are much lower. What we know is that online retail in different countries will converge over time. Global real estate strategies can capture the growth aspect of structural change at its earliest phase, or they can find more abundant opportunities where the evolution has happened first and fastest.
The UK market represents just 8% of the total global real estate market and we believe that finding the best opportunities to capture thematic trends is a global exercise. The global market is estimated to be around $11 trillion in size, yet it is not always possible or efficient to invest on a direct basis and with optimal timing. More liquid forms of real estate investing, such as public listed markets, offer the ability to target structural change with specialist managers or to time the evolution of a cycle more effectively.
Considering the nuts and bolts of global strategies
Mechanical drivers of returns are also important for opportunities and diversification. Some leases include contractual obligations to increase rents at pre-determined periods through open-market rent reviews. In other parts of the world, rents increase year-on-year by an index that is often driven by a domestic rate of inflation. This might seem like a mere technical detail, but this fundamentally drives the income characteristics of an asset. Adding a global perspective to an existing domestic portfolio increases an investor’s ability to diversify income too.
Global investment strategies have certain challenges and complexities, but they are not insurmountable. Tax and currency are two variables that can affect returns. These can both be managed by experienced teams and via appropriate structures, such as hedging, which can help improve portfolio efficiency.
Taking a global perspective in real estate can significantly increase the opportunities for investors. It can allow investors to capture the best trends at the best times. A global approach also ensures investors benefit from diversification and better risk-adjusted returns over time.
Craig Wright is Head of European Research, Real Estate at abrdn
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abrdn is a global investment company that helps customers plan, save and invest for their future.
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