Anthony Duggan, Head of Capital Markets Research, looks at why investors are increasingly looking at global real estate.
The global real estate markets are in the eye of a perfect storm of capital allocation. Investors across all asset types continue to attract additional capital but are, at the same time, wrestling with the current low yield, low return environment as well as shifting allocations away from some fund types such as hedge funds.
In addition, there are worries around perceptions of stretched valuations for some publically traded bond and equity markets. This is leading to strategies being increasingly tilted towards alternative investments, with real estate being a prime target for a large proportion of this capital due the attractiveness of its relatively high yield.
This dynamic is driving strong demand for real estate across the largest, most liquid markets and sectors and, increasingly, as investors search for higher returns within the sector, across emerging markets and specialist real estate asset classes.
As you might expect, when it comes to best in class for real estate strategy, there is no single right answer. Each investor has individual requirements and ambitions for their capital and this manifests itself into distinct and nuanced approaches. Add the fact that every property is different in some way, and you get a marketplace that requires subtlety, expertise and, undoubtedly, flexibility.
Indeed, as the ocean of capital chasing real estate both broadens and deepens, even the traditionally clear demarcations between investor types in the real estate space are morphing.
Private Equity funds have been widening their offerings with major investors including Blackstone and Carlyle raising core-plus funds to complement their more opportunistic capital. Institutional investors are broadening both the types of assets they buy, including an increasing weighting towards specialist sectors, and the variety of exposure to real estate including products such as debt funds.
Growth in debt
In Europe, until recently, commercial real estate debt was seen as a product offered by banks using their balance sheets and a growing Commercial Mortgage Backed Security market.
However, following the Global Financial Crisis in 2008-2009 many banks retrenched from the market in the face of increased regulation and legacy asset issues.
In their place, this space has been filled, at least in part, by investors traditionally focussed on direct real estate ownership; attracted by the returns available, a legal charge on the underlying asset and the loan to value ratio protection from valuation falls.
The broad variety of these new entrants means debt is increasingly available, from senior debt through to higher margin non-senior positions including junior lending, mezzanine, stretched senior or B notes.
At the same time, institutional lenders are gradually diversifying their exposure to specialist asset classes such as student housing and healthcare debt.
These new players in the market now have significant capital to deploy to debt strategies. However, they will increasingly be in competition with the traditional bank lenders who we expect to start to rebuild their exposure to real estate.
As legacy issues are sorted and those banks in economies with rising interest rates start to attract substantial capital, there will be increasing pressure to lend.
The resultant impact on the global property markets could be significant. The market cycle so far has been driven primarily by equity capital and conservative lending; an increase in debt at the same time as overall capital allocations to real estate continue to grow is likely to add another stage to the maturing cycle.
Overall, as more capital flows towards real estate, both equity and debt, the competition for assets is only going to get fiercer. We expect the major economies and their Super Cities to continue to attract the majority of this activity but, increasingly, investors will look to emerging markets for higher returns and less competition.
Emerging markets and momentum cities
Indeed, we now observe greater volumes of capital flowing towards those markets that have taken longer for their economies to recover since the financial crisis and hence have lagged the market cycle so far.
Many are now showing real signs of improvement and stronger occupier dynamics that will, in turn, lead to positive rental growth and capital value outperformance.
The locations that will outperform at this point in the cycle are the Momentum Cites. As discussed throughout this report, these cities are going through an evolution driven by a compelling mix of education, lifestyle, infrastructure, technology and real estate that makes them the places where people want to work, shop, play and live.
In a virtuous circle, this mix attracts further domestic investment, which helps to create additional momentum and, importantly, the liquidity and performance needed to draw in global real estate investors.
Case study – Auckland: blurring the lines
Mixed-use development is reshaping Auckland’s central city, blurring the lines between work and living environments.
The largest urban regeneration project currently underway in New Zealand, Wynyard Quarter, is transforming the former industrial port into a mix of residential, retail, leisure, hotel and office space.
New types of purpose built spaces will be created such as the innovation hub, housing a campus-style precinct fostering creativity, technology and originality for start-up companies.
A diverse range of tenants include the Auckland Theatre Company, financial firm ASB, architects Warren and Mahoney, the Hyatt Hotel Group and multinational dairy co-operative Fonterra.
When completed in 2030, Wynyard Quarter will house approximately 3,000 residents and 25,000 workers. The redevelopment covers 37 hectares of land and stretches three kilometres along the coast.
Investment backing for the project came from off-shore, private investment, third sector and government sources. The waterfront could be further transformed if Auckland stages the next America’s Cup in four years’ time.
Rachel McElwee, Head of Research, Knight Frank New Zealand